Permanent life insurance refers to any cash value type of insurance that provides continuous coverage to age 95 or 100. This type of policy generally has a level premium that must be paid to keep the coverage in-force. Under some circumstances, premium payments may be reduced or stopped, but this cannot be counted upon. Permanent policies typically will accumulate a cash value, which is tax deferred. Most permanent policies allow you to borrow against the policy value or withdraw all or a portion of the cash value.
Premiums for permanent life insurance are higher than you would pay for the same face amount of term insurance, but they are less than the cumulative premiums you would eventually pay if you were to keep renewing a term policy into advanced age. This is because interest earned on the cash value helps to offset the higher cost of pure life insurance protection as the insured person grows older.
Some policies (e.g., universal life) allow you to vary your premium payments every year and even skip a payment if you wish. The premiums you pay (less expense charges deducted from the premium payments) go into an accumulation account that earns interest. Mortality (insurance) charges are deducted from the account. Insurance coverage continues as long as there is enough money in the account to pay the insurance charges.
The cash value of many life insurance policies may be affected by an insurance company’s actual experience over time. For example, mortality expense charges are based on actuarial assumptions that may require periodic adjustment as national mortality experience gradually changes. Likewise, expense charges are affected by such factors as how efficiently the company operates, economies of scale, overall company expenses, and so forth. Policy loans will also affect the long-term performance of a policy.
To best explain how the cash value of a life insurance policy works, image a barrel of water. Every so often – whether it be annually, semi-annually, quarterly, or monthly – premiums are paid into the policy. This increases the level of water in the barrel.
The insurance company turns the spigot monthly and takes out its expenses and mortality charges.
If there is not enough water in the barrel, the policy will lapse and possibly terminate.
The remaining water in the barrel is the accumulated value. Subtract the surrender fees and you get the surrender value.
Advantages of Permanent Life Insurance
- As long as the necessary premiums are paid, protection is guaranteed for life.
- Premium payments can be fixed or flexible to meet personal financial needs.
- The life insurance policy accumulates a cash value that may be borrowed against. Loans must be paid back with interest, or else the beneficiary will receive a reduced death benefit. You may borrow against the policy’s cash value to pay future premiums or use the cash value to provide paid-up insurance with certain policies.
- The policy’s cash value may be surrendered partially or entirely for the cash value, or it may be converted to an annuity. An annuity is an insurance product that provides an annual income for every year in a person’s lifetime or for a specific period of time.
- An additional rider can be added to a policy, giving you the option to purchase additional insurance without taking a medical exam or having to furnish evidence of insurability.
- It pre-funds the high rising insurance costs.
- The cash value accumulates on a tax-deferred basis in most cases.
Disadvantages of Permanent Life Insurance
- Higher premium payments, when compared to term life insurance, which may make it hard to buy enough protection.
- It may be more costly than term insurance if you don’t keep it long enough, as the premiums are higher than term insurance in the early years of the contract.