Last month, I discussed the importance of life insurance after a divorce. This month I will discuss the two major types of life insurance: term and permanent.
At first glance, term may seem like the more appealing option, but you may want to look at the numbers more closely before moving ahead.
The cost of term insurance is usually the reason why people select it over permanent insurance, but this option may be cost-prohibitive over time. Regardless of whether you will need insurance for final expenses, capital gains on a recreational property, charity, estate planning, as part of your retirement income, or as a tax-effective method for getting money out of your business, permanent life insurance may be the ideal longer-term solution for you and your family.
Term Insurance
Term insurance, as the name indicates, is available for a specific term or period of time. Term insurance is usually available for 10, 20 or 30-year terms. When the term is up for renewal, the renewal rate increases, usually by 4 to 5 times the original rate.
The benefit is that regardless if your health status changes, the insurance company will honour the coverage you are insured for, provided you continue to pay the premiums. Term insurance does have its place. It can secure any debt that you may have upon your death. Items like mortgages, future earnings, lines of credit, future educational costs, loans and credit card debt are good items to cover with term insurance.
The cons; term insurance is typically unavailable for renewal after the insured turns 85. The cost of term insurance is usually so expensive that many can’t afford the premiums, and the policy will not pay out after the insured turns 85. Many people will convert some or all of their term insurance to permanent insurance so they are guaranteed at least some payout upon their death. Converting to permanent sooner than later is advised because your rates are locked in on the date that you decide to convert. The younger you convert, the lower your premiums will be.
The term of the insurance should match the payout of the liability. If you have 20 years left on your mortgage, then you should have 20-year term insurance. If your children are going to be done school and out of the house in 15 years, then you should factor in that amount.
Permanent Insurance
Permanent insurance remains at a fixed rate over the entire period that you choose to select.
Like the names says, it is permanent, so you are guaranteed to leave at least something to your heirs. The other nice aspect about permanent insurance is that you can build up cash values within the policy so your death benefit will increase over time. The cash value within a permanent policy can also be borrowed against by the policy owner. Therefore, it becomes an asset in your financial portfolio.
With permanent insurance, you can pay off your premiums on an expedited basis, usually within a 10, 15 or 20-year period. Many will opt to have their insurance paid for while they’re working and as a result, they don’t have to worry about the ongoing expense in their retirement years when they’re on a fixed income.
Compare the Numbers for Yourself
It’s important to understand the cost of the different types of insurance over time. Below is a side-by-side comparison looking at the cost of term insurance versus permanent.
The comparison uses a healthy 35-year-old male, non-smoker, looking at a face value amount of insurance of $500,000. The term insurance is based on a 10-year term, meaning the renewal rate increases every 10 years. The permanent insurance is a whole life policy and is paid until age 100.
The comparison is based on the current rates of a large insurance carrier. The premiums are calculated on an annual basis.
| Date | Term Cost | Cash Value | Death Benefit | Permanent Cost | Cash Value | Death Benefit |
| Year 1-10 | $305 | $0 | $500,000 | $3,690 | $13,400 | $500,000 |
| Year 10-20 | $1,570 | $0 | $500,000 | $3,690 | $53,500 | $500,000 |
| Year 20-30 | $3,755 | $0 | $500,000 | $3,690 | $110,000 | $500,000 |
| Year 30-40 | $10,235 | $0 | $500,000 | $3,690 | $219,000 | $500,000 |
| Year 40-50 | $27,560 | $0 | $500,000 | $3,690 | $335,000 | $500,000 |
| Year 50-60 | Not available | $0 | $0 | $3,690 | $404,100 | $500,000 |
| Cumulative Premiums | $434,250 | $0 | $221,400 | $404,100 | $500,000 |
As you can see with the numbers, permanent life insurance can grow into a significant amount over time with a guaranteed payout at the end. Or, the cash value can be leveraged and utilized within your lifetime.
Combination of Term and Permanent Life Insurance
Generally, coming up with a combination of both term and permanent makes sense for most individuals. Term insurance for the items that you’d like paid off in the event of a premature death, and permanent insurance for those items that you will have an ongoing requirement for. Term insurance can be converted to permanent insurance at any time after the policy is issued. The key is to convert when the cost of permanent insurance is not cost-prohibitive to your budget.
Remember, permanent insurance grows tax-free, and depending on how you access its cash value, it can be collected on a tax-preferred basis. This can be accessed by you at any point within the policy when you’d like to get your hands on the cash value. The growth may start slowly, but over the course of many years, the power of compounding can turn your investment into a significant amount.
At the end of the day, whether it be term or permanent life insurance, having some life insurance is better than not having any life insurance at all.