Term vs. permanent life insurance
At Bankrate, we understand that choosing a life insurance policy can feel like a big decision. For many, it’s about creating a financial safety net for loved ones — whether that means helping cover future expenses, providing income replacement or simply offering peace of mind. When exploring your options, you’ll likely come across term or permanent life insurance, two of the most common types of coverage.
Each has its own benefits, and understanding how they work can help you make a more informed choice for your unique circumstances. In this guide, we’ll explore what sets these policies apart and offer insights to help you navigate which one might align with your needs.
What is term life insurance?
Term life insurance is a type of life insurance that provides coverage for a specific period, or “term,” such as 10, 20 or 30 years. During this term, if the insured passes away while the policy is active, the beneficiaries receive a tax-free death benefit to help cover expenses like income replacement, debts or future financial needs. However, no death benefit is paid if you die after the coverage has ended.
The most common type is level term life insurance, where both the premium and death benefit remain fixed throughout the term. Other variations include annual renewable term (ART), where the premium increases each year; decreasing term, where the death benefit reduces over time (often to match a mortgage balance); and return-of-premium (ROP) term, which refunds the premiums paid if the insured outlives the policy. These options allow policyholders to tailor their coverage to meet specific needs.
When the policy term ends, there are a few options. Many policies offer renewability, enabling you to extend coverage annually, though premiums typically increase with age. Some policies also provide a conversion option, which allows you to switch to a permanent life insurance policy, such as whole or universal life, without a new medical exam. Alternatively, you can let the policy expire if additional coverage is no longer needed.
As with anything, there are pros and cons to term life policies. Let’s look at a few:
Pros
- Affordable and predictable costs: Term life is more affordable than permanent life insurance and typically offers fixed premiums for the duration of the term.
- Flexible coverage duration: You can choose a term length that aligns with your financial goals, such as raising children, paying off debt or covering a mortgage.
- Simplicity: Term life policies are straightforward, providing pure life insurance without the added complexities of cash value or investment components.
Cons
- Coverage ends with the term: If the policy expires and isn’t renewed or converted, no death benefit is paid.
- Renewals can be costly: Premiums may increase significantly if you renew the policy after the original term ends.
- No cash value accumulation: Unlike permanent life insurance, term policies don’t build value.
Term life insurance could be an excellent choice for those looking for affordable coverage for a set time period to protect their loved ones during critical financial periods.
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Whole life insurance combines life insurance with an investment component.
- Coverage for life
- Tax-deferred savings benefit if premiums are paid
- 3 variations of permanent insurance: whole life, universal life and variable life include investment component
Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.
- Fixed premium over term
- No savings benefits
- Outliving policy or policy cancellation results in no money back
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What is permanent life insurance?
Permanent life insurance provides long-term coverage, enabling your beneficiaries to receive a death benefit whenever you pass away. For those wondering what permanent life insurance is, it’s a policy designed to last your entire life, as long as premiums are paid. Coverage typically extends from ages 95 to 121, depending on the policy and insurer.
One standout feature of permanent life insurance is its cash value component. This feature allows a portion of your premium payments to accumulate value over time. While not a savings or investment account, cash value offers flexibility, and you may be able to borrow against it, withdraw funds or even use it to pay premiums. However, these benefits come at a higher cost, as permanent life insurance tends to be significantly more expensive than term life insurance.
Permanent life insurance policies come in several types, each offering unique benefits and features:
- Whole life insurance: This traditional form of permanent life insurance provides fixed premiums, a guaranteed death benefit and a predictable cash value growth rate. The cash value grows based on a guaranteed interest rate set by the insurer. Participating whole life policies can also receive a dividend. Whole life could be ideal for those seeking stability and a straightforward policy.
- Universal life insurance: With universal life, you get flexibility in your premium payments and death benefit amounts. The cash value grows based on interest rates set by the insurer, which are subject to change. If you’re looking for flexibility to adjust your coverage as your needs change, this policy may be a good fit.
- Indexed universal life insurance: Indexed universal life (IUL) is a popular type of universal life insurance. It has the same flexibility options, but the cash value crediting interest rate is based on a specific market index, such as the S&P 500.
Variable life insurance: This type of permanent policy allows you to invest the cash value in market-based options such as stock mutual funds and bond mutual funds or other mutual funds. While this offers the potential for higher returns, it also carries higher risks. Poor investment performance can impact the cash value and even the death benefit, making it best suited for those comfortable with market fluctuations.
The cash value feature in permanent life insurance provides a versatile financial tool. As part of your premiums go toward the cash value, this amount grows over time based on the type of policy. Here’s how you can use it:
- Loans: Borrow against the cash value for major expenses, like education or emergencies. Loans are tax-free but must be repaid with interest to avoid reducing your death benefit.
- Withdrawals: Take money out for immediate needs. However, withdrawals lower the cash value and may reduce the death benefit if not replenished.
- Pay premiums: Use the cash value to cover your premium payments once it has grown sufficiently.
Consequences to consider: Borrowing or withdrawing from your cash value can reduce the death benefit left for your beneficiaries. If unpaid loans exceed the cash value, your policy could lapse. Always review the terms carefully before accessing funds.
Now that you have a baseline knowledge about permanent policies, let’s weigh some pros and cons.
