Identifying the need for life insurance is a critical step. Everyone has a need at some point in his or her life, but once that need is established you’ll have to figure out exactly what type of life insurance policy to buy.
What’s the Difference between Term and Permanent?
A term life insurance policy has a set duration and does not have a savings or investment component. Term policies provide a death benefit – a flat amount of money based on what you opted to purchase and will only pay out if you die within the policy period. This type of policy does have limitations, especially in terms of the life of the policy. Say, for example, you have a mortgage. You might buy a 20-year term policy to ensure you have life insurance for the life of your mortgage. Policy terms can range up to 40 years, depending on the company you choose.
The cost of term life insurance is often lower than permanent life insurance, and the premium generally rises with the length of the term chosen. When a term life policy term ends and the insured is still alive, there is no pay out or return of premium unless it is a return of premium life policy. If you should die during the term of the policy, your survivors will receive the value purchased. The odds of a person actually cashing in on a term life policy are relatively low, which is why term policies are an affordable way to protect loved ones from financial hardship after an untimely death.
Permanent life insurance does not expire unless the insured does not pay their premiums or they forfeit the policy. The premiums for this type of policy are higher because part of it is applied toward savings or “cash value”. The longer your policy remains active, with regular payments towards it, the higher the cash value of your policy will be. The policy will build cash value by setting aside a portion of the premium but it will also have an interest rate or dividend attached. As long as an individual maintains his or her policy, the policy will pay out upon their death.
How to Choose between Term and Permanent
You’ll have to carefully assess your present needs. If you are on a tight budget and strictly want to cover dependents in the event you die, term insurance is probably the best option. If you have some extra income, permanent insurance may make more sense because you can earn interest and build an asset through cash value.
Many insurance professionals and financial experts recommend a combination of both policies. Let’s refer back to your mortgage. You know you’ll have it paid off in 10 years, so you take out a term policy with a 10-year term. The general need is to protect your mortgage and the premium is lower than a permanent life policy. You could invest the difference between what you pay for term and what you might pay for permanent into a separate investment account and then opt to buy a permanent policy, which carries a lower risk, later on.
Talk to your insurance agent about running a term vs. permanent analysis for you. You’ll be able to assess your needs and see, on paper, how you might want to spread your life insurance investments out over the course of your life.