Life insurance comes in many forms, but ultimately falls into one of two categories: term insurance and permanent insurance. The main difference between the two is given in the name – term insurance expires after a certain period of time (usually 10 or 20 years), while permanent insurance provides coverage until the death of the insured. Before delving into the insurance that makes sense for you, it would be helpful to first look at the pros and cons of each type of policy.
The main benefit of term insurance is that the premium payments are generally lower than an equivalent permanent policy. This makes sense because the insurance company always has to pay out for permanent policies, whereas they won’t have to pay you anything if you survive the term. The downside is that the term insurance does not accumulate cash value and there is no flexibility with regards to the amount and frequency of your premium payments. Term insurance can be thought of as an expense, like rent, which costs money but doesn’t build your assets.
There are many benefits to permanent insurance, the most obvious one being that you are guaranteed a payout as long as the policy stays in force. Permanent insurance also accumulates cash value which can be withdrawn if you surrender the policy (in the case of whole life insurance), or used to pay for premiums for investment purposes (in the case of universal life insurance). The biggest drawback is that premium payments are higher than those of term insurance. Permanent insurance can be thought of like a mortgage payment – it costs more than rent but helps you accumulate value over time.
Term insurance makes sense for people who are not looking for permanent coverage. For example, you may want to provide for your children until they reach the age of 25, or you may want to help your spouse pay off the mortgage. In these cases, it makes more sense to get a term policy because these are not long-term needs. Be sure that your need is indeed not a permanent one though, because premium payments increase every time you renew your policy and coverage generally isn’t available past the age of 75.
Permanent insurance makes sense for people who have a long term need they need to insure, such as funeral expenses or payment of estate taxes. Another thought to consider is that permanent insurance has a “forced savings” feature built into it because of cash accumulation. For whole life policies, cash value usually accumulates at a fixed rate while for universal life policies it depends on how your investments perform. This could be helpful for people who have trouble saving but also want life insurance coverage.
The choice of whether you should get term or permanent life insurance ultimately depends on what you need coverage on and how long you need it for. But remember that it is not an all-or-nothing choice – you could always get term insurance to cover your short term needs and permanent insurance to cover your long term needs. In many cases this could very well be a better choice than going one way or the other.