Congratulations for being responsible enough to consider life insurance. Life insurance is an important part of financial planning if you have dependents, liability, and loved ones you want to take care of in case of an untimely death.
Permanent life insurance, also known as whole life insurance, is one of the main types of life insurance policies. The other main type of life insurance is term life insurance.
Let's explore permanent life insurance in more detail.
What Is Permanent Life Insurance?
Permanent life insurance is an umbrella term for life insurance policies that do not expire. In other words, the life insurance policy is permanent, until whenever you die.
The other main feature of permanent life insurance is that it has a death benefit along with a savings portion. The savings portion is called the cash value.
The three main types of permanent life insurance are whole life insurance, universal life insurance, and variable life insurance.
1) Whole Life Insurance
Whole life insurance offers life insurance coverage for the full lifetime of the policyholder and its savings can grow at a guaranteed rate. Think about a whole life insurance policy like paying an amortizing mortgage that goes to interest AND principal. It’s more costly than just getting an interest-only mortgage.
For those of you who have a lifelong dependent such as a child with a disability and/or who plan to accumulate much more than the estate tax exemption amount, a whole life insurance policy is a tax efficient way to provide life insurance coverage and grow wealth.
2) Universal Life Insurance
Universal life insurance also offers a savings element in addition to a death benefit, but offers different types of premium structures and earns based on market performance.
In other words, universal life insurance provides more options for savvy investors who are willing to take more risk. You can also use your policy’s cash value to lower your premiums or increase your death benefit later in life.
3) Variable Life Insurance
Variable life insurance allows you to decide how your cash value is invested. Instead of just having your cash value build up in a low-interest savings account, you can invest the cash value in mutual funds or index funds. Of course, there is more risk involved, but there is also potentially greater return.
With variable life insurance there are slightly higher fees than other cash value life insurance policies because you pay a fee to invest your money. Fund managers aren't going to do their jobs for free. If you are savvy about investing and believe in the long-term growth of the S&P 500, a variable life insurance policy may make sense to you.
How Permanent Life Insurance Works
Term life insurance is quite simple. You decided on the duration of coverage, usually 10, 20, or 30 years, and you pay the premium for the duration. In exchange, your life is covered for the agreed upon duration. You are welcome to stop paying premiums to drop coverage as well.
Permanent life insurance, on the other hand, lasts the lifetime of the insured, unless you stop paying the premium as well. A person taking out a permanent life insurance policy likely has lifelong dependents and a higher wealth trajectory. They likely earn enough to fully contribute to tax-advantageous retirement accounts like the 401(k), backdoor Roth IRA, SEP-IRA, and Solo 401(k). As a result, they'd like another vehicle to help them build wealth.
Like paying an amortizing mortgage, permanent life insurance premiums go both towards maintaining the policy's death benefit and allowing the policy to build cash value. The cash value can be borrowed against, used to pay policy premiums, used to pay for a child's education or medical needs, and invested.
Before a policyholder of a permanent life insurance policy can use the funds for anything, there is a waiting period of usually 5-10 years so that the cash value can build up to a sufficient size. Therefore, if you are in constant need of liquidity, getting a permanent life insurance policy is likely not the right policy for you.
If you decide to borrow against your cash value, please be aware that if the amount of the total unpaid interest on a loan, plus the outstanding loan balance, exceeds the amount of your policy's cash value, the insurance policy and all coverage will terminate.
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Permanent Life Insurance and Taxes
One of the key reasons why wealthier individuals get permanent life insurance is due to its favorable tax treatment. The growth of the cash value is generally on a tax-deferred basis, just like the growth in an IRA and a 401(k). Therefore, there is no tax drag on any earnings in the cash value. As a result, the cash value can grow faster than a normally exposed investment account.
Further, as long as certain premium limits are adhered to, money can also be borrowed against the cash value without being subject to taxes. In general, withdrawals up to the sum total of premiums paid can be taken without being taxed. This is great, but remember, you are initially paying your monthly or annual premiums with after-tax dollars. So it's not like you are getting a free lunch.
The key is to allow the cash value to compound for as long of a period as possible and then take advantage of the cash value. This way, you are getting as much tax-free money as possible. Compounding truly is the 8th wonder of the world if you want to get rich.
Converting Term Life to Permanent Life
As someone with a term life insurance policy that is expiring in three years, I'm kind of stuck trying to get a new affordable term policy. The reason why is that I went to see a sleep doctor for my snoring, and he discovered I also have sleep apnea. Once the sleep apnea was recorded in my medical records, life insurance companies get the notice, and premiums skyrocket. Lesson learned: get a life insurance policy before seeing a doctor for non-life-threatening illnesses.
However, my term life insurance policy, like many term life insurance policies, has the option to covert to a permanent life insurance policy if so desired. Life changes all the time. When I got my 10-year term policy, I didn't have children. Now I have two children under four years old. I need to protect them until they became independent adults.
My conversion from a term life insurance policy to a permanent life insurance policy will cost more money since I'm paying a cash value in addition to paying for a death benefit. However, I don't need to take a medical exam to re-qualify. Neither will you if you go this route.
