Permanent life insurance coverage is a contentious issue for some as the cost of insurance goes up if the life policy has to inevitably pay out.
Permanent life insurance also includes a cash accumulation component called the policy’s cash value. This life policy acts both as an investment tool and a way to legate a financial lifeline for your loved ones after you die.
Furthermore, permanent life insurance might not be a good fit for some, because of its high cost. In this article you will find out if permanent life insurance is the best option for you.
What is permanent life insurance?
As the name suggests, permanent life insurance lasts for your entire lifetime. Permanent insurance doesn’t have an expiry date, unlike a term life insurance policy.
This makes permanent life insurance costs higher than that of term life insurance.
A permanent life insurance policy has two important components — the death benefit and cash value. The policy's death benefit is a fixed amount paid out to your beneficiaries when you pass.
Apart from the guaranteed death benefit, it accumulates cash value over time, which grows on a tax-deferred basis. You can withdraw from or borrow against your policy’s cash value anytime and for any reason.
How does permanent life insurance work?
With permanent life insurance, a portion of your permanent life insurance premiums go toward paying the cost of insurance, while the other portion of the insurance premiums go into a savings component (the cash value), which grows over time on a tax-deferred basis.
When you pass, your family receives the death benefit as a single payment or in installments. For instance, they could choose to receive the payout over a period of six or eight years. The policy's death benefit is not taxable, but the interest earned on an unpaid death benefit is. Let's say the payout of an insurance policy is $100,000. The beneficiaries decide to receive the benefit in ten equal monthly installments. So, when the insurer pays the first installment of $10,000, the interest earned on the remaining $90,000 will be taxable.
If you cancel your life insurance policy, the insurer will pay out the cash surrender value to you. The cash surrender value is equal to the actual cash value minus any surrender fee.
You can tap into this basket of tax-free income in the form of a policy loan and use the money as you see fit. Since you are borrowing your own money, the insurer doesn’t ask you any questions, nor runs a credit check. But if you don’t repay the loan, the insurance company will deduct the outstanding amount from the death benefit. As a result, your family will receive less income when you pass.
If a family is looking to maximize their net worth once their TFSA and RRSP are maxed out, a permanent policy can be a good compliment. The tax-free sheltered growth of a permanent policy allows your contribution to grow every year tax free after the cost of the insurance.
One caution with this strategy however are the administrative fees associated, which makes a permanent policy less attractive in many cases compared to a TFSA or RRSP alternative. Planning a broader strategy with your advisor is important to realize effective ways to leverage insurance for your financial situation.
Who needs permanent life insurance?
Term life insurance is cheaper and offers protection when you need it most. A term policy should be able to cover an asset, liability or both for a fixed period of time to protect your loved one from unfortunate, unexpected events. A permanent policy, however, provides additional benefits including:
- High-income earners who have maxed out other investment vehicles and have a need for life insurance.
- People with a special-needs child or lifelong dependents
- Wealthy individuals who want to preserve the value of their estates for their heirs
- People who want to legate a financial legacy to their loved ones
- Seniors who don’t have enough savings to cover their end-of-life expenses, like medical care and funeral costs
- People looking for lifetime coverage instead of term coverage
Types of Permanent Life Insurance
Permanent life insurance comes in four different options:
- Whole Life Insurance
- Variable Life Insurance
- Universal Life Insurance
- Variable Universal Life Insurance
Which one is right for you will depend on your level of risk tolerance and the kind of payment adjustability you want.
Whole life insurance
Whole life insurance is as predictable as it gets. Whole life insurance comes with a guaranteed level premium and guaranteed tax-free death benefit. That means both the premium and the death benefit stays the same for life. The rate of growth on a whole life insurance policy’s cash value is also guaranteed (set by the insurer). So whole life insurance may be perfect for people who like predictability.
Some whole life insurance policies also give you the opportunity to earn dividends. These policies go by the name of participating whole life insurance policies. They are called as such because they let you participate in the surplus earnings of your insurer.
With whole life insurance, you can receive dividends in cash or keep them with the insurer and earn interest on the amount. You can also use them to purchase additional coverage or reduce future premium payments.
There are multiple factors to take into account to determine if whole life insurance is worth it for you.
Variable life insurance
Variable life insurance offers more investment options. It provides flexible premiums and a flexible death benefit. While the cash doesn’t grow at a guaranteed rate, you get to determine how the cash value is invested.
With this type of insurance policy, you allocate your premium payments to a separate account. The money in this account gets invested in a menu of investment choices — bonds, stocks, and money market instruments — that you choose.
The policy’s cash value will fluctuate according to the performance of these investment choices. Every month, the insurer will debit the policy’s cash value to pay for the cost of maintaining the policy.
Your life policy will stay active for as long as there is enough cash value to pay for the policy’s monthly charges. If the funds are too low, the insurer will ask you to pay more in premiums, or else the policy will lapse.
Variable life insurance gives you an opportunity to earn more than you would with a whole life insurance policy. However, if things don't go your way, you could lose money, including the initial investment.
Universal life insurance
Universal life insurance offers a lot of flexibility. Universal life insurance policies are the only permanent life policies with flexible premiums. You can adjust the frequency and amount of your premium payments (within certain limits). You can also adjust the death benefit of the policy according to your needs.
