Permanent life insurance is one of the most confusing topics in personal finance. This makes a discussion of whether to buy term or permanent insurance a daunting task.
Let's first define some terms:
Term insurance provides a level premium and a level-death benefit protection for a stated period of time, such as 10 or 20 years.
Permanent insurance typically provides both a death benefit and cash savings. There are different types of permanent insurance, including whole life, universal life, index-universal life, variable life and variable-universal life.
The initial premium for permanent insurance is higher than for term insurance with a comparable death benefit. A portion of the premium may be invested, eventually providing a buildup of cash value.
Pros and cons of term insurance. Term insurance can be a good fit for younger individuals and families, who need protection against the loss of income of a primary earner for a stated period of time, at an affordable cost. In most cases, a medical examination will be required.
Term insurance does not build cash value, so at the end of the term, the policy will have no value.
An additional benefit of term insurance is that it is a simple product, so comparison shopping is quite easy. The market for selling term insurance is competitive, presenting good values for consumers.
Brant Steck, director of client relationships for Brokerage Unlimited, Inc., in St. Louis, recommends buying a level term insurance policy and matching the length of the level premium period to the amount of time the need exists. At the end of the level-premium period, the policy should not automatically cancel (unless instructed by the policy owner), but the premium will likely increase quite markedly if you elect to continue the coverage. You should consider a term policy with a conversion privilege, which will permit you to convert the policy into permanent insurance, without proof of insurability, and lock in the rate class you had at the inception of the policy.
For many consumers, the only way they can afford the coverage they need, for the time when they need it, is through term life insurance. For those people, it's the insurance product of choice. Jeremy Ragsdale, vice president, Life Insurance and Annuities at TIAA-CREF, notes that more than 85 percent of the policies sold by TIAA-CREF are term policies, although they represent a much lower percentage of total premiums.
Pros and cons of permanent insurance. Permanent insurance may provide protection for your entire life. If a guaranteed level premium is important to you, make sure your policy provides for one.
Permanent insurance accumulates a cash value, and the policy owner may be able to borrow against it tax-free or use it for retirement or other goals (like education). Premiums are initially higher than for term coverage.
Who should consider permanent insurance? According to independent insurance consultant Glenn Daily, permanent insurance can make sense for consumers who need to create liquidity in order to pay projected federal estate taxes. He also recommends permanent insurance to those concerned about asset protection, where state law provides that the cash value and death benefits of insurance policies are not subject to claims by creditors.
Permanent life insurance also has an element of forced savings that can be attractive. In this environment of low interest rates, Daily notes that some policies have been paying a tax-deferred return of 4 percent or more. Of course, mortality and administrative costs of the policy will still be deducted.
Steck notes another situation in which permanent insurance may be the preferable option. If you are a retired couple concerned about spending money because it will deplete the inheritance you wish to leave for your children, Steck recommends designating a small portion of available funds and buying a survivorship-permanent policy. This policy should have a no-lapse guarantee. Steck believes this kind of policy will assure the couple that their children will receive the intended inheritance, while allowing them to enjoy their retirement.
Ragsdale notes that permanent insurance is no longer used only for estate planning or wealth transfer. He has seen an increase in policies issued to those who are older than 50, to cover newly acquired mortgages and other financial obligations.
Most retirees don't need significant (or any) life insurance when they retire, unless they still have dependents, need to fund funeral expenses or provide for their spouse.
Term insurance often prevails, in theory. Both Daily and Steck believe term insurance is the best option for most consumers. Daily considers it the "default option" and says he "has to be convinced" that cash value insurance is a better one.
You have probably heard the expression "Buy term and invest the difference," as a justification for buying term insurance. This saying is premised on a critical assumption: You will actually invest the difference instead of spending it. It also assumes the historical performance of the capital markets will continue in the future.
Insider information on cash-value insurance. Few consumers understand there are skilled professionals who can recommend cash-value policies that may be more suitable than those typically offered to them. For example, a "blended" policy combines whole-life and term-life into a single policy. This kind of policy may generate higher near-term cash values and higher death benefits at life expectancy than whole life alone. Blended policies are sold by many highly rated insurance companies, including Northwestern Mutual, Guardian and MassMutual. These policies can be competitive with term policies for some consumers.
Blended policies are not a panacea. Steck generally does not recommend them because of the heavy reliance on non-guaranteed dividends.
When considering the purchase of permanent insurance, Steck believes it's important to focus on what is guaranteed and what is projected (or hypothetical). You will need to carefully monitor the policy if you are making a decision based on hypothetical scenarios that rely on a projected dividend, interest rates or subaccount performance. You should also be prepared to make additional capital contributions, if necessary.
A final recommendation. Daily, a fee-only insurance consultant, says that most clients who consult with him end up doing something different than what they had originally planned. He does not believe consumers are getting the information they need to make an informed decision.
Steck believes consumers benefit from getting an objective, third-party opinion, but feels they can do so without incurring a fee by using an independent brokerage firm. His firm offers a " performance evaluation" of clients' existing life insurance policies at no cost. He says many clients require only an adjustment to their existing policies, rather than replacement insurance.
Whichever route you take, you would be well-advised to seek a second opinion when making a decision that has meaningful ramifications for you and your loved ones.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, "The Smartest Sales Book You'll Ever Read," will be published March 3, 2014.
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