The Internet is flooded with people giving advice about what kind of life insurance to buy. An often-heard refrain is, “Buy term and invest the difference.” Others say, “Why rent (term), when you can own (permanent)?” It just ends up being confusing because many people don’t really understand the difference between these two major types of life insurance.
Term life insurance covers you for a specific period of time, or the term. This is usually 10, 20 or even 30 years. This type of coverage makes sense for those who have temporary needs to cover. For example, young families need a lot of coverage to replace lost income, pay off debts, and put their children through college. It makes sense to have a term life insurance policy in place to cover those years, in case something happens to one or both parents.
An advantage of term life insurance is that it generally costs less than permanent life insurance. This makes it a more affordable option for young families that may not have a lot of disposable income, but have a large need for life insurance coverage.
Keep in mind that at the end of the level term period, the premium for the term starts to go up every year, which can become very expensive. That might leave someone without needed coverage if, for example, they are unable to afford higher premiums now that they are older, or if they have become uninsurable in the interim.
Whole life insurance and universal life insurance are examples of permanent. In general, as long as you continue to pay your premiums, you will have lifelong coverage. This type of coverage is good for someone who has an ongoing need, such as caring for a child with special needs, a spouse who will need coverage through retirement or final expenses, such as funeral costs and debt payoff.
A benefit of most permanent life insurance policies is that they accumulate cash value over time. Permanent life insurance combines a life insurance element with a cash value element. Each time a premium is paid, a portion goes to pay for the insurance coverage and a portion goes to an investment element. Cash value builds up over time. You are then able to borrow or withdraw that money for whatever needs may come your way—college funding, emergency expenses due to an illness, or to help fund your retirement. Keep in mind, however, that withdrawals will reduce the death benefit, or in some cases, result in the policy lapsing. Policy loans must be repaid, or the death benefit will be reduced.
Because of the lifelong coverage and the cash-accumulation features of most types of permanent policies, they are generally more expensive than term life insurance.
However, this doesn't have to be an all-or-nothing debate. Many people use a combination of the two types of life insurance to cover temporary and permanent needs. Another approach is to “convert” their term coverage to a permanent policy.
The conversion privilege available in many term policies may offer those who cannot initially afford cash value insurance a great opportunity to convert to a cash value contract at a later date. Some term policies may offer a conversion credit that makes converting to cash value insurance even more economical.
Converting a term policy to a cash value contract eliminates the need to undergo a new medical examination or provide updated financial information (as long as there are no increases in the amount of coverage, or any additional riders).
The kind of life insurance that matters most is the life insurance that’s in place when you die. Make sure your life insurance—term, perm or both—is one that you are able to keep in place while you need it.
At any stage in life – if anyone depends on you – there is a good chance that you need life insurance.
Be sure to "kick the tires" before you purchase.