Term vs Permanent Life Insurance – A Complete Overview

Permanent life insurance comes in several types with each providing different benefits than the other. Although permanent life insurance in many cases satisfies the needs of the policyholder, there are three primary types that can accomplish this.

Whole Life Insurance

Whole life insurance, as the name suggests, is designed to provide lifetime coverage for the policyholder. Unlike term insurance, which offers protection for a specified period, whole life insurance guarantees a death benefit to the beneficiaries as long as premiums are paid throughout the policyholder’s life. The predictability of the death benefit, coupled with consistent premium amounts, makes whole life insurance a preferred choice for many seeking long-term security.

One of the most distinguishing features of whole life insurance is its cash value component. A portion of the premiums paid not only goes towards securing the death benefit but also contributes to a cash value account. This account grows over time, often at a guaranteed rate set by the insurance company, on a tax-deferred basis. Policyholders can borrow against this cash value or even withdraw from it under certain conditions, offering an additional layer of financial flexibility. Over time, with consistent premium payments and the accumulation of cash value, a whole life policy can also become an asset in one’s financial portfolio.

If the applicant elects to purchase whole life insurance from a mutual insurance company, the policyholder can share in the financial success of the insurance company. When the insurer performs well and generates excess profits, it may distribute a portion of those profits to the policyholders in the form of dividends. It’s important to note that while these dividends are not guaranteed, they can provide a valuable source of additional returns.

Policyholders can often choose how they want to use these dividends: they can take them as cash, use them to reduce future premiums, reinvest them to purchase additional coverage, or allow them to accumulate at interest within the policy. This potential for dividends, while contingent on company performance, offers a unique opportunity for policyholders to benefit from the profitability of their insurance provider.

Universal Life Insurance

Universal life insurance, a type of permanent life insurance, stands out because of its inherent flexibility. Unlike whole life insurance, where premiums and death benefits are often fixed, universal life insurance allows policyholders to adjust these based on their changing financial circumstances and needs. At its core, universal life combines a death benefit with a savings component, often referred to as the policy’s cash value. The interest earned on this cash value is typically pegged to a financial index or the insurer’s portfolio performance, but with a guaranteed minimum interest rate to ensure some level of growth.

A popular variant of universal life insurance is indexed universal life (IUL). IUL policies earn interest based on the performance of an external market index, like the S&P 500. It’s crucial to understand that with IUL, policyholders aren’t directly investing in the stock market. Instead, they have the potential to earn returns based on the index’s performance, subject to certain caps and floors.

This means that if the chosen index performs well, the cash value might increase up to a predetermined cap. Conversely, if the index performs poorly, the cash value won’t decrease below a specified floor, ensuring that the policyholder’s interest rate never dips below zero. This structure allows for growth potential while providing a safety net against market downturns.

Variable Life Insurance

Variable life insurance is a type of permanent life insurance that combines the protective features of a death benefit with the potential for investment growth. Unlike other life insurance types where the cash value’s growth is either guaranteed or tied to an index, variable life insurance allows policyholders to allocate their cash value among various investment options, typically consisting of stock, bond, and money market sub-accounts. This means the policy’s cash value and, consequently, the death benefit can fluctuate based on the performance of these chosen investments.

While this structure offers a higher growth potential, it also comes with increased risks. The policy’s value can go up during prosperous market conditions, but it can also decline during market downturns. Therefore, variable life insurance is best suited for individuals who are knowledgeable about investments, comfortable with market volatility, and looking for both life insurance protection and a vehicle for potential investment growth.