This conversion feature a feature is appealing for someone with medical issues that could make a new policy prohibitively expensive, for instance, or with chronic conditions that require ongoing expenses that could be drawn from the savings portion.
At 42, I am five times wealthier than when I first took out the 10-year term policy as a 28-year-old. Therefore, the higher permanent life insurance premiums aren't difficult to absorb. This is likely the same for many people who convert a term life insurance policy to a permanent life insurance policy.
Negatives Of Permanent Life Insurance
Here are the main negatives of permanent life insurance versus term life insurance:
- Higher cost: Just like it costs more to buy a house than rent one, it costs more to have a cash value life insurance policy versus a term life insurance policy. Your premiums are higher because you have to also build the cash value. But that's what you want anyway, so the cost really isn't that much of a higher cost as the cash value is yours.
- Cash value can only be used when alive: Should your passing be untimely, your family will only receive death benefits while the cash value you managed to grow stays with the insurance company. Therefore, you must actively use the cash value while living.
- No access to cash value in the beginning: As you are building your cash value, you generally can't access it for the first 5-10 years. This is the waiting period. Like your investments, you need to let them grow, unabated so they can compound over time.
Main Ways To Use Your Cash Value
If you get a permanent life insurance policy, make sure to USE the cash value before you die. Otherwise, you end up wasting that build up. Upon your death, the remaining cash value goes back to the insurance company.
Here are five main ways to use up your cash value before you die.
Boost the Death Benefit
Choose to leave a larger death benefit to your beneficiaries if you don't plan to use the cash value before you die. To do so, just call your life insurance company and say you’re interested in making a change. Because the company doesn’t want to lose your business, it will more than likely accept your request.
During the exchange, your objective should be to completely drain the cash value and transfer the full amount over to the death benefit or the face value.
For example, if you have a universal life insurance policy with a $300,000 death benefit and $100,000 in cash value, your goal is to completely empty the cash value and boost the death benefit to $400,000. That’s $100,000 more that will fall into your heirs' hands instead of going to the life insurance company.
Pay Life Insurance Premiums
Once your cash value has grown large enough (paid up), as your insurance company to use the cash value to pay for premium payments.
Take Out a Loan
Feel free to take out a loan against your cash value at a low interest rate. If you don't pay back the loan, your credit score and situation will be fine since it is your cash value. Just know that any money you borrow, plus interest, will be deducted from the death benefit when you die.
Make A Withdrawal
If you need more cash for some reason, you can call your insurance company up and make a withdrawal. However, know that with some whole life policies, the withdrawal may reduce the death benefit and sometimes by even greater than the amount you withdraw. Doesn't seem fair, so you best double check before doing so.
Policy Surrender
You can always surrender your policy and receive the accrued cash value. But think hard before doing so. If you fully surrender, you’re relinquishing the death benefit when you surrender a life insurance policy, which means your heirs will receive nothing from the policy when you die.
In most cases, you’ll also be charged surrender fees, which could greatly reduce your cash value.
Additionally, the cash you receive through the surrender is subject to income tax. If you have an outstanding loan balance against the policy, you could incur even more taxes.
Sell Your Policy
If you absolutely don't want your policy anymore and feel like surrendering it, don't. Try and sell the policy to a second party. The settlement you receive will be less than your death benefit, but it'll be much higher than nothing. If the settlement you receive is higher than the sum of premiums you’ve paid, you will also be taxed.
Who Is Permanent Life Insurance Right For?
To summarize, permanent life insurance is good for:
- Wealthier individuals who plan to max out their 401(k), IRA, Roth IRA and other tax-advantageous accounts
- People who plan to get wealthier than average
- Planners who like to plan for the unknown
- People with dependents and debt
- People who want insurance for life
- Parents who may have disabled children who will depend on them for life, god bless their hearts
- People who expect their health to deteriorate over time due to hereditary reasons
If you have dependents, solid earning power, and plan to grow your wealth far greater than the average American, getting a permanent life insurance policy is a good idea. If you're curious about what other choices are out there, this post explains all insurance options in an easy to understand format.
I personally like the Variable Life Insurance policy route because of the option to invest in stocks and other instruments. As a 25-year investment veteran who worked at a couple major investment banks, I'm comfortable taking investment risk.
In fact, after I retired in 2012 at the age of 34, it was the stock market and real estate market that helped grow my wealth tremendously.
Compare Insurance Quotes For Free
The most efficient way to get competitive life insurance quotes is to check online with PolicyGenius, the #1 life insurance marketplace where qualified lenders compete for your business.
It's much easier to apply on PolicyGenius than go to each carrier one-by-one to get a quote. I've know the founders for years and they have truly build a fantastic resource for individuals and small business owners.
Remember, life insurance is an act of love and kindness. Hope for the best and plan for the worst. Life is unpredictable. No day is guaranteed.
About the Author: Sam worked in finance for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis, taking care of his family, and writing online to help others achieve financial freedom too.
Sam started Financial Samurai in 2009 and has grown it to be one of the largest independently owned personal finance sites in the world. You can sign up for his free private newsletter here.