It’s an impressive sounding term: “permanent life insurance.” But what is it, exactly? How does it differ from other types of insurance and does it make sense for your needs and goals?
The first step in answering these questions is understanding the two most basic categories of life insurance: permanent life insurance and term life insurance.
Permanent vs. term life insurance
Both permanent life insurance policies and term life insurance policies offer protection through a death benefit. And the death benefit is typically paid out to the beneficiary tax free.
But term insurance is for defined periods of time, usually periods anywhere from 10 to 30 years. Premiums for term insurance policies are generally guaranteed to remain the same over the coverage period. And there are usually provisions within term insurance policies allowing for conversion to permanent insurance .
Because term life insurance only provides coverage for a limited period of time, it tends to be more affordable. But, depending on a potential policyowner’s needs and the carrier, there can be important differences in value between various term life insurance offerings. (Learn more: Term policies: Not all are created equal)
Permanent insurance: Different types
Unlike term insurance, permanent insurance policies offer a death benefit throughout a policyowner’s life, provided the premiums are paid for a certain period.
In addition, various types of permanent life insurance offer the opportunity to build up a “cash value” component over time. Policyowners can tap the cash value of a permanent life insurance policy for any reason — a down payment on a house, college tuition, or supplementing retirement income.1 That cash value grows on a tax-deferred basis.
But beyond that, different types of permanent life insurance policies offer different features for areas like premium payment and cash accumulation.
Whole life insurance. This kind of permanent policy is probably the most straightforward in terms of having lifetime protection with cash accumulation. The cash value grows based on a set interest rate guaranteed by the carrier.
Premiums for whole life insurance policies can be set at a certain dollar amount for a certain payment period, depending on a policyowner’s particular needs and resources. For instance, some policies can be paid up after 10 premium payments, while others can be acquired with a pay-to-age-100 premium schedule.
Additionally, many whole life insurance policies are “participating,” which means they may receive dividends. Dividends can be used toward premium payments, to add to the cash value, or to increase the size of the death benefit of the insurance policy. Dividends are not guaranteed and their payment typically depends on the operating results of the insurance carrier. (MassMutual has paid dividends on qualifying policies since 1869.)
Universal life insurance. Like whole life, universal life insurance policies offer death benefit coverage and the accumulation of cash value, based on how much you pay in premiums.
The premiums are generally flexible, within certain limits. Once you’ve built up enough cash value in your policy to cover the cost of insurance and administrative charges, you can adjust your premium payment. That means you can pay more or less into your policy, as your individual circumstances warrant.
Why would flexible premium payments be desirable? Some people pay the maximum premium possible into a policy for the first years of coverage, building up the policy’s cash value. That cash value can then be used to pay premiums if their income shrinks in retirement.
Variable universal life insurance. This kind of insurance allows policyowners to put a policy’s cash value into an investment account managed by the insurance company.
The earnings from the account add to the cash value, and may increase the size of the death benefit of the insurance policy. Insurance and other costs are paid from the account. However, the account could post a loss, because it is tied to market performance. That, in turn, could affect the amount of funds available to pay for the underlying insurance protection and the size of the death benefit.
These kinds of policies tend to appeal to those who want the opportunity to make possible investment gains with their insurance, along with income tax advantages.
Additionally, this kind of policy typically offers the premium flexibility of universal policies. As a result, policyowners can have the opportunity to have greater cash value gains than offered in whole life insurance. And they have the opportunity to adjust their premium payments in response to any ups or downs those market investments tend to produce. So premiums could decrease when the policy’s investments gain or premiums could rise, or the death benefit shrink, when those investments lose ground.
Indexed universal life. This type of insurance also offers investment options, which are generally tied to the performance of a stock market index. But gains and losses are capped at certain levels. This allows the policyowner an opportunity to take advantage of strong market performance up to a certain level. At the same time, a policyowner is somewhat protected in market downturns. (Related: Understanding the tricky math behind IUL)
Survivorship insurance. This is life insurance that covers two policyowners and pays off at the second death. It can be a whole life or other type of permanent life insurance policy and is generally designed for couples who only want to leave money to a beneficiary after they have both passed. Survivorship policies, for example, may be ideal for married couples with a special-needs child, or for business owners who wish to plan for an orderly transition of ownership to the next generation. (Learn more: What is survivorship insurance?)
Later in life. There are certain types of insurance — simplified issue whole life insurance and guaranteed acceptance life insurance — available for those in their later years looking to safeguard their loved ones against unpaid bills and funeral costs. These options are aimed at those who can’t get a more traditional policy, either because a preexisting medical condition makes them ineligible or because their age would make a traditional policy’s premiums prohibitively expensive. Such policies may also offer limited benefits for a period of time. (Learn more: Options for life insurance in your later years)
Permanent insurance can also have riders added to the policy. These are additional benefits that allow for things like the opportunity to buy more insurance in the future or to waive premium payments in certain circumstances. Such provisions typically add to the cost of the policy but offer solutions for policyowners looking to address particular circumstances or protection needs. (Learn more: Understanding life insurance policy riders)
In the end, many types of life insurance are available, from bare bones term policies to more complicated, and perhaps risky, versions of variable universal life. Some types are more appropriate for some people than others and consumers often turn to a financial professional to help sort through the options. But knowing the basics about the differences in different types of life insurance is a good first step in determining what may be right for you.
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1 Borrowing from cash value will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.