Permanent Life Insurance

By Jon Scott

Abstract: A comparison of different types of permanent life insurance and important terms to understand when choosing a policy.

No one lives forever, so how do you make a financial plan for your passing while also paying attention to your financial needs while you are still alive? This article will compare the two main types of permanent life insurance including whole and universal.

Terms to know

Permanent Life Insurance

Permanent life insurance is meant to provide lifelong protection to the insurance holder along with a cash value. The two main options for permanent life insurance are whole life insurance and universal life insurance. Permanent life insurance is different from term life insurance.

Insurance Premium

The amount the policyholder pays per month to keep the policy viable.

Death Benefit or Face Value

The amount the beneficiaries receive when the policyholder dies–this is also called the face value.

Cash Value

Cash value is the portion of your whole insurance (or universal life) policy that earns interest over the lifetime of your policy. This amount is composed of payments made toward your policy premium (if the policy allows for a cash value) and often this cash value is invested in certain securities like stocks and bonds. Typically the policyholder can borrow against or withdraw from the cash value and use the funds on whatever they see fit. However, understand that unpaid loans from the cash value will reduce the death benefit available to the beneficiaries upon the death of the policyholder. Depending on the policy, the cash value may go back to the insurance company, but there are some universal policies where the beneficiary will receive some or all of the cash value.

Surrender Value

The surrender value is the money the policyholder receives if they access the cash value of the policy. With most cases whole life insurance policies, the cash value is guaranteed but only surrendered when the policy is canceled. Some universal life insurance policies have different terms and will depend on your specific policy. Oftentimes early withdrawal of the cash value will result in penalties such as surrender fees, reducing your surrender value.

Whole Life Insurance

Whole life insurance is the most common permanent life insurance. Premiums from whole life insurance are fixed–meaning they do not change over the life of the policy and are more expensive than term life insurance and typically more expensive than universal life insurance. The death benefit is also fixed. However, the benefit of whole life insurance over term life insurance is the cash value. The cash value is built with your premium payments. Specifically, some of the funds that you pay as part of your premium go toward building your cash value. In addition, your cash value is increased since part of your cash value is invested. Typically, whole life providers pledge a minimum amount of interest to increase your cash value–such as 2-3%. However, this interest amount can increase based on the investment results of your cash value. With the cash value, you are able to take out loans or withdraw money from this amount. Additionally, whole life insurance allows for dividends, or payments by the mutual insurance company from your policy that can be taken as cash, put back in as a payment toward your premium, or used to purchase paid-up additions. It is important that with whole life insurance the cash value almost always returns to the company who held the policy upon the death of the policyholder.

Universal Life Insurance

Universal life insurance is similar to whole life in that there is also a death benefit and a cash value. However, the difference between universal and whole lies within the premium payment. Whereas whole life insurance has a fixed premium, most universal life policies have a flexible premium. In practice, this means that instead of paying $300 a month for whole life insurance for the entirety of the policy, universal life allows you to change this premium amount over time. However, changing the premium will have an effect on the cash value of your policy.

In addition, there are multiple types of Universal Life Insurance including Guaranteed Universal Life, Index Universal Life, and Variable Universal Life.

Guaranteed Universal Life

The important difference is that guaranteed universal life insurance provides a fixed premium payment and death benefit that will not change over the life of the policy. You also select an age when the policy will end. The negative part of universal life versus whole and other universal options is that this policy has little to no cash value, and since there is no cash value to borrow against any missed payments will likely terminate the policy.

Indexed Universal Life Insurance

Indexed universal life insurance offers flexibility with the policy’s death benefit and premium. There is also a cash value that is often linked to a stock market index such as the S&P 500 or other indexes. You can take out loans against this amount or withdraw money from this value. Payments go toward the policy fees and charges, and the rest will go to the cash value. An important factor to note is that many of the stock market or other gains made by your invested cash value are capped at a certain percentage–this is important to consider since these caps can take away a lot of your invested cash value’s upside. However, investments often have a floor as well–meaning your cash value will not lose money in any year from investments. These policies can be very complicated so make sure to do your research.

Variable Universal Life Insurance

Variable life insurance also allows you to change the premium payment and death benefit of the policy. It also has a cash value that can be invested, however this policy will need to be actively managed since you will need to select the sub-accounts where your cash value is invested. These choices can lead to good returns since the cash value gains are typically not capped, however variable universal life often has higher premiums and more attention that the other universal life options. Additionally, this policy doesn’t feature a floor like indexed universal life or most whole life policies, meaning you could see investment losses. This plan would only be advisable for someone willing to take an active hand in the investment of their cash value.

Term Life Insurance

Term life insurance is not a permanent life insurance and is very different from whole and universal life insurance policies. Term life insurance typically lasts for anywhere from 5-30 years. There is no cash value and the policy simply terminates when the set time period for policy coverage ends. Term life is by far the cheapest option as well but again serves a different purpose from whole and universal insurance policies in terms of long-term goals.

Withdrawing funds from your cash value

There are few different ways to withdraw money from the cash value:

• You are able to make a tax-free withdrawal from your policy. However, withdrawing more than the cash value contributed by your premium payments can lead to the additional amount being taxed as income. Additionally, funds taken from your cash value will reduce the death benefit received by the beneficiaries.

• You can borrow against the policy tax free, but you will be required to payback the amount. Failure to pay back the loan before the death of the policyholder will result in the loan amount being subtracted from the death benefit received by the beneficiaries.

• You may surrender the policy. This means you end the policy and receive the cash value minus any surrender fees.

Policy Riders

Policy riders “ride along” with your policy and become part of the contract. Specifically, riders are certain conditions you attach to the life insurance contract at extra cost to you. Examples include:

• Critical illness: The policyholder can claim part of the death benefit–in cash–if they become critically ill.

• Accidental death: The policyholder’s death benefit increases if they succumb to an accidental death.

• Disability: The company holding your policy will waive all payments if you the policyholder becomes disabled.

Policy riders are useful additions to a policy if the policyholder is willing to pay a higher premium to protect against unexpected calamities.

Minimum premium and the minimum requirements to keep a policy in force

Minimum premiums are set by the several variables determined by the age, health, sex, assumed rate of return, riders, and possibly more variables specific to the policyholder. In order for the policy to stay in force, the policyholder must pay the entire premium of the policyholder upfront or pay the premiums monthly.