Just like whole life insurance, universal life insurance offers a guaranteed death benefit coupled with an investment feature. However, in its case, the interest rate on cash value may vary, although it won’t go below a set minimum. For example, your policy can set a minimum interest rate of 2% that is guaranteed for the life of your policy.
The cash value growth is tied to investment performance. So, the reward can be great, but if things don’t go as per the plan, you must pay higher premiums to keep the universal life insurance policy in force.
Another benefit is you can take money out of the policy’s cash value via a loan or withdrawal. You can even use it to pay premiums.
Variable universal life insurance
Variable universal life insurance combines the features of variable and universal life insurance. You decide how premium dollars get invested and can adjust premium payments and the death benefit.
You can diversify your investments through money market accounts to earn higher returns. But there’s an element of risk because it’s impossible to predict how the market will perform. Variable universal life insurance may be a good fit for people seeking maximum flexibility.
Permanent Life Insurance Quotes
Permanent life insurance is costlier than term life insurance due to the cash value component. However, premium rates are significantly different among different permanent life insurance policy types. In general, whole life premiums are higher than universal life for the same coverage amount.
Permanent vs. Term Life Insurance
Both permanent and term life insurance provide financial protection to your loved ones upon your passing. But that’s pretty much where the similarities finish.
Term insurance covers you for a limited period of time; while a permanent policy covers you until death, providing lifelong financial protection. Also, permanent policies — unlike term life insurance — build cash value.
Furthermore, all term life insurance policies offer guaranteed death benefits, but the same can’t be said for permanent life insurance policies. Some permanent life insurance policies let you increase or decrease the benefit amount as per your needs.
Finally, in the case of some permanent policies, you can adjust the frequency and amount of your premium payments. This kind of adjustability is not available in term life insurance policies.
Due to the cash value component and lifelong/permanent coverage, permanent life insurance is costlier than term life insurance.
Advantages of Permanent Life Insurance
A guaranteed payout
A permanent life insurance policy doesn’t close before you pass. Your policy remains in force for your whole life, as long as you make premium payments. When you buy permanent life insurance, you can rest assured knowing your loved ones will receive a tax-free death benefit regardless of when you pass away.
Fill-it, shut-it insurance product
With a term life insurance policy, you have to renew the policy at the finishing of each term to keep the coverage going. At every policy renewal, you pay higher premiums and might even have to undergo medical testing to prove insurability.
You don’t have to worry about all this with permanent life insurance. You take a medical exam only once — as part of the approval process. Once the insurer issues the life policy, it will cover for your whole life, regardless of any health issues that might develop later.
Builds cash value
Unlike term life insurance, permanent life insurance policies accumulate cash value. Since a part of your premium payments goes into building the cash value, it is a sort of “forced” savings vehicle. You can withdraw from or borrow against the policy’s cash value at any time. You can even use it as collateral for a third-party loan.
Generally, the cash value accumulates up slowly at first but then picks up the pace after some years. If you don’t withdraw or take out a loan, eventually the cash value may have enough money to pay premiums for the rest of your life.
The death benefit of a permanent life insurance policy is typically tax-free, while the cash value grows at a tax-deferred basis. This means any money you withdraw from it won’t get taxed, as long as the withdrawn amount is not more than the amount you’ve already paid in.
Some permanent life insurance policies give you the opportunity to earn dividends. You can reinvest the dividends into your policy to:
- build up the cash value more quickly
- buy additional coverage
- pay for future premiums, or
- personal income or investments outside of your permanent life policy
Disadvantages of Permanent Life Insurance
It’s costlier than term life
Without question, the single biggest drawback of permanent life insurance is cost (which arises from the cash value component). Generally speaking, permanent life insurance can cost at minimum a few hundred dollars per year. Permanent life insurance rates can be five to 15 times more than the rates for comparable term life insurance.
It’s not always a good investment
Cash value is part of the permanent life insurance appeal. A portion of your premium payments goes into a savings account which grows tax-free. So in a way, permanent life insurance acts as forced savings.
All the same, there are three main disadvantages to this savings feature:
- You have little control over how the insurer invests your premiums.
- The Rate of return tends to be lower than what you can get elsewhere. The average annual rate of return for whole life policies hovers around 3-6%. Most other dedicated investment options (like mutual funds) provide a better return.
- Fees for permanent life investments are on the higher side (at times even exceed 3%).
Is it a good option for you?
Permanent life insurance policies can be a smart option for someone who:
- Wants their beneficiaries to receive a payout regardless of when they pass away
- Wants to leave money to their loved ones or preserve the value of their estate for their heirs/future generations
- Has already maxed out other investment options and is seeking a tax-deferred savings account
Permanent life insurance offers several benefits — lifelong/permanent coverage, cash value, and flexibility. However, these perks don’t come cheap. You are likely to pay five to 15 times more for permanent life insurance than term life insurance. Also, keep in mind certain permanent policies and require close monitoring.
Get in touch with an independent broker, like Dundas Life, to understand if permanent life insurance is a better choice for you and find the best coverage at the best possible price.