The Debate Over Term vs. Permanent Life Insurance
By Ginger Applegarth
Here's a quick look at all of the options: term, whole, variable and universal.
Few people who have bought insurance -- or even window-shopped for it -- have escaped
the debate over term versus permanent insurance.
And the wrong kind of life insurance can do more damage to your financial plans
than just about any other financial product today. So, the first and most important
decision you must make when buying life insurance is: term, permanent or a combination
of both? Let's look at each.
Term life policies offer death benefits only, so if you die you win (so to speak).
If you live past the length of the policy, you (or, more specifically, your family
members) get no money back.
Permanent life policies offer death benefits and a "savings account" (also called
"cash value") so that if you live, you get back at least some of, and often much
more than, the amount you spent on your premium. You get this money back either
by cashing in the policy or by borrowing against it.
Permanent life insurance is more expensive
As you might expect, permanent life insurance premiums are more expensive than term
premiums because some of the money is put into a savings program. The longer the
policy has been in force, the higher the cash value, because more money has been
paid in and the cash value has earned interest, dividends or both.
The debate is all about that cash value. If you buy a policy today, your first annual
premium is likely to be much higher for a permanent life policy than for term.
However, the premiums for permanent life stay the same over the years, while the
premiums for term life increase. That extra premium paid in the early years of the
permanent policy gets invested and grows, minus the amount your agent takes as a
sales commission. The gain is tax-deferred if the policy is cashed in during your
life. (If you die, the proceeds are usually tax-free to your beneficiary.)
The saying you always hear is, "Buy term and invest the difference." The fact is,
it depends on how long you keep your policy. If you keep the permanent life policy
long enough, that's the best deal. But "long enough" varies, depending on your age,
health, insurance company, the types of policies chosen, interest and dividend rates,
and more. The reality is that there is not a simple answer, because life insurance
is not a simple product.
Guidelines to live by when buying
Even with all of these variables, there are some guidelines you can follow. The
key is how long you plan to keep the policy. If the answer is less than 10 years,
term is clearly the solution.
If it is more than 20 years, permanent life is probably the way to go. The big gray
area is in between. Here is where you need an expert to run the term vs. permanent
analysis for you. Of course, this assumes you keep the policy in force. Most people
drop their policies within the first 10 years, but if you do your homework now,
that shouldn't be the case for you.
How to choose
Start by assessing your life insurance needs with MSN Money's Life Insurance Needs
Categorize your insurance need by its use. If you need $60,000 for college and your
youngest child will graduate in three years, you need $60,000 of term insurance
as a short-term hedge against your death, thus insuring that your child can finish
his or her education. Meanwhile, if your estate will owe $200,000 in taxes at your
death, you probably need permanent insurance, because you're not likely to die in
the next 20 years (you hope). You also may want to re-evaluate your estate plan,
but that's a different issue.
Once you figure out your needs, it's time to choose the type of policy that makes
most sense for you.
Reproduced with permission of MSN Money.com, from The debate over term vs. permanent
life insurace, Ginger Applegarth, 2007; permission conveyed through Copyright Clearance