Understanding permanent life insurance

When it comes to life insurance, there are two main options: term life insurance and permanent life insurance. Which one is right for you? It depends.

Term policies are a good fit for most people, but permanent life insurance offers lifelong coverage and investment opportunities. This article is designed to help you build a foundational understanding of permanent insurance.

What is a permanent life insurance policy?

Permanent policies offer coverage for the rest of your life, as long as you pay your premiums. They also provide a financial cushion that can help ease the burden on your loved ones.

Your family can use the death benefit, which the insurer pays after you die, to cover your debts, pay for your funeral or help replace your income.

If you know you'll have lifelong dependents — like a child with special needs — or want to help your heirs avoid hefty estate taxes, you might benefit from the protection and savings options offered by a permanent life insurance policy.

How does permanent life insurance work?

Unlike term life insurance, permanent life insurance policies are meant to stay in force until the policyholder dies.

Permanent policies offer a death benefit as well as a component called cash value. Think of the cash value like a living benefit. You may be able to withdraw from or borrow against the cash value during your lifetime to help pay for things like a child's college tuition or medical expenses. Some policies also allow you to apply the cash value to your premiums.

If you die with the policy in force, your beneficiary receives the death benefit tax free. But if you cancel or surrender the policy, the insurer will pay you the balance of the policy's cash value and you may have to pay a surrender charge and taxes.

Permanent insurance policies are usually more expensive than term insurance premiums. Your premium could be varied or fixed, depending on the type of permanent policy you select.

Some permanent life insurance companies offer no-exam final expense coverage. That means the insurer won't turn you down for coverage, even if you've been turned down for other life insurance before. However, most companies and policies do require a medical exam, so before purchasing you'll want to ask plenty of questions.

What are the types of permanent life insurance?

There are four types of permanent policies with various levels of payment flexibility and investment opportunities:

• Whole life: The most basic type of permanent insurance is a whole life policy. It offers fixed premiums and a fixed-growth cash value component. Most offer several ways to pay the premiums. You may choose payments for a set number of years, until a certain age, or for your entire life.
  
  The death benefit is fixed as well. Your beneficiaries will receive the face value of your policy, not the face value plus cash value. Some whole life policies are considered "participating" policies. This means the insurance company shares its profits in the form of dividends added to the cash  value. These dividends can change based on the company's performance.
• Universal life: The ability to adjust your premiums and death benefit is the main appeal of universal life policies. This adds more flexibility if your financial situation changes. Some policy types allow you to combine the death benefit with the cash value, increasing the payout to your beneficiaries, though that will hike your premium.
• Variable life: This type of policy allows you to put your cash value into an investment account, called sub-accounts. The insurance company manages these accounts. If the cash grows, it can be available for loan, withdrawn as cash or go to increasing the death benefit for your beneficiaries.
  
  Keep in mind that if your investments do badly, the opposite could occur — though most insurance companies offer a guaranteed minimum benefit to ensure some money goes to your beneficiaries.
  
  It's common for variable policies to have several types of fees and charges due to their complexities. So, it's important to do your research.

• Variable universal life: These policies are a combination of variable and universal policies. The cash value component is tied to your investments, like a variable policy. And you can adjust your premiums any time, within set minimum and maximum limits, as you can with a universal policy. That flexibility comes with risks. If your investment choices don't perform well, you could end up owing money or even losing the policy coverage completely.
• Indexed Universal Life: Another option is indexed universal life insurance. It offers a variable interest rate on your cash value tied to a stock index. That means there's potential for greater gains — but also big losses, depending on your investments. However, most indexed universal policies also include a guaranteed‍ ‍ ^{See note 1} minimum death benefit for your beneficiaries, regardless of your investments' performance.

What's the difference between term and permanent life insurance?

The main difference between term and permanent life insurance is timing. Term policies cover a set number of years. Once the plan expires, so does your benefit. Your term policy will only pay out if you die while it's still active.

Term policies are popular because they generally have lower premiums. Many people also believe they will "outgrow" the need for life insurance later in life, after they've put away savings, paid off debts and finished raising a family. In that case, the right choice might be a term life insurance policy.

Should I convert my term policy to permanent?

Ideally, by the time your term insurance policy expires, you'll have paid off most debts and other financial obligations and built enough savings to make a large life insurance policy unnecessary. However, some people decide they'd prefer to have ongoing coverage, which is why many term life policies offer the option to convert to permanent coverage.

Often, you can convert your term life into a permanent policy without taking a medical test or otherwise requalifying for coverage. This might benefit those with chronic conditions or medical issues that could make a new policy too expensive. Those people might also benefit from a permanent life insurance policy's cash value component, as they can withdraw from it to cover ongoing medical care.

Are there tax benefits to permanent life insurance?

Whether purchased as a stand-alone or converted from term, owning a permanent life insurance policy may provide some benefits come tax time.

• Taxes are usually deferred on cash value growth, so you won't pay on any earnings while the policy remains active and the balance grows.
• Policy loans are generally not considered taxable, as long as your total premiums paid exceed the cash value balance and the policy stays in force.
• Generally, the life insurance death benefit goes to your beneficiaries tax-free.

A financial planner and tax advisor can help you explore your options, as well as explain how to use a permanent life policy as a tax-favorable vehicle to cover living needs or for estate planning.

Is permanent life insurance worth it?

A permanent life policy can help you build cash value while protecting your loved ones financially. As you weigh your policy options, consider factors like longevity, cost and flexibility to help select the policy for your financial goals.