Insurance

Term or Permanent Life Insurance: What You Are Actually Buying

One covers a period of your life. The other bundles coverage with an investment, at a very different price.

Life insurance pays a sum to the people you name when you die. Every policy does that. The difference between products is how long the coverage lasts and whether the policy accumulates value along the way.

Term insurance

You choose a period, commonly 10, 20 or 30 years, and a benefit amount. You pay a level premium for that term. If you die within it, your beneficiaries receive the benefit. If the term ends and you are alive, the coverage stops and nothing is paid.

Most people find this uncomfortable and it is exactly the point. You are insuring a period during which your death would create a financial problem for others: while a mortgage runs, while children are dependent, while a partner relies on your income. Once those obligations end, the need does too.

Term is inexpensive because most policies never pay a claim. That keeps the cost low enough to buy a benefit large enough to matter.

Permanent insurance

Whole life, universal life and variable life all last for your whole life provided premiums are paid, and all build cash value alongside the death benefit.

Part of each premium funds the insurance. Part goes into an account that grows, at a guaranteed rate in whole life, tied to a formula or to investments in other variants. You can borrow against the cash value or surrender the policy for it.

Premiums run several times higher than term for the same death benefit. Early years fund commissions and expenses, so surrendering in the first several years often returns less than you paid in.

Working out how much coverage

Add up what your death would need to fund: outstanding mortgage, other debts, the income your household would lose for the years it would need replacing, childcare, future education costs, and final expenses. Subtract existing assets and any coverage you already hold through an employer.

Employer coverage is worth counting carefully. It is often a multiple of salary, it usually ends when the job does, and it is rarely portable on the same terms.

Where each product fits

Term suits the common case: a defined period of financial responsibility, and a preference for the largest benefit per dollar of premium.

Permanent insurance suits narrower situations. A dependant who will need support for life. An estate with liquidity problems, where heirs would otherwise have to sell assets. A business succession arrangement. Someone who has filled every tax-advantaged account available and wants another one.

The usual argument against buying permanent insurance as an investment is the cost of the insurance wrapper. Buying term and investing the difference in a tax-advantaged retirement account often produces more, though it depends on you actually investing the difference rather than spending it.

Features worth checking

• Convertibility. A term policy that converts to permanent without new medical underwriting protects you if your health changes.
• Renewability. Whether the policy renews at the end of term, and at what price. Renewal rates are typically much higher.
• The contestability period. Insurers can investigate and deny claims for misrepresentation during the first two years. Answer application questions accurately.
• Riders. Waiver of premium during disability, accelerated death benefit for terminal illness, child riders. Each adds cost.

Getting the beneficiary designation right

The beneficiary named on the policy controls where the money goes, and a will generally does not override it. Leaving an ex-spouse named on a policy is therefore a real risk, though not an automatic outcome: many states have revocation-on-divorce statutes that strip a former spouse's designation once a divorce is final, and those statutes do not apply uniformly, particularly to employer-sponsored plans governed by federal law. The practical rule is not to rely on divorce itself to produce the beneficiary outcome you want. Update the designation directly with the insurer, and confirm in writing that the change was recorded.

A few things worth doing when the policy is issued and again after any major life change:

• Name a contingent beneficiary in case the primary dies first. Without one, the payout may go to your estate, which delays it and exposes it to creditors.
• Avoid naming a minor child directly. Insurers cannot pay a minor, so the money goes into a court-supervised arrangement. A trust or a named custodian is the usual alternative.
• Review after marriage, divorce, a birth, or a death. This is the single most common failure in life insurance, and it is entirely avoidable.
• Tell someone the policy exists. Insurers do not know a policyholder has died unless a claim is made. Unclaimed policies are a real and recurring problem.

Life insurers are regulated at state level, and state regulators publish buyer's guides explaining the difference between term and permanent cover. The Texas Department of Insurance's life insurance guide is a representative example. Your own department can confirm whether a company is licensed and handle complaints, and most states run a free policy locator service for families searching for a deceased relative's coverage. the NAIC directory of state insurance departments links to each department.

Underwriting

Pricing depends on age, health, family history, smoking status, occupation and hobbies. Most policies require a questionnaire and often a medical exam.

Age is the input you cannot improve, and premiums rise with every year you wait. Simplified issue and guaranteed issue policies skip the exam and cost substantially more for less coverage, which makes them a fallback rather than a shortcut.

This article is general information about how consumer finance products work in the United States. It is not financial, tax or legal advice and is not a recommendation of any specific product or provider. Rules and pricing vary by state and by institution.