Permanent life insurance: what it is and how it works
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Life insurance policies fall into two primary categories: term life or permanent life. Both will pay an income tax-free benefit to your beneficiaries if you pass away, but with term life insurance, coverage only lasts for a limited amount of time (the policy "term" is typically 10, 20, or 30 years). Permanent life insurance policies provide lifelong coverage — even if you live to 100, the policy will pay a benefit as long as premiums are paid.1 Permanent policies, such as a whole life policy, have another important feature: they build cash value.2 Premium dollars can contribute to a policy’s cash account while growing – tax-deferred – and can be used while you're still alive.3 Over time the cash account can grow into a sizable asset that can be borrowed against with tax advantages, used to pay premiums, or even surrendered for cash to help fund your retirement.
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There are two main types of permanent life insurance: whole and universal
Both provide lifetime coverage and have a cash value component but differ in other ways.4
Whole life insurance | Universal life insurance |
|---|---|
For people who want more guarantees Universal life insurance For people who want more flexibility The premium is guaranteed. The premium payments never change or increase with age, so you always know the cost. | For people who want more flexibility. Premiums can vary. You can raise or lower your payments within certain limits, making it easier to keep your coverage if your circumstances change. But you may eventually have to pay higher premiums to keep your policy in force. |
Cash value growth is guaranteed. A whole life insurance policy builds tax-deferred cash value at a guaranteed rate over the life of the contract. So you know it will be worth at least a predetermined amount if you want to access the policy's cash. However, it could also grow faster if the policy qualifies for dividends (see below).5 | Cash value growth can vary. The cash account growth is also tax-deferred. Despite having a guaranteed interest rate, because of the premium flexibility, the projected future guaranteed cash value may change over the course of coverage. |
There's a guaranteed death benefit. However, the payout will be reduced if there are outstanding policy loans when the policyholder passes away. | The death benefit can vary. A universal life policy may allow you to change the amount of your death benefit. |
Whole life insurance policies cost more than universal life. | Universal policies are less expensive than comparable whole life policies. |
How does cash value accumulate in a permanent life policy?
Cash value grows on a tax-deferred basis. Still, growth varies depending on the type of permanent policy — just as funds grow differently in a bank savings account versus a brokerage account. With whole life insurance, funds grow at a guaranteed interest rate — but if you get your policy from a "mutual" insurer, you may receive dividends that can boost cash value growth beyond the guaranteed rate. That's because mutual insurance companies — like Guardian — are actually owned by their whole life policyholders, who may qualify for annual dividends based on policy cash value and company performance. While dividend payments cannot be guaranteed, Guardian has paid them to customers every year since 1868. These payments can further increase your cash value and have the potential to make a size able contribution to your overall wealth. If you decide to surrender your policy, you will receive the cash surrender value, which is the amount of cash value accumulated minus any surrender charges.
Unlike whole life insurance, you don't receive dividends on universal policies, even with a mutual insurer. However, because the interest rate in a standard universal life policy (or UL) is variable, your cash value can grow faster or slower than for whole life. And, for those willing to accept a greater degree of risk, there are two variations on UL that offer the potential for even greater growth because the investment component is based on market returns:
A variable universal life insurance policy (VUL) gives you the option to tie cash value growth to grouped stock market and bond investments called "sub accounts."6 However, growth in a variable life insurance policy is not guaranteed as in a standard universal or whole life policy. You, the policyholder, assume investment risk for any losses – just as you would with a brokerage account.
An indexed universal life insurance policy (or indexed UL) lets you tie all or part of your cash value growth to the performance of a broad securities index, such as the S&P 500.7 There's a floor and cap for the minimum and maximum rates of return, so while you won't realize all the gains of your reference index, you won't suffer all the losses either.
How different permanent policies calculate cash value growth
Whole life | A guaranteed fixed interest rate, plus potential dividends with a mutual company |
Standard universal life | Current market interest rates, but guaranteed not to go below a minimum set in the insurance contract |
Variable universal life | Based on the performance of sub account investments you choose, which are similar to mutual funds. You enjoy any gains and assume the risk for any losses. |
Indexed universal life | Based on the performance of a broad market index, such as the S&P 500, with minimum and maximum caps to limit your investment risk. |
Four ways to use cash value while you're still alive
Money in your cash value isn't taxed as it grows, so it has the potential to grow faster. It usually takes a few years for cash value to grow into a usable sum, but once that happens, it becomes a financial asset with many advantages. Generally speaking, there are four ways to access the value of that asset:
Surrender | You cancel the policy and take the cash surrender value payment. However, you'll no longer have life insurance protection. With a newer policy, there also can be significant surrender fees and/or taxes, so it's generally not advisable before retirement age since there are other ways to use policy funds. |
Withdrawal | You can typically withdraw cash from your permanent policy, and the money is non-taxable as long as it's less than the amount paid into the policy. However, the death benefit will usually be reduced, and the reduction may be greater than the amount withdrawn, depending on the terms of your policy. |
Loans | You can use your policy cash value to secure a loan that grows at a fixed or variable loan rate set in the contract. Rates can be competitive or lower than a personal loan and there is no application or credit check. You can even choose not to repay, but the outstanding loan balance will normally be deducted from your death benefit. |
Premium payment | Want to stop paying premiums after you retire? You can often use the your cash value to pay part or all of your premiums. This can make it much easier to keep your coverage intact if your income declines when you are no longer working. |
Pros and cons: permanent vs. term life insurance
Permanent coverage | Term coverage | |
Yes | Income tax-free death benefit | Yes |
Higher | Cost | Lower |
Lifetime | Coverage length | Temporary |
Yes | Cash value | No |
Yes | Policy loans | No |
Yes, typically | Health exam required | Yes, typically |
Yes | Estate planning benefits | Not typically |
Yes | Customizable riders8 | Yes |
How much does permanent insurance cost?
