Term or Permanent Life Insurance

When should I buy permanent insurance instead of, or in combination with, a term life policy?

Q:

Is there ever a set of circumstances that would warrant buying permanent insurance instead of, or in combination with, a term life policy?

A:

Your question reminds me of that great song "Turn! Turn! Turn!," which Pete Seeger wrote using words from the Book of Ecclesiastes and the Byrds recorded for a hit in 1965:

"To Everything Turn, Turn, Turn, There is a season Turn, Turn, Turn, and a time for every purpose, under Heaven"

Which is to say that, yes, there is a time and a purpose for virtually everything, including permanent life insurance. Before we get to that time and purpose, however, let me first explain a few terms for people who might not be familiar with insurance jargon.

Term life insurance

Term life insurance is bare-bones insurance coverage. You pay a premium and if you die while the policy is still outstanding, the insurer pays a death benefit to policy's beneficiary, usually a family member or loved one you've chosen.

It's called term insurance because the coverage lasts for a specific term. That term can be anywhere from one year to 20 years, and is typically renewable. So, for example, you could buy what's known as annual renewable term, pay the annual premium and renew each year at a price that would go up as you age.

Or, you could lock in the price for up to 20 years by buying what's known as a level-premium policy. The premium on the level-premium policy would start higher than with annual renewable, but it would remain the same for the policy's full term, whether five, 10 or 20 years.

Most term policies, however, are renewable only to a certain age. That age varies by policy and insurer, but it's usually about age 75. After that, the term coverage ends.

So when you buy term, you take the chance that the policy may, in effect, expire before you do, in which case you'll have paid premiums for many years but your beneficiary may not collect on the policy. That doesn't mean you'll have suffered a loss or been ripped off in any way, just the same as you aren't financially harmed if you own car insurance but never total your car.

Permanent insurance

Permanent insurance also pays off in the event of your death, but it operates differently.

You pay a premium that much larger than the premium for term -- often five to 10 times the size -- but a portion of that premium goes into a savings component known as the policy's "cash value." That's why permanent insurance is sometimes referred to as "cash value" insurance.

Initially, the cash value is very low because much of the early premiums go to sales charges and the agent's commission. Over time, however, the cash value can grow, depending on the dividends or interest the insurer pays policyholders.

There are several different types of permanent insurance or cash-value policies, but the most common are whole life and universal life.

There's one other crucial difference between permanent and term policies. As their name implies, permanent policies are permanent. As long as you pay the premiums and keep the policy in force, you can keep the policy your entire life (which accounts for the name "whole life" policy).

"Term vs. perm"

Okay, so under what circumstances would one want permanent as opposed to term insurance, or "term vs. perm" as they say in insurance circles?

Well, the main reason to own insurance is to replace income that your dependents are counting on and would lose should you die. If your spouse, who earns $100,000 a year, were to die tomorrow, then you would presumably need to replace some portion of that income.

An insurance policy is one way to do that, especially for people who don't have much in the way of investments or other assets that could generate a regular income.

But most people don't need this sort of income-replacement protection their entire lives. Once your kids grow up and begin living on their own, they're no longer dependent on your income.

And once you're retired and living off Social Security, investments and perhaps a pension, then you have no earned income you've got to replace should you die. So many people simply don't need to carry life insurance after they're retired, or at least not very much of it.

Term also has the advantage of having far lower premiums than permanent insurance. As a practical matter, that means that to get the amount of coverage they will need -- click here for more on how to determine that amount -- most people pretty much have to buy term anyway. If they buy permanent insurance, chances are they'll have to stint on the coverage, which is not a good thing to do.

For those reasons, I and many other people say that term insurance is usually the best bet for people looking for basic insurance protection, that is, people who want their loved ones to be cared for in the event they die prematurely.

And now, the exceptions to the rule

Now we come to the "time for every purpose" part. Although I think these cases are rare for the vast majority of people, there are instances in which we may want to keep life insurance for our entire lives.

Parents who have a disabled child who will never be able to support himself even as an adult may want to assure that there are some assets for that child after they die. A permanent insurance policy is one way to assure assets will be there.

And unless the estate tax is eliminated (it's currently scheduled to disappear in 2010 and then reappear in 2011), someone who expects to leave an estate well in excess of the current exemptions may also consider permanent insurance as a way to help heirs pay whatever taxes might be due.

In short, any time someone thinks he may need to have an insurance policy that would pay a death benefit regardless of when he dies, permanent insurance is the way to go.

Do your research

Whether you choose term or perm or some combination of the two, it pays to do some research and compare prices. That's much easier to do with term insurance because you're basically looking to get the lowest premium for a given amount of coverage.

You'll also want to stick to insurers that are highly rated by a company such as Standard & Poor's. To check out ratings, click here. You can check out term rates at such sites as Accuquote.com and Insure.com.

Comparisons are more difficult with permanent insurance because these policies contain myriad assumptions about mortality rates, expenses and investment returns that affect the buildup of cash value.

What I recommend there is that you get policy illustrations from a few large highly rated insurers and then see how they stack up against policies offered by a "low-load" company such as Ameritas Direct that keeps down sales and marketing charges by selling insurance directly to consumers.

After you've done all this, I suspect your brain will be numb. So what better way to revive yourself than to rev up the old iPod or slip a Byrds CD into your CD player, sit back, relax and listen to "Turn! Turn! Turn!"

Source: money.cnn.com 08-24-2004