Insurance: Term Beats Permanent

Permanent life insurance is a bad idea for most people because it is more expensive and complex than what most people need. Term life insurance is typically more affordable and offers the same financial protection for a set number of years. Permanent life insurance, on the other hand, lasts for the rest of your life and often includes a cash value component that can be borrowed against or withdrawn. However, the high costs of premiums and the risk of not being able to keep up with payments make it a risky choice for many. In addition, the cash value component can reduce the death benefit if it is borrowed against or withdrawn. For these reasons, permanent life insurance is generally not the best option for most people.

Permanent life insurance is more expensive than term life insurance

• Protection for Life: Whole life insurance, the most common type of permanent life insurance, provides coverage for your entire life, as long as you keep up with premium payments. In contrast, term life insurance only pays out if you die during the specified term, and there is a chance you will outlive the policy. This difference in coverage length is a significant factor in the cost disparity between the two types of policies.
• Cash Value Account: Whole life insurance includes a cash value account, which is an investment component that grows tax-deferred. This account allows you to build up funds that you can borrow against or withdraw while still alive. Term life insurance, on the other hand, does not have this investment feature and only provides basic insurance coverage.
• Loans and Withdrawals: With whole life insurance, you may be able to take out a loan against the cash value of your policy to cover emergencies or other financial needs. Additionally, some policies permit tax-free withdrawals from the cash account. However, any amount you borrow or withdraw will reduce the death benefit paid out to your beneficiaries.
• Potential for Dividends: Some whole life insurance policies offer the opportunity to earn dividends. Mutual insurance companies may pay annual bonuses if their financial performance exceeds expectations. These dividends can be received as cash or used to purchase additional coverage.
• Age and Health Factors: Age and health are significant factors in determining life insurance premiums. Younger and healthier individuals tend to pay lower premiums because their life expectancy is longer, and they are less likely to die during the policy term. As a result, permanent life insurance premiums can be significantly higher for older or less healthy individuals compared to term life insurance premiums.

It's often more complex

Permanent life insurance is often more complex than term life insurance due to its cash value component. While permanent life insurance policies can accrue a cash value over time, which can be borrowed against or withdrawn, this aspect of the policy introduces complexities that are not present in term life insurance.

The cash value component of permanent life insurance policies adds complexity in several ways. Firstly, policyholders need to understand how the cash value accumulates over time, which can vary depending on the type of permanent life insurance policy. For example, the cash value of whole life insurance grows at a guaranteed rate, while universal life insurance earnings are based on market interest rates. Secondly, there are tax implications associated with the cash value of permanent life insurance policies. While cash value generally grows on a tax-deferred basis, taking out a policy loan or withdrawing cash can have tax consequences and reduce the future death benefit for heirs.

In addition to the complexities introduced by the cash value component, permanent life insurance policies can also be more complex in terms of their flexibility. Universal life insurance policies, for example, offer more flexibility than whole life insurance policies, allowing policyholders to adjust their premium payments and death benefit within certain parameters. On the other hand, whole life insurance policies have fixed and guaranteed premiums, rates of return, and death benefits, which may be seen as a benefit by some but a drawback by others.

Another factor that contributes to the complexity of permanent life insurance is the variety of policy options available. There are multiple types of permanent life insurance, including whole life, universal life, variable universal life, and variable life, each with its own unique features and benefits. Navigating the different options and choosing the most suitable policy can be a complex and confusing process.

Furthermore, permanent life insurance policies often come with high internal fees that can eat into the potential cash value. These fees, along with the generally higher premiums of permanent life insurance, add to the complexity of the product and can make it challenging for policyholders to maximize their returns.

Overall, while permanent life insurance can provide valuable benefits, it is important to recognize that it is often a more complex product compared to term life insurance. The additional complexities introduced by the cash value component, the variety of policy options, and the associated fees and premiums can make permanent life insurance more challenging to understand and manage.

There are tax implications

Permanent life insurance has several tax implications that prospective buyers should be aware of. Firstly, it's important to note that permanent life insurance premiums are not tax-deductible under most circumstances. However, there are certain cases where the Internal Revenue Service (IRS) will treat life insurance premiums differently, resulting in tax consequences. These cases often arise when a business owns or pays for the life insurance policy.

Another tax implication to consider is that if you take out a loan against your permanent life insurance policy, the loan amount is generally not taxable as long as it does not exceed the sum of the insurance premiums you have paid. However, if you don't repay the loan and interest, your policy could lapse, and you would be required to pay income tax on the overall investment gains.

