Term vs. permanent life insurance: the differences and which one fits you

What term life insurance is

It is coverage for a set period. If the person passes away during that period and the policy is up to date, the insurance company pays the benefit to the person they chose. According to the Texas Department of Insurance, the term can be one year or anywhere from 5 to 30 years or longer; 10, 20 and 30-year terms are very common. The premium stays the same for the whole term.

Most term policies do not build cash value. If the term ends and you are still alive, the coverage stops and you do not get money back.

• Renewal: many term policies can be renewed at the end of the term even if your health has changed, but the new premium is higher. Ask what renewal would cost and up to what age you can renew.
• Conversion: some policies let you exchange it for a permanent policy with no medical exam and no health questions. The permanent policy’s premium will be higher than the term’s. The conditions and deadlines to convert depend on each policy.

That is why it helps to pick the term based on how long your family depends on you: for example, until the kids are on their own or until the house is paid off.

What permanent life insurance is

It is coverage for your whole life as long as you keep up the payments the policy requires. Besides the death benefit, part of what you pay builds a cash value that grows over the years and that you can use while you are alive. Because of the length of coverage and that value, the Texas Department of Insurance explains that it costs more than term for the same amount.

There are several types. These are the main ones:

• Whole life: a fixed premium on a set schedule, a fixed death benefit and a guaranteed cash value that grows according to the policy’s table. Some are “participating” and may pay dividends, which are not guaranteed.
• Universal life: lets you adjust how much and when you pay, as long as you pay enough to keep the policy in force. The cash value earns interest. If interest rates drop and the cost of insurance rises with age, you may have to pay more to keep it from lapsing.
• Indexed universal life (IUL): a universal life policy where interest is calculated based on a market index, like the S&P 500, without your money being invested in the stock market. It usually has a floor (for example, 0%) and a limit, or cap. The cap and participation rate are not guaranteed: the insurance company can change them, within the contract’s minimums. Even if the index goes down, policy charges keep being deducted.

Term vs. permanent: side by side

These are the differences that matter most when you decide:

• Length: term covers a set period; permanent covers your whole life as long as you pay what is required.
• Cost: term is usually more affordable, especially in the early years; permanent costs more for the same death benefit.
• Cash value: term usually has none; permanent does, and you can use it while you are alive.
• When the term ends: term coverage stops or renews at a higher premium; permanent stays in force.
• Flexibility: whole life has fixed payments; universal life and IUL let you adjust payments, with the risk of having to pay more if the value falls short.
• If you cancel: term gives you nothing back; permanent pays you the surrender value, which in the early years can be little or nothing because of surrender charges.

Cash value and policy loans

With permanent policies you can take a loan using the cash value as collateral, usually up to the amount of that value. The loan charges interest and you do not have to repay it before you die, but if it is not repaid, the insurance company subtracts what is owed, plus interest, from the benefit your family receives.

If loans and their interest end up exceeding the cash value, the policy can lapse. If a policy lapses or is surrendered with an outstanding loan, it may create taxable income. Before using the cash value, talk with your consultant and a tax professional.

One fact that applies to both types: according to the IRS, money a beneficiary receives because of the insured person’s death is generally not taxable income; interest paid on that money is.

Life insurance is not an investment account. Its main purpose is to protect your family; cash value is an added benefit that depends on how the policy is designed and funded.

Infinite banking: whole life as your own fund

Infinite banking is a way of using a participating whole life policy, usually from a mutual insurance company, meaning one owned by its policyholders rather than shareholders. The idea is to fund the policy well so the cash value grows, then take loans against that value for big needs instead of always depending on a bank, and pay them back into the policy with discipline.

Dividends are not guaranteed and the insurance company can change them. Loans charge interest and, if not repaid, reduce the benefit for your family. Cash value takes years to grow, so it does not produce quick results.

• It usually makes sense for people with a steady income who can pay the premium for many years without strain and already have an emergency fund.
• It usually does not work for people with high-interest credit card debt, income that changes a lot from month to month, or who need the money in a year or two, or for anyone who only needs temporary protection at the lowest cost.

Who each one usually fits (and why you can combine them)

Term usually makes sense when the need has an end date: parents of young children, families with a mortgage or large debts, or anyone who needs a large amount on a tight budget. Permanent usually makes sense when the need lasts a lifetime, like leaving money for final expenses or an inheritance, or when you want cash value you can use while you are alive and can pay for it long term.

You do not have to choose just one. The Florida Department of Financial Services’ guide describes combining a small whole life policy, for life, with larger term coverage while the mortgage is being paid. Illustrative example: a family could have whole life for final expenses and a 30-year term that covers the mortgage years.

Before deciding, figure out how much your family needs and how much you can pay consistently. A policy that lapses for lack of payment protects no one.

If you already have a policy, do not cancel it until the new one is approved and in force. Your health today can change the price or the approval of the new one.

Frequently asked questions