Which to Buy? Term vs. Perm (Part 3 of 5)

The world of life insurance can be divided into two categories, term insurance and permanent insurance. Term insurance is very easy to understand, and permanent insurance gets complicated quickly.

Term Insurance

Term life insurance is called that because it lasts for a certain period of time. If you have a 30-year life insurance policy and you die on day one of the 31st year, no one gets any money.

Example: On January 1st, 2015, you buy a 30-yr term policy with a death benefit of $500,000. The policy expires 30 years later on January 1st, 2045. If you pass away before that day (and you have been paying all your premiums), your beneficiaries will get $500,000. If you pass away on January 1st or after, your beneficiaries are out of luck.

Term policy

That’s it! Easy, right? As long as you are paying your premiums, you have life insurance.

Permanent Insurance

Permanent insurance comes in all kinds of variations with optional riders (i.e., add-ons). What do they all have in common? They can build cash value.

Cash value is best explained with an analogy. Permanent insurance is like owning a home, and the payments can start to build value. On the other hand, term insurance is like renting an apartment, and the rent that you pay does not get returned when you move.

This means that the cash value is something that can grow with the insurance policy. Depending on your policy’s details, you can use that cash value for things like retirement, paying your premiums, or buying another policy.

This cash value can grow with a fixed rate (example: 4% each year) or an indexed rate (example: moves up and down like interest rates at the bank). The cash can also be invested in mutual funds, and then the value will grow or shrink with those mutual funds.

The Catch

The cheapest solution to build up cash while having life insurance is to buy a term policy and get a retirement account or a savings account. Why? Because if you have a permanent life insurance policy and you die, the life insurance company keeps the cash value. Your family still gets the life insurance money, but wouldn’t you rather have your family get the life insurance money and the cash?

For most families, having a life insurance policy end at retirement is a great solution. If you’re still skeptical, check out the example below.

Perm vs. Term Example              

Option 1: Buy a $500,000 whole life policy at $500/mo. Since it is a permanent policy, you will be paying $500 per month for the rest of your life, but you also get cash value. This policy guarantees that you will have $200,000 in 30 years.

Option 2: Instead of a whole life policy, you decide to buy a $500,000 term life policy for 30 years at $50.99/mo. You decide to invest the difference between the two policies (or $449.01/mo) into a mutual fund getting 9% each year. At the end of 30 years, your life insurance goes away, but your mutual fund account will be worth $822,022.10.

Which would you prefer?

Note: All numbers were found online at MetLife.com on October 13, 2014. If you are considering purchasing life insurance, speak to a registered and licensed life insurance agent.