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Permanent Life Insurance: What It Is and How It Works

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Buying permanent life insurance is like welding training wheels onto your bike and expecting to ride to victory in the Tour de France. You may feel safe, but you’ll never win.

When you’re just starting to build wealth, buying life insurance makes sense. You really need to know that your family will have a stable income no matter what. Life insurance is how you do that. It keeps you steady as you’re taking off (like a little tike’s training wheels). But training wheels shouldn’t be permanent—and neither should your life insurance!

If you’re like most people, you probably do need life insurance today (in particular term life insurance, which as you’ll see, is always the best option). But over time, you’re going to roll out of debt and build up some income-replacing wealth. Once you do that, you’ll be self-insured. And it’ll be time to cut that policy loose.

 

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Permanent life insurance is a rip-off because it tries to do too many things, and do them for too long. We’re going to show you what it is, how it works and why term life is a way better form of coverage for you and your family.”

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What Is Permanent Life Insurance?

Permanent life insurance is a type of coverage that is—surprise, surprise—permanent. (Other common names are whole life or cash value life insurance.) The company that sells you a permanent life insurance policy will use your premiums to cover two things:

  • Your death benefit, or the payout, that goes to a beneficiary of your choosing when you die
  • A cash value account that’s supposed to grow over time as an investment

In general, permanent life plans are much more expensive than term life. There are a couple of reasons for that, but mostly it’s because you’re paying for a lot more than an insurance policy.

What Is a Permanent Life Insurance Policy?

When you go for a permanent life insurance policy (see more below about why we don’t recommend one), it costs more. Why?

Because it’s trying to do double duty as life insurance and an investment account.

 

Key Takeaways

  • A policy that combines a life insurance benefit and a cash value account
  • Marketed as a way to achieve two important things at once, investing and insurance
  • Always pricier than term life insurance
  • Not a great value because it has higher premiums than term life and usually measly returns on investment

And mixing insurance with investing is a really bad idea.

To push permanent life policies, these companies hype up this savings account scheme they say is going to build cash value. There’s sometimes even a guaranteed return on your cash value. Why wouldn’t you want to use a single payment to get a death benefit and a tidy ROI?

One big problem: These guaranteed returns are pretty low on average—after all, it’s a lot easier to guarantee them that way. As we’re about to see, the cash value account tends to keep your premiums high and gives you lousy returns on your investment.

 

How Does Permanent Life Insurance Work?

Companies who sell permanent life insurance go into their pitch knowing you already want to protect your loved ones. Here comes the emotional play! Since life insurance is an emotional product, talking about it can bring on emotional purchases. (We all have that second cousin Larry who chooses the Fourth of July barbecue as the perfect time to pitch permanent life insurance.) And we all know how that works. But don’t let your legit feelings of love and loyalty lead you to buy one of the worst financial products out there.

Paper and Pencil

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Here’s how permanent life insurance works:

  • You pay your premiums. Every month, the insurance company uses part of your premium to pay for the death benefit they’ll one day pay you and puts the rest into a cash value account. The mix of how much of your premium they invest versus how much goes toward your policy changes over time. Early on in the life of the policy, a larger percentage of permanent life insurance premiums goes toward the cash value. In the later years, your life insurance coverage takes up more. (The reason for that is morbid but true: The cost to insure you increases as you age.)
  • Your cash value inches up over time. Your cash value account will slowly grow thanks to a puny interest rate. (You’ be doing much better putting the same cash toward a tax-advantaged retirement account, by the way.) And after you’ve built some savings, you can choose to borrow against it or leave it alone. (But neither move is ideal, and we’ll see why in a minute).
  • Next, either you get to the maturity age . . . Maturity age means the day you can finally withdraw all the money you’ve saved in your cash value account. Insurance companies define this age differently, but most set this at 120 years old. Or (what’s way more likely) . . .
  • Or you die before turning 120, and your cash value disappears. Guess what happens if you forget to spend your cash value while you’re alive? The insurance company keeps it! Is that legal? You better believe it! Your family gets the death benefit, but the insurance company pockets that hard-earned cash value. (This sucks! And it’s why we will always tell you to steer clear of permanent life insurance.)

 

Got Kids? Use These 5 Tips to Get the Right Length of Life Insurance.

If you have kids depending on your income, you might be wondering, How long should my life insurance policy last? Great question!

Try These Tips

Types of Permanent Life Insurance

There are many types of permanent life insurance policies, each with slight variations added to make it seem like The One. But they’re all pretty bad—and the two main ones to know about are whole life insurance and universal life.

Whole Life Insurance

Whole life insurance is the least flexible type of permanent life insurance. Once you choose your plan, the premium amount gets permanently locked in for the life of your policy. You’re stuck paying that amount every month (or year) for . . . wait for it . . . your whole life.

As you’ll guess, a slice of your premium goes into the cash value part of your policy—and that’s another thing you’re not allowed to change. Your rate of return will probably hang out around 2%— just enough to keep up with inflation. Once again, you’ll build up cash value as long as you keep the policy in force. But that pathetic rate of growth and the lack of flexibility make whole life insurance a really dumb bargain. You’d be way better off getting the price and ease of a term life policy, then investing your savings in a tax-advantaged retirement account.

