Term vs Permanent Insurance
People think insurance is a ripoff and expensive. It doesn’t have to be. Let’s use the example of $300,000 in insurance on a man (since they’re more expensive) who doesn’t smoke. If you were to buy a 20-year term policy, protecting your family from age 25 to 45, the premium would be only $287 a year, or less than $24 a month. Hey, we’re talking a case of beer here. Wait until you’re 39 to buy the same policy and your costs go up to almost $400 a year, which isn’t exactly a budget killer, unless you want a permanent insurance policy. Then the difference in the numbers is more significant. Buy a permanent policy at 25 and you’ll pay about $1645 a year or $137 a month. Wait until you’re 39 and the price goes up to $3025 a year or $252 a month.
So, is term insurance better than permanent (whole life or universal) insurance? Whether you buy “term,” “whole life” or “universal life” insurance will be dependent on two primary factors:
- the amount of insurance you need, and
- how long you need that insurance to be in place.
Term insurance provides protection for a predetermined period of time (perhaps 5, 10, or 20 years) or until a certain age. However, many term insurance plans end at a specific age, such as 65, 70 or 75 With men and women living considerably past that age, if you’re looking for longer-term protection, term insurance won’t cut it.
With term insurance, when the term of the contract expires your coverage ends unless you renew the term. Each time the term is renewed, the premium is adjusted upwards. So on the term policy above for the guy who bought a 20-year term at age 29, if he needed to renew for another ten years, the premium would jump from $304 to $552.
Think of term insurance as an expense, like rent. While it will give you comfort and peace of mind, it accumulates no residual value. If you want coverage to last your lifetime or want to use insurance to build assets, term insurance isn’t the right choice.
Term insurance is cheaper than permanent insurance, but that’s because the statistics are in favour of the insurance company with term insurance. With permanent insurance the company is going to have to pay out, it’s only a matter of when.
Whole life and universal life insurance are permanent, remaining in place until death. With whole life policies, the insurance company does the investing. (People debate that they don’t do a very good job of it, but they are purposely conservative, and with the recent swings in the market, you can see why.) With universal life, you have much more control over the types of investments the money is going into. The premium is generally the same for the life of the policy, so the annual cost can be low if taken early in life (when the risk of death is low), or very high if taken late in life. If term insurance is rent, then permanent insurance is a mortgage payment; in the early years there isn’t a lot of asset accumulation, but over the long term the pot will grow nicely.
Most whole life policies have a “reserve,” which can be refunded if you cancel the policy before your death. This reserve is referred to as the cash value of the plan. You can also borrow against this cash value at an interest rate set in the policy. However, if you haven’t paid it back, the money owed will be deducted from the death benefit.
So, back to the question, “What kind of insurance should I buy?” The best place to start is with the amount of coverage you need. Let’s say you’ll need $125,000 to pay off your mortgage, $5,000 to cover your funeral expenses, $15,000 to cover legal and accounting bills, and an additional $100,000 to cover the capital gains your estate will be hit with. All told, you’ll need about $245,000. Buying a policy with a lower payout clearly won’t serve your needs.
The next thing to look at is how long you’ll need the coverage. Some of your needs may be short-term. Declining term insurance is often the most cost-effective way to cover mortgage debt. On the other hand, the need to meet your funeral expenses and minimize the tax hit on your estate is permanent. So permanent insurance will be your best bet here.
Remember, since the premium on your permanent insurance will remain the same, while the premium on term insurance will rise each time the policy is renewed, the cost of term insurance will appear far less expensive in the early years of a policy. Compare the lifetime cost of both types of policies (remember to compare similar features and benefits — apples and apples), and then make your decision.
Another interesting fact: with some policies, you can buy the right to convert your term policy to a whole life policy at a later date. So if you decide to start off with term insurance to protect your young family, and then decide to convert to a whole life policy when your needs change and you have more money, your health won’t be a factor in setting the premiums. However, your age will be and the older you are the more your insurance will cost.
Shop around when looking for life insurance. Get several quotes, make sure you’re comparing apples with apples, and buy the policy that best meets your needs. Resist the urge to over-buy, but don’t sell yourself, and your family, short either. Evaluate your future earning potential and your family’s ongoing needs realistically, take inflation into account, and then buy enough insurance to meet your needs.