Term vs. permanent life insurance: Which is right for you?

In a nutshell

Life insurance is a key tool to protect your loved ones in the event of your death and is a key part of estate planning for many. With life insurance, you can work toward providing an estate for your loved ones while you are building your assets during your lifetime with investments and other means.

• Term insurance covers the insured for a period of time — the term — and permanent insurance covers the insured indefinitely or until they die.
• The death benefit from life insurance can be used to cover your final expenses and provide money for ongoing living expenses, to pay off a mortgage, and to cover educational expenses for your children.
• The tax advantages offered by life insurance can also be an asset in the estate planning process.
• Business owners can use life insurance to provide funds to both their families and their businesses in the event of their untimely death as well as fund a buy-sell arrangement between business partners where the proceeds paid to the family are used to buy out the ownership interest of the deceased partner.

What is term life insurance?

Term life insurance policies carry a level premium over the term of the policy, which generally spans anywhere from one to 30 years. Term policies provide life insurance protection with no cash value component. The policy stays in force as long as the premiums are paid for the length of the policy’s term.

Term policies pay the death benefit only during the policy term — as long as the premiums have been paid. Once the policy’s term expires and the policy owner stops paying the premium, there is no death benefit if the covered person dies. Term insurance is a temporary (versus a permanent) solution for your life insurance needs.

There are several variations of term life insurance including:

• Level premium term insurance: This type of life insurance carries a level premium for the length of the policy’s term. The premium will not change for as long as the policy is in force.
• Annual renewable term insurance: This type of life insurance is a term policy where the premium increases each year when you renew the policy. Coverage is guaranteed; you don’t need to reapply each year. It is often smarter to buy a level premium term policy for several years if you think you will need the coverage for that period.
• Decreasing term life insurance: This type of life insurance has a death benefit that decreases each year, but the premium remains unchanged over the length of the policy’s term. This type of policy is often used to ensure a debt (decreasing as it is being paid down) is covered in the event of the insured’s death.
• Return of premium term insurance: This type of life insurance will return the premiums paid into the policy if you outlive the term of the policy. This feature makes this type of policy more expensive than some other term policies.

Pros and cons of term life insurance

Term life insurance has several pros and cons.

What is permanent life insurance?

Permanent life insurance is what the name implies: It provides permanent coverage. Unlike with term life insurance, there is no expiration of the policy; it will stay in force as long as the policy owner pays the premiums.

The death benefit is guaranteed and is not dependent on the insured’s age. Premiums generally stay level, though some versions of permanent life insurance may have variable premiums.

Permanent life insurance also has a cash value component, wherein a portion of each premium payment is directed towards the policy’s savings feature. The cash value earns interest over time and can be available for use by the policy owner. If there is a policy loan — or if some of the cash value has been withdrawn upon the insured’s death — that will serve to reduce the amount of the death benefit for the policy’s beneficiaries. When the insured dies, the cash value remaining in the policy generally reverts to the insurance company and not to the policy’s beneficiaries.

Some people look at the cash value as an investment to be used over time by the policy owner. It can be put to use for a variety of purposes, but that must be weighed against the impact on the death benefit.

There are several variations of permanent life insurance:

• Whole life insurance: This is a form of permanent life insurance that includes a cash value component that earns interest and grows over time.
• Universal life (UL) insurance: This insurance offers flexibility to modify the premium and the death benefit over time. The policy builds cash value based on the performance of the policy’s underlying investments. UL policies can be indexed, variable, or guaranteed.
• Variable life insurance: These policies allow the policy owner to take on more investment risk through investments in stocks, bonds, and money market funds. This can result in solid gains but also losses in the policy’s cash value.

Pros and cons of permanent life insurance

There are some pros and cons of permanent life insurance.

Term vs. permanent life insurance

There are several differences between term and permanent life insurance.

In general, life insurance companies price their policies based on the likelihood that they will have to pay a death benefit and how soon that benefit might need to be paid. Based on this, several factors influence the cost of both term and permanent life insurance policies.

