If life insurance is a back-up plan (as noted in “What is Life Insurance?”, Simplis blog), then Permanent Life Insurance is a back-up plan, with a back-up plan. Unlike Term Life Insurance, Permanent Life Insurance is very forgiving when it comes to being human. If you don’t make a premium payment, no problem. The accumulated cash value in your Permanent Life Insurance policy will make the payment and your coverage will continue*. Over a long period of time, most people experience a life event which creates the need to use this valuable benefit. And, of course, this benefit comes at a price.
Permanent Life Insurance can be pricey when you’re on a budget. These policies provide death benefits to the Beneficiary of the policy, and living benefits to the Policyholder (Owner). It is primarily the living benefits which make these products expensive and, over time, valuable. Essentially, Permanent Life Insurance is a life-long insurance policy joined to an interest-bearing savings account which builds equity over time. Most Permanent Life Insurance policies are designed to remain in-force, with a level premium, for the entire life of the Insured. The savings account (called “cash value”) is there to offset the rising cost of life insurance in the later years of life. In other words, you will overpay your premium in your younger years so you can underpay it in your later years. If you die along the way, your Beneficiary will receive the death benefit. There is also an option for your Beneficiary to receive the savings portion of the policy as part of the death benefit.
While living, the Policyholder may use the policy equity (cash value) for any purpose. The cash can be accessed by withdrawal or through a loan provision in the policy. Policyholders need to understand that this living benefit needs to be used with caution. If the money is not paid back into the policy, the policy will be in danger of lapse at some point in the future.
For anyone considering the purchase of a Permanent Life Insurance policy, it is important to understand the strengths and weaknesses of each type of policy, and choose the one which best fits your situation, now and in the future (See “Meet The Permanent Life Insurance Family”, Simplis Blog). Permanent Life Insurance can be a great financial tool for anyone who wants to build a stable financial future. However, these policies require a steady financial commitment.
Designed To Last Your Lifetime – Not all Permanent Life Insurance policies are created equal. Therefore, while “permanent” may be the concept, it isn’t always the outcome. So, which policies are designed to provide lifelong protection? Generally speaking, Whole Life policies are designed to guarantee lifetime coverage, as long as you fulfill your financial obligation to the life insurance company. Guaranteed Universal Life (GUL) is also designed with strong guarantees, and similarly will last your lifetime. However, it is also less tolerant of late payments. Other Permanent Life Insurance designs introduce weaknesses, which make the policy susceptible to lapse due to circumstances outside the control of the Policyholder. If lifetime coverage is your goal, Whole Life and Guaranteed Universal Life are your best options.
Equity – Similar to home ownership, most Permanent Life Insurance policies will build equity over time. The equity (technically called “cash value”) will eventually be used to subsidize your premium payment in the later years of your life. You will overpay in the early years of your policy (building equity), so that you can underpay in the later years. The life insurance company will simply withdraw a small amount of your equity and join it to your regular premium payment. So, when you’re 75 years old you’re still paying the same amount of premium from your budget that you were paying when you were 35 years old. By designing the policy in this way, the life insurance company won’t need to increase your premium payment in your later years.
Loans & Withdrawals – You can easily access cash from the equity in your Permanent Life Insurance policy through loans and withdrawals. This is a great benefit when used responsibly. However, if it is abused, the policy will eventually lapse due to underfunding.
A loan from your life insurance policy is unlike any other type of loan. You literally borrow money from yourself, therefore, you don’t need to qualify for the loan. You set the repayment terms of the loan. You can pay it back right away, or sometime in the future. You can pay it back in a lump sum, or monthly payments over time. You are your own banker, so you set the rules, except for the interest rate. The life insurance company sets the interest rate, and attaches it to your loan. The accumulated interest on your loan is part of your payment when you start to return the money into your policy. The interest is charged in order to make up for the lost interest crediting to your policy equity. Because the money is taken as a loan, this method of access does not create a taxable event to the Policyholder. However, if the Insured dies while the loan is still outstanding, the death benefit will be reduced by the loan amount still owed.
A straight withdrawal of cash is also available to the Policyholder. In this scenario, the Policyholder is not allowed to return the cash to the policy. And the death benefit of the policy is reduced by the amount withdrawn. Example: If you withdraw $20,000 from your $500,000 Permanent Life Insurance policy, your death benefit will be immediately reduced to $480,000 ($500,000 – $20,000 = $480,000). Additionally, the withdrawal may create an income tax event. So, it’s important to check all angles before you withdraw cash from your Permanent Life Insurance policy.
Lowest Cost – At the beginning, Permanent Life Insurance is far more expensive than Term Life Insurance. However, in the end, it costs far less than Term. Over time your Permanent Life Insurance policy will build equity. Eventually, the equity will be equal to the premium payments you made into the policy. At that point, you technically own a zero-cost life insurance policy. Now, as you continue your premium payments, your policy will become profitable and begin making money for you.
Tax Deferred/Tax Free – Permanent Life Insurance receives tax friendly treatment by income tax law. You deposit after-tax money into your Permanent Life Insurance policy, through your premium payment. The cash value receives interest crediting and grows tax deferred, which allows your policy equity to grow faster. After you have accumulated a sufficient amount of equity in your policy, it can be used tax free if accessed properly. Though there are restrictions to the amount of money which can be deposited in a single year, those restrictions are not as severe as more traditional retirement savings programs. This is one of the most powerful secondary benefits of Permanent Life Insurance. And it is one of the reasons why it is popular with the wealthy.
Secondary Retirement Income – Some people accumulate enough equity in their Permanent Life Insurance policy to help with expenses later in life. If this is done properly, the policy will never be in danger of lapse. This is a popular selling point with life insurance professionals. However, it should only be considered a realistic option if you plan to overfund your policy, or you purchase a large Whole Life policy.
Expensive To The Budget – Permanent Life Insurance is expensive. Often too expensive for those on a budget. And the expense of owning a Permanent Life Insurance policy doesn’t go away. For this type of policy to work as designed, you need the ability to afford it now and in the future. In other words, if your career path is roller coaster-like, then you will need to consider how to pay the premium when you’re on a downward slope.
Additional Fees – Permanent Life Insurance comes with some additional fees not associated with Term Life Insurance. It’s somewhat similar to home ownership in this way. If you buy a home, and then you sell it a year later, you probably won’t make any money from the sale. Permanent Life Insurance is very similar. If you cancel your policy early on, you may not have much to show for it. However, you will never owe money to the life insurance company.
Lapse Could Cause A Taxable Event – Permanent Life Insurance receives income tax friendly treatment, and that’s a good thing. Nevertheless, a policy lapse can change that to a bad situation. If you accumulate money in a policy, borrow a large percentage of that money and never pay it back, your policy may lapse. If that happens, any interest crediting to your policy equity may now be taxed. If your policy never lapses, the cash growth within your policy will never be taxed as income.
The best back-up plan is the one that is there for you when you need it. If you never need it, and you can recapture the money you paid for it, better yet. Permanent Life Insurance provides this benefit. Unfortunately, most people find these policies are financially out of reach for the majority of their life insurance need. You may consider including a small amount of your life insurance need in a Permanent Life Insurance policy. It’s called “The Balancing Act”, and it works very well for many people.
*The balance of the accumulated cash value within the policy must be sufficient to make the payments necessary to keep the policy in-force.