Almost everyone needs life insurance. Whether it’s to pay off debts, ensure the family income and standard of living, make sure college can be paid for, leave a bequest to charity, provide liquidity for a business or real estate, or hedge against the return of estate taxes. Most of our clients need at least some life insurance. At the same time, two people who are outwardly similar may have very different needs, cash flows, risk tolerances, and so forth. For many people, the biggest decision is not the amount of insurance—it’s how to pay for the insurance they need.
That brings up the term versus permanent life insurance consideration.
In some cases, the need for insurance is temporary—maybe for the next 20 years, until the house is paid for and the kids have left the nest. In other cases, the need may be for a longer term—maybe until a business interest is sold. The need may, also be for a lifetime–to ensure estate taxes can be paid or to provide cash to equalize an estate, and so on.
When Should You Consider Choosing Term Life Insurance?
Term life insurance is much like a starter home or apartment. It is basic and inexpensive, and that’s all some people will ever need. But as with starter homes, there are variations of term life insurance that offer room to grow as needs change. There are also fixed-duration options, where the amount you pay is guaranteed, and other options where the amount adjusts—just like a mortgage.
In other ways, term life insurance is like renting—you pay money every month, on time, or you lose your insurance (or apartment). Like some rentals, term insurance has a “lease with option to buy” provision. This can be the best of both worlds when you can’t afford the permanent insurance (or home) just yet, but know you will be able to buy it in the next few years. If you buy term insurance just to cover a specific time period, such as the years when the children are young, it makes sense to select a plan that will last, at the same premium amount, for that entire period. But, since nothing ever seems to go as planned, we usually recommend that our clients buy “convertible, level premium” when they choose term life insurance.
What is convertible, level premium term life insurance?
This is a plan that is inexpensive while it is used as a term life insurance policy, and the premiums stay the same for the selected period (anywhere from five to thirty years or longer). The convertible aspect is what makes this option such an attractive choice when money is tight. Convertibility is simply a feature the insurance company offers that allows a person to convert part or all of the policy face (pay-out) amount to a permanent insurance plan. This conversion can normally be done over a period of years, bit by bit.
Converting to this option as cash flow improves is a great way to get the most insurance benefit for your dollars. So, who really buys term life insurance? Lots of people:
•Families and single parents with children
•Small business owners
•People who are caring for a disabled family member
•People needing permanent life insurance who can’t afford the cost
•Divorcing couples who need life insurance as part of the settlement
Term life insurance is inexpensive, flexible, and often an excellent interim solution. But it has its downside, too. If you miss a premium payment, you no longer have life insurance. There is no cash value to carry a missed payment. If you decide you no longer want the insurance, you get nothing back, even after years of regular payments. There is no tax-favored accumulation of cash.
When Should You Consider Choosing Permanent Life Insurance?
Permanent life insurance includes a number of insurance plans that have a major feature in common: If you pay enough money for enough years, the plan is “permanent”—it will last until the person being insured dies or reaches an age such as 100, when the full amount will be paid by the insurance company. The way insurance companies can make this type of insurance last is by charging a premium that covers two main things:
•The actual cost of the insurance, plus other expenses (as is the case with term life insurance)
•An additional, much larger amount that accumulates and earns dividends (similar to interest) and grows year by year
Permanent insurance has several features not available with term (unless you convert it):
•It has a cash value and you can borrow money from it.
•You can pay extra money and pay the policy up sooner (assuming the return on your cash value is high enough).
•As long as there is enough cash value, you can miss a payment (in most cases).
•There are tax advantages to accumulating money inside an insurance policy.
So who uses permanent life insurance?
•People who need to know their coverage will last even if they miss a payment here and there
•People who need to know their insurance will be around to cover estate taxes and provide cash for liquidity needs at death
•People who like the idea of the tax advantages
•People who want supplemental retirement income
•People who want another way to save money for college
Many people are good candidates for permanent life insurance, and many others will be, so convertible term can work for them. Maybe it’s time for us to weigh the options and run the numbers to see what is right for you.