Additionally, permanent life insurance policies that have an investment component, such as whole life insurance, allow you to grow wealth on a tax-deferred basis. This means you don't pay taxes on any interest, dividends, or capital gains on the cash value of your policy until you withdraw the proceeds. However, if you surrender your policy or pass away with an outstanding loan, you or your beneficiaries may face tax implications.

Furthermore, permanent life insurance death benefits are typically income-tax-free for beneficiaries. However, estate taxes could apply to these death benefits, although the exemption amount is very high.

Lastly, withdrawals from permanent life insurance policies are generally considered a return of premiums paid and are therefore not subject to taxation. However, if you withdraw more than the value of the premiums paid and begin withdrawing gains, those amounts would be taxed as income.

It's not a good choice for funding a trust

Permanent life insurance is not always a good choice for funding a trust. Here are some reasons why:

High Costs and Complexity

Permanent life insurance is typically much more expensive than term life insurance. Whole life insurance, the most common type of permanent coverage, can cost up to 20 times as much as a 20-year term policy for a healthy 30 or 40-year-old purchasing a $500,000 policy. The high costs of permanent life insurance can be a significant burden, especially during volatile economic times such as a recession or pandemic, when job loss and financial instability are more likely.

Additionally, permanent life insurance is often more complex than term life insurance due to its cash value component, which can accrue over time. The complexity of permanent life insurance policies can lead to higher management expenses and agent commissions, adding to the overall cost.

Lack of Flexibility

Permanent life insurance policies are designed to cover you for life, as long as premiums are paid. While this can be beneficial for those who require lifelong coverage, it can also be a drawback for those whose circumstances change. If you outgrow the need for life insurance or can no longer afford the high premiums, you may be locked into a policy that no longer suits your needs.

Term life insurance, on the other hand, offers more flexibility, as it covers you for a set number of years. After the term ends, you can reassess your need for life insurance and choose to renew or opt-out, depending on your circumstances.

Potential Tax Implications

Permanent life insurance policies may have tax implications for both the policyholder and their beneficiaries. If you decide to surrender a policy or pass away with an outstanding loan, there may be tax consequences. Additionally, taking out loans or accelerated benefits against the policy's cash value could reduce the death benefit paid out to your beneficiaries.

Better Alternatives

For most people, there are more advantageous ways to invest for retirement than permanent life insurance. Term life insurance, coupled with other types of tax-free investments, can often provide better returns and more flexibility. By investing the difference in premiums between term and permanent life insurance, individuals can potentially generate higher investment returns and have more control over their financial portfolios.

In summary, while permanent life insurance may be suitable for some individuals, it is not always the best choice for funding a trust. The high costs, complexity, lack of flexibility, and potential tax implications make it a less attractive option for many people. It is important to carefully consider your financial goals, needs, and alternatives before deciding whether permanent life insurance is the right choice for you.

You may be better off investing the difference

Permanent life insurance is more expensive than term life insurance, and for most people, the benefits don't outweigh the costs. Permanent life insurance is a good idea for those who want lifelong coverage and to build cash value. However, for those who only need coverage for a specific period, term life insurance is a more affordable option.

Term life insurance is designed to cover you for a set term, such as 20 or 30 years. During this time, you pay a premium, and in return, your beneficiaries will receive a predetermined death benefit if you pass away. On the other hand, permanent life insurance covers you indefinitely as long as you keep paying the premiums. A portion of each premium goes towards the policy's cash value, which you can borrow against, withdraw from, or surrender and collect the cash value minus any fees.

While permanent life insurance has its advantages, it is not the best option for most people. The premiums are much higher than term life insurance, and the cash value of the policy may not be worth more than the premiums you've paid into it for 15 to 20 years. Additionally, permanent life insurance policies are complex, making it difficult to comparison shop. The high commissions and internal fees can eat into the potential cash value.

Instead of permanent life insurance, you may be better off investing the difference in premiums in other types of tax-free investments or retirement accounts such as IRAs or 401(k)s. These tend to offer higher rates of return over time than whole life policies. For example, if you invest the difference in premiums in stocks, you can expect an average annual return of 7%. Even investing in a savings account with a 1% interest rate would give you more than the guaranteed cash value of a permanent life insurance policy.

In summary, permanent life insurance may be a good option for those who need lifelong coverage or want to build cash value. However, for most people, term life insurance is a more affordable option, and investing the difference in premiums can provide higher returns and better financial flexibility.

Frequently asked questions