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Life Insurance: Term versus Permanent

Hoover Financial AdvisorsFebruary 4, 2016

Insurance

One of the most important aspects of any financial plan is addressing and covering risk. In working with clients we uncover risk in many forms – investment risk, the risk of not saving enough, and the risk of not properly organizing your affairs for when you are gone. One of the most effective ways to cover the risk of loss is through the use of insurance.

Term vs. Permanent

There are two broad categories of life insurance: term and permanent. Considered temporary life insurance, a term policy is typically selected to cover specific needs for a period of time. On the other hand, permanent insurance policies generally cover a need in conjunction with providing a “return” of some form in the event the policy is never used as originally intended. For instance, some policies may have the ability to provide investment returns through underlying policy investments or through the return of cash at some point. Following are some basic features of both types of insurance:

Term Insurance

Permanent Insurance

Features
▪ Temporary life insurance ▪ Permanent life insurance
▪ Two types: level premium term (premiums remain the same) and annual renewable term (premiums change each year) ▪ Many different types exist, including: whole life, variable life, universal life, and variable universal life
     ◦ Note: in the event the term ends on a level premium policy, it typically converts to an annual  renewable term, if desired ▪ Premiums may be fixed or flexible depending on the type of policy
▪ Provides specified death benefit ▪ Can provide a specific or variable death benefit
▪ Contract is for a specific period of time, generally 10, 15, 20, or 30 years ▪ Typically features “cash value” – an amount of cash the policy owner is entitled to, even if the policy is terminated
▪ May have the option to convert to permanent insurance ▪ Generally separated into two accounts – one for the death benefit, another for the cash value
▪ If the insured lives past the term, no payment is made at death as the insurance is technically no longer in force ▪ Investments in the market can sometimes be made with some funds depending on the structure of the policy
▪ Guaranteed insurability for the life of the contract ▪ Some policies provide the insured with the ability to take withdrawals or loans against the policy
▪ May sometimes be used as a component of gifting/estate planning strategies
▪ May sometimes be used for additional investment/savings opportunities for high net worth individuals
Pros / Cons
▪ Pro: Ability to receive a substantial amount of coverage at a relatively minimal cost ▪ Pro: Builds living benefits through the use of cash value, providing possible funds for other uses
▪ Con: Over time, term insurance becomes more expensive. The cost of insurance as one ages can become cost-prohibitive. ▪ Con: the cost of maintaining these policies can be exorbitant
▪ Con: Pure death protection only ▪ Con: In some cases, the policy owner may face investment risk just as one would see in the market

Addressing Your Risk

So is term or permanent insurance best for you? While one answer does not exist for every situation, consider these factors in analyzing your options:

  • Need: Take some time to think about what is most important to you in providing coverage for your loved ones. Are you most concerned about covering the mortgage? How about providing enough funds for college for your children, or sufficient income to transition your partner past the loss for a period of time? Each individual has distinct thoughts on what is most important to them in a loss of life scenario. Take some time to determine your priorities and what gives you the most peace of mind.
  • Contributions: Have a realistic and honest conversation with yourself and your partner/family about your contributions to your overall financial situation. A lower income does not necessarily mean a smaller need for insurance exists, as intangible contributions can be quite significant when dollars and cents are attached to them. Determining how much you contribute – both financially and otherwise – is an important factor.
  • Cash Flow: Irrespective of your need for insurance, what is your ability to pay for a policy? Premium payments can vary widely depending on the type of policy you purchase. How much – and for how long – are you willing to pay these premiums?
  • Employer-Sponsored Plans: Keep in mind that most employers provide some form of life insurance coverage to their employees. While the coverage may not be sufficient and would actually be lost if you switched employers, it is good to have a handle on exactly what is available to you as you evaluate total need. Some employer plans will also allow you to purchase additional coverage through the plan. It is worth noting that coverage for group policies such as these are typically issued without any underwriting. If you have health issues/concerns, this is a huge advantage.
  • Legacy Intentions: Though not as common, some individuals view insurance as a way to provide their heirs/family members with funds after their passing. If this seems to fit within your needs, determine how much you are hoping to leave for this specific purpose and how it can best be structured to meet your needs.

As always, make an effort to work through this issue with the professionals you engage. Hopefully, you are working with a financial planner (or other professional operating under the fiduciary standard) that can walk you through a detailed and thoughtful analysis. At the very least, find an insurance agent you trust to talk through your concerns and identify the best fit for you.

In summary, life insurance is an extremely personal topic and choice. There are many different factors that weigh into the decision-making process that can seem daunting. If you would like help analyzing or discussing your personal situation please feel free to contact our office. We would be happy to help you sort through your options and provide professional guidance.