• Age: The younger you are, the longer you will likely live. In the case of a term policy, this might mean that the insurance company may never pay out a death benefit. In the case of a permanent life policy, they may have a longer period to collect premiums from you and for the policy to build cash value, both of which can help offset the death benefit that would be paid out.
• Gender: Gender is a factor because women will generally pay less for the same policy. All other factors being equal, women have a longer life expectancy than males.
• Health: Health is a key factor for both types of policies. Those who are in good health are likely to live longer. This makes both types of policies more profitable for the insurance company. Those who are not in good health pay higher premiums (or may be denied coverage altogether). Is your height and weight in line? Being overweight can pose a greater health risk.
• Occupation: Does your job impose added risk on your health and safety?
• Smoking: Are you a smoker?
• Risk-taking: Do you engage in hobbies that are considered dangerous?

How much does life insurance cost?

Monthly premium costs can vary based on age, health status, and company. Here are some representative rates for 2023 based on publicly available data. These are monthly premiums for a 10-year term policy with a $250,000 death benefit for someone who is a non-smoker in excellent health:

Note that your specific circumstances will effect your premium, including not only your health, age and gender, but also your location and other variables. These prices are directional only and for purposes of illustration.

If we look at that same policy for a 35-year old across different risk classes, we see the impact that falling into various risk classes can have on monthly premiums.

The same types of relationships in premium costs carry through as you look at longer-term periods, both in terms of age and risk class ratings. “Preferred Plus” is the lowest risk applicant, and “Standard Tobacco” (standard applicant who uses tobacco) is the highest risk applicant. Note that the Standard Tobacco applicant’s estimated monthly premium is more than four times as expensive as the Preferred Plus applicant’s cost.

If we look at a $100,000 participating whole life policy for a 35-year-old across different risk classes we will see the impact that falling into various risk classes can have on the monthly premium for a whole life policy.

These premium/age/risk class relationships hold with other types of permanent life insurance as well.

How much life insurance do you need?

This will vary widely based on your situation, your age, and other factors. For example, a 35-year-old who is the chief breadwinner of their family with a stay-at-home spouse and two young children may need a higher amount than a 60-year-old whose kids are grown (and who has saved a good amount for retirement).

Factors to consider when deciding on the size of a death benefit for a policy:

• Your age and how long you will need the coverage.
• What you are trying to ensure. For example, a parent with a young family will want to have coverage to replace their lost income for their family as well as to cover the cost of a mortgage on their home and the cost of college for their children. In other cases, the life insurance policy might be used to cover potential estate taxes. Or it might be used to allow continuity in a business if the policyholder owns a business and dies while still running the business.
• Other assets that may be in place that can help protect your loved ones or others that you might be looking to protect with life insurance.
• The value and type of any other life insurance policies that you have in place. This includes the remaining term on any term life policies you have in force. This can also include any life insurance offered by your employer; however, you will need to check to see if these policies can be continued after you leave that employer.

Term and permanent life insurance alternatives

Both term and permanent life insurance are solid ways to protect loved ones and can be an integral part of your estate planning efforts. Some alternatives to life insurance can provide financial protection to your heirs as well.

• Pre-need life insurance: This type of coverage is purchased directly through funeral homes. It offers several options in terms of coverage for services that might be needed. This takes the burden off of loved ones because they don’t have to worry about your funeral costs and other final expenses.
• Accidental death and dismemberment (AD&D) insurance: AD&D insurance is a type of insurance policy that only pays out if a serious accident or other specified situation results in your death (or a serious injury as specified in the policy).
• Dedicated savings and investment accounts: These policies can be left to your beneficiaries upon your death. This option provides you with control over how money is invested, but you will lose the tax benefits of the life insurance — and also the guaranteed nature of the death benefit.

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Life insurance exists to protect your family and loved ones in the case of your death. For younger people who don’t want to spend a lot in monthly payments, term insurance can protect your family for terms as long as 30 years. For people who can afford to treat life insurance as an investment as well as an insurance product, permanent life insurance offers tax and investment benefits, as well as a policy that will cover you for your entire life.