Permanent life insurance may not be something you’ve considered as a tool for growing and protecting wealth, but it’s become more popular in recent years. In fact, a 2020 LIMRA study revealed 51% of policyholders own permanent life insurance. As more and more people begin to learn about the living benefits a permanent life insurance policy offers—benefits like tax advantages and cash value—it’s becoming more appealing as a smart addition to a diverse financial portfolio, both from an investment standpoint and an insurance point of view.
Unlike your run-of-the-mill term life insurance, which is relatively straightforward and inexpensive, permanent life insurance is more complex and requires a bit more “skin in the game,” so to speak. For these reasons, many financial pundits dismiss permanent life insurance, recommending instead to “buy term life insurance and invest the difference.”
The truth is, insurance isn’t a one-size-fits-all product. The right type of life insurance for your family and your financial situation depends on your goals and how you plan to use your policy. In this article, we’ll explain how permanent life insurance works and its benefits as a wealth building strategy, so you can decide if it’s right for you.
What is Permanent Life Insurance?
Permanent life insurance is a type of life insurance that provides coverage for your entire life. Simple enough, but the concept becomes a little more complex when you consider there are several types of permanent life insurance, each with its own unique features.
Whole Life Insurance
Of all the types of permanent life insurance, whole life insurance offers the most guarantees and is possibly the easiest to understand. When you buy a policy, your premiums are fixed for the duration of the policy (they won’t go up). A portion of your premium goes toward the policy’s death benefit and administrative costs, and the rest goes toward the policy’s cash value—a built-in savings account that can offer a higher rate of return than your bank savings account.
Whole life insurance policies pay out a guaranteed rate of return on the cash value in your account. Wealth grows tax-deferred until you withdraw it, which you can do at any point while the policy is active.
Whole life insurance policies purchased from a mutual insurance company offer even more benefits in the form of non-guaranteed dividends. The top-rated insurance companies in the U.S. have historically paid out dividends for over 100 years. Dividends can be paid out to you in cash (usually tax-free), used to pay your premiums, or used to purchase additional insurance, increasing your death benefit and/or cash value.
Here’s where things get a little more detailed. Instead of taking a withdrawal from your cash value, you can take out a policy loan. This is a loan between you and your insurance company. With a policy loan, you can borrow growth of cash value (interest earned) tax-free. But it gets even better—the cash value of a whole life insurance policy still earns a guaranteed rate of return regardless of the amount of the loan. You essentially earn interest on borrowed money. Your insurance company will charge you a low interest rate on your loan, but you determine the payback schedule.
Sometimes, like if you plan on using your cash value to fund your retirement, you’ll never pay back the loan. You’ll use all your accumulated growth tax-free and the outstanding “debt” owed to your insurance company will be deducted from your death benefit when you pass away. If you don’t have any outstanding loans, your policy pays out a guaranteed death benefit to your beneficiary in full, tax-free.
This is why it’s important to consider your goals before purchasing a life insurance policy. Obviously, if you intend to use your policy to help take care of your family after you’re gone, or to pass down generational wealth, outstanding policy loans can greatly reduce the amount your beneficiaries receive. On the other hand, if your goal is to increase your retirement income and decrease market volatility risks, policy loans from the cash value of a whole life insurance policy are a great way to enjoy tax-free income in retirement.
Variable Life Insurance
On the other end of the permanent life insurance spectrum, you’ll find variable life insurance. This type of permanent life insurance has the least amount of guarantees (aka most risk). With variable life insurance, your premium payments might be fixed, or they might be flexible. This means you may have the option to pay less and adjust your death benefit.
A portion of your premium goes toward your death benefit and administrative fees, which can be considerably higher than other types of permanent life insurance. The rest goes toward your cash value, where you have the option to invest in select stocks, bonds, and/or money market funds. The performance of these funds is reflected in your cash value, whether it’s a gain or a loss.
Wealth grows tax-deferred until you withdraw it, which you can do at any point while the policy is active. When you pass away, your policy pays out a death benefit to your beneficiary—assuming there is sufficient value in your policy. You can also utilize policy loans.
Universal Life Insurance
Universal life insurance policies come in several types, all falling somewhere in between whole life and variable life, as far as risks and guarantees. Most offer flexible premium payments—you can adjust your premium and your death benefit—over the lifetime of the policy. However, your insurance company can raise your premium at any time.
A portion of your premium payment goes toward your death benefit and administrative fees. The remainder goes toward cash value. How cash value grows wealth in a universal life policy depends on the policy type. From least risk to most risk:
- Guaranteed universal life policies earn a very low guaranteed rate of return (less than whole life insurance).
- Indexed universal life policies earn returns based on the performance of certain indexes like the S&P 500 or NASDAQ.
- Variable universal life policies earn returns based on the performance of market-based sub-accounts.
Many insurance companies who offer universal life policies will offer a minimum guaranteed rate of return, regardless of index or market performance, but they also often place caps or participation rates on growth.
Regardless of which type of universal life insurance policy you buy, wealth grows tax-deferred until you withdraw it, which you can do at any point while the policy is active. When you pass away, your policy pays out a death benefit to your beneficiary—assuming there is sufficient value in your policy. You can also utilize policy loans.
Do I Need a Permanent Policy?
If the only benefit you need out of a life insurance policy is a death benefit for your family to cover short-term financial obligations, then you might not need a permanent life insurance policy. A term policy is a more affordable, stripped-down option that just covers basic life insurance. But if you’re interested in using life insurance to grow and protect wealth, then yes, you do need a permanent life insurance policy.
Here are some instances where permanent life insurance makes sense:
- You want to reduce reliance on banks or other outside lenders
- You want to capitalize on the opportunity cost of borrowing money and earn interest on yourself
- You need liquidity for real estate investments or other opportunities
- You want to pass down generational wealth through an insurance policy and/or a life insurance trust
- You own significant assets that would subject your estate to higher taxes
- You own a business and need a succession plan as well as a source of business capital
- You want tax-free retirement funds that are protected from market volatility
- You have dependents who need financial assistance for the duration of their lifetime
What If I Don’t Want My Policy Anymore?
One of the benefits of a permanent life insurance policy is that if your financial situation changes or your goals shift, you can cancel or surrender your policy and your insurance company will pay out your cash value, minus any surrender charges. Surrender charges typically only apply during the earlier years of a permanent policy.
What If I Can’t Afford Permanent Life Insurance Right Now?
Permanent life insurance policies are more expensive than term life insurance. For individuals just starting families or in the early stages of a career, these types of policies can seem like a big commitment. Since it’s better to have some insurance coverage than none at all, a good strategy is to purchase a convertible term life insurance policy.
Convertible term policies allow you to get coverage now but also allow you the option of upgrading your coverage to a permanent life insurance policy at a later date without a medical exam. This means you can get guaranteed permanent coverage at the best premium rate possible. And if you convert your term policy to whole life insurance, which has fixed premiums, you’ll lock in that lower premium for life.
How Do I Find the Best Policy for My Budget?
At Paradigm Life we can customize a policy to fit your financial situation. Our expert Wealth Strategists are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals. , no strings attached.