Many factors impact the cost of life insurance premiums, including age, gender, tobacco use, overall health, and the amount of coverage. But in general, permanent life insurance costs significantly more than term life insurance because it provides considerably more benefits – and can be used in ways that term life can't. Also, whole life insurance rates tend to be higher than universal life. Your specific policy cost will vary, but the following charts show typical rates for healthy male and female nonsmokers at different ages. Note that no matter what kind of coverage you want, the younger you are, the less you'll pay.
$500,000 coverage - Average Monthly premiums for women
Term1 | Universal2 | Whole3 | |
Age 30 | $16 | $125 | $313 |
Age 40 | $24 | $187 | $467 |
Age 50 | $54 | $320 | $733 |
$500,000 coverage - Average Monthly premiums for men
Term1 | Universal2 | Whole3 | |
Age 30 | $19 | $144 | $355 |
Age 40 | $28 | $219 | $541 |
Age 50 | $69 | $359 | $856 |
1 Source: https://www.nerdwallet.com/article/insurance/average-life-insurance-rates Accessed 06/15/2022
2 Source: https://www.nerdwallet.com/article/insurance/universal-life-insurance Accessed 06/15/2022
Permanent life policies can be tailored to your needs
Most term life and permanent policies offer "riders" – optional provisions that give you added protection and benefits. However, permanent insurance policies typically offer more riders and customization because they're designed to cover a lifetime of different possibilities. Here are some of the options to discuss with your financial professional:
Waiver of premium rider:9 If you become disabled and can't work, this rider will pay your entire premium, allowing you to keep your policy in effect. A similar rider, called "Waiver of Cost of Insurance," 10 only pays the death benefit portion of your premiums, not the cash value portion.
Accelerated benefit rider: This rider provide an option to accelerate a portion of the death benefit while you are still alive if you become terminally ill or chronically ill (not able to perform at least two out of six Activities of Daily Living (ADL).
Guaranteed insurability rider: This allows you to increase the size of your death benefit at certain times without providing evidence of insurability or undergoing a new medical exam – effectively letting you lock in lower rates now and get a bigger policy later. Guardian gives you up to eight option dates throughout your life to purchase additional coverage.
Tax Benefits of Permanent Life Insurance
Permanent life insurance policies offer several tax benefits that can help policyholders save money and maximize their coverage. Here are some of the key tax benefits of permanent life insurance:
Tax-deferred cash value growth: The cash value of a permanent life insurance policy grows tax-deferred, meaning that policyholders won’t have to pay taxes on the gains until they withdraw them. This allows the cash value to accumulate more efficiently over time.
Income tax-free death benefit: The death benefit of a permanent life insurance policy is typically paid out income tax-free to beneficiaries. This ensures that your loved ones receive the full amount of the death benefit without any tax deductions.
Tax-efficient loans: Policyholders can take out loans against the cash value of their policy which can provide a source of tax-efficient funds for various financial needs.
Tax-efficient withdrawals: Policyholders can withdraw cash from their policy without having to pay taxes on the withdrawal amount, as long as it does not exceed the amount of premiums paid into the policy. This can be a valuable source of tax-free income in retirement.
Who Should Get Permanent Life Insurance?
Permanent life insurance is a good option for anyone who wants lifelong coverage and a cash value component. Here are some scenarios where permanent life insurance might be a good fit:
Families with young children: Permanent life insurance can provide a death benefit to support children’s education and living expenses if a parent passes away. This ensures financial stability for your family during critical years.
Business owners: Permanent life insurance can be used to fund buy-sell agreements, provide key person insurance, and offer employee benefits. It helps in maintaining business continuity and protecting the company’s financial health.
High-net-worth individuals: Permanent life insurance can be used to pay estate taxes, provide liquidity for heirs, and offer a tax-efficient way to transfer wealth. It helps ensure that your estate is preserved and passed on according to your wishes.
Individuals with special needs: Permanent life insurance can be used to provide a death benefit to support individuals with special needs. This helps ensure that they have financial support even after you are no longer there to provide for them.
Getting the Most Out of Your Policy
To get the most out of a permanent life insurance policy, policyholders should:
Choose the right type of policy: Whole life, universal life, and variable universal life insurance policies offer different features and benefits. Policyholders should choose the type of policy that best fits their needs and financial goals.
Pay premiums on time: Paying premiums on time is crucial to maintaining coverage and building cash value. Consistent premium payments ensure that your policy remains in force and continues to grow in value.
Monitor and adjust the policy: Policyholders should regularly review their policy to ensure it still meets their needs and make adjustments as necessary. Life circumstances can change, and your policy should adapt to those changes.
Take advantage of riders: Riders can provide additional benefits and features, such as waiver of premium or accelerated death benefit. These options can enhance your policy’s value and provide extra protection.
Consider working with a financial professional: A financial professional can help policyholders choose the right policy, optimize their coverage, and integrate their life insurance with their overall financial plan. Professional guidance can ensure that you make the most informed decisions about your life insurance.
By following these tips, policyholders can maximize the benefits of their permanent life insurance policy and ensure that it continues to meet their financial needs throughout their lifetime.
Talk to a life insurance professional about your needs
Life insurance costs go up with age, so there's no better time than the present to consider getting a policy. Permanent life insurance can be a powerful financial resource that helps to protect your family and lifestyle now, and builds cash value for needs later in life. However, your situation is unique, and professional guidance is needed to build a permanent life contract designed for the specific needs of you and your loved ones. So it helps to discuss your situation with a financial professional who has helped others get whole life insurance coverage. If you need help finding such a person, Guardian can connect you to a financial professional who can help.