Universal Life Insurance

Universal life insurance is more complicated than whole life because you have some control over how much you pay in premiums. For example, you’re allowed to pay above your monthly premium and send the difference to your cash value account. Over time, if your cash value grows enough, you can use it to lower your premiums.

What kind of growth can you expect to see in a universal life policy? That depends on which type of universal life you buy (like we said, it’s complicated). The sub-types are: variable universal life, guaranteed universal life and indexed universal life.

Just know: We don’t recommend any kind of permanent life insurance, including the universal types. Focus on term life to protect your family. Then use the money you’ll save to eliminate debt or build wealth faster.

 

Average Cost of Permanent Life Insurance

Maybe you’re wondering, If I choose term life over permanent life insurance, what kind of savings are we really talking about here? Well, to help you see what we mean, we made a couple handy charts. The first shows average savings for males, the second for females.

Term Life vs. Permanent Life: Monthly Cost by Age for Males*

Age

Term

Permanent

Savings

25

$12.18

$142.12

$129.94

30

$12.45

$176.30

$163.85

35

$13.39

$210.49

$197.10

40

$17.55

$268.11

$250.56

45

$26

$325.94

$299.94

50

$38.54

$427.41

$388.87

55

$60.18

$528.47

$468.29

Term Life vs. Permanent Life: Monthly Cost by Age for Females*

Age

Term

Permanent

Savings

25

$10.74

$134.59

$123.85

30

$10.97

$166.20

$155.23

35

$11.84

$194.15

$182.31

40

$15.20

$244.67

$229.47

45

$21.19

$294.98

$273.79

50

$30.69

$371.52

$340.83

55

$44.98

$447.85

$402.87

*Rates displayed are based on a $250,000 policy for nonsmokers in the Preferred Plus health classification; term life quotes are from Legal & General (20-year term length) and whole life quotes are from Transamerica. Individual rates will vary based on applicant-specific information.

Both genders and all ages will see enormous savings from picking term life over permanent. In some cases, we’re talking about hundreds of dollars a month, and in all cases, we’re talking about thousands of dollars annually!

 

Monthly Cost by Age

Term Life Whole Life Savings
$12.18 $142.12 $129.94
Term Life $12.18
Whole Life $142.12
Savings $129.94
Rates displayed are based on a $250,000 policy for non-smokers in the Preferred Plus health classification; term life quotes are from Legal & General (20-year term length) and whole life quotes are from Transamerica. Individual rates will vary based on applicant-specific information.

 

Whole life sucks compared to term life. Check out term life insurance prices specific to your situation! See your rates here.

 

Permanent Life Insurance vs. Term Life Insurance

The main difference between permanent versus term life coverage is that term has a set premium that remains the same throughout the life of the policy, and it only lasts for a defined number of years.

Permanent life insurance premiums can vary (a lot), last your whole life even after you’re past the age when you’d need a death benefit for dependents, and are over-complicated by bad investment options. Term, on the other hand, is simple and (this is key) only lasts as long as you need it.

Here’s a pros-and-cons list to get a clear picture of how they compare.

Permanent Life vs. Term Life

Feature

Permanent Policy

Term Policy

Cost

Higher

Lower

Cash Value?

Yes

No

Loans Against Policy

Yes

No

Coverage Length

Lifelong

Temporary

Is the Death Benefit Taxable?

Almost never

Almost never

Medical Exam Required?

It depends

It depends

 

The Truth About Permanent Life Insurance

By now you should see that permanent life’s a bad deal for you and your family. The only purpose of life insurance is to guarantee that when you have people depending on your income, they’ll be okay even if something bad happens to you. But permanent life doesn’t deliver on that need and also lasts way too long. Term life, on the other hand, takes care of that need at a fair price—and only while you need it.

Here’s another truth about a permanent life insurance policy. If you follow Ramsey’s 7 Baby Steps, there’s going to come a day when you won’t even need life insurance—you’ll be self-insured.

What does that look like?

It’s a dreamy future where . . .

  • You’re totally debt-free
  • You have a full emergency fund
  • And your investments are earning enough money to replace your annual income after death

When that’s the world you live in, you’ll be happy to throw out those old training wheels—or as they’re sometimes known, monthly premiums.

 

How much does term life insurance cost?

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Get the Right Type of Life Insurance

Permanent life insurance—and the lousy way it builds up cash—just can’t compare to the results you get by investing your money independently. Don’t leave investing to some insurance company.

To choose the right type of life insurance for you and your family, talk to a qualified life insurance professional. For over 50 years, our trusted friends at Zander Insurance have been helping people find the best policy to protect their families. Or if you want to get an idea of how much a policy might cost for your specific needs, check out our Term Life Estimator.

 

Life Insurance Calculator 

You can get an idea of how much you need (and save some brain calories while you’re at it) by using this quick life insurance calculator. 

How much term life insurance do you need?

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