Pros
- Lifelong coverage: Coverage typically remains in force for your entire life, providing peace of mind.
- Cash value growth: Offers financial flexibility for loans, withdrawals or premium payments.
- Locked-in premiums: Whole life policies and some UL policies feature fixed premiums that won’t increase over time.
- Not impacted by new health conditions: Your coverage isn’t affected by health issues that develop after you purchase the policy.
Cons
- Higher cost: Premiums are significantly more expensive than term life insurance.
- Complex structure: Policies are more complicated than term life and may require ongoing management.
- Market risk (variable life, variable universal life): Poor investment performance can reduce cash value and even the death benefit.
- Possible lapses: Unpaid loans or insufficient cash value could cause the policy to lapse, potentially with a phantom income tax gain.
Permanent life insurance could be an excellent option for those who want lifelong coverage, financial flexibility or an estate planning tool. By understanding the features and trade-offs of each type of policy, you can determine whether permanent life insurance aligns with your long-term goals.
Permanent vs. term life insurance
When comparing term life insurance vs. permanent life insurance, it’s helpful to focus on the primary differences: how long you’ll need financial protection and your available budget. Each type has unique advantages, and understanding their distinctions can help you choose the right option for your family.
Coverage duration
- Term life insurance is designed to last for a specific period, typically 10, 20 or 30 years. It’s best for temporary needs, like covering a mortgage, replacing income while raising children or other financial obligations that diminish over time.
- On the other hand, permanent life insurance lasts your entire life as long as premiums are paid. It’s better suited for lifelong needs, such as leaving an inheritance, covering estate taxes or providing for dependents with long-term needs.
Cost considerations
- Term life insurance typically has lower, fixed premiums, making it the more affordable option. This is why it’s popular among young families and those with tight budgets.
- Permanent life insurance comes with higher premiums because it offers lifetime coverage and includes a cash value component. This cash value grows over time and provides additional financial flexibility, but the higher cost may not fit every budget.
Added features
- Term life insurance policies are straightforward, focusing purely on the death benefit with no additional cash value or long-term savings feature.
- Permanent life insurance includes a cash value component, which can be accessed through loans or withdrawals. However, using the cash value can reduce the death benefit if not managed carefully.
By laying out these differences, it becomes clear that term life insurance is often the best choice for finite protection needs, while permanent life insurance offers long-term financial tools alongside lifelong coverage. Understanding how these two types work can guide you in selecting the policy that aligns with your goals and financial situation.
Why choose term life insurance?
Term life insurance is a budget-friendly way to protect your family during life’s most financially vulnerable years. With lower premiums compared to permanent policies, it could free up room in your budget to save for other priorities, like building an emergency fund or investing more heavily in a 401(k). It’s a practical option for those who need coverage tied to specific timelines, such as raising children, paying off a mortgage or covering college tuition.
This type of policy works well if your financial responsibilities have a clear end date. For instance, a 20-year term can provide peace of mind while your kids are still growing up or until major debts are paid off. When the policy ends, you may no longer need the same level of protection, allowing you to focus on other financial goals. With its affordability and simplicity, term life could be a smart choice for families looking for short-term security without stretching their budget.
Why choose permanent life insurance?
Permanent life insurance can provide lifelong coverage and is designed for families or individuals with enduring financial responsibilities. This could make it ideal for those with dependents who have special needs, small business owners protecting their legacy or individuals with significant assets seeking estate tax advantages.
Unlike term policies, permanent insurance doesn’t expire — as long as premiums are paid and there is sufficient cash value to cover costs — offering long-term peace of mind. It also comes with a cash value component that grows over time and can be used for loans, withdrawals or even to cover premiums. While it’s not an investment account, this added flexibility can help manage unexpected expenses.
For high-net-worth individuals, permanent life insurance can play a critical role in estate planning, helping to preserve wealth and ease the transfer of assets to heirs. Though the premiums are higher, the combination of lifelong protection and financial tools could make it a valuable option for those with lasting obligations or advanced financial needs.
Alternatives to term and permanent life insurance
While term or permanent life insurance are usually the most popular options, they’re not the only ways to plan for end-of-life expenses or provide financial support for your loved ones. Depending on your needs, budget and stage of life, there are several alternatives worth considering:
- Final expense insurance: Final expense insurance is a small whole life policy designed to cover end-of-life costs, such as funeral expenses, burial fees or medical bills. With coverage amounts typically up to $25,000 (no medical exam or health questions) or $50,000 (health questions but no exam), this option offers peace of mind to those who want to avoid leaving their family with unexpected expenses. It’s often easier to qualify for final expense insurance, making it a practical choice for seniors or individuals with health issues.
- Guaranteed issue life insurance: Guaranteed issue life insurance provides coverage without requiring a medical exam or health questionnaire. While premiums are higher, this type of policy is ideal for individuals who may not qualify for traditional life insurance due to health concerns. Coverage amounts are generally modest, up to $25,000, making it a suitable option for covering specific needs like funeral costs or small debts. Keep in mind that there’s often a waiting period before full benefits are available.
- Pre-paid funeral insurance: Pre-paid funeral insurance works hand-in-hand with a funeral home to lock in today’s prices for your arrangements. This specialized policy ensures that your funeral costs are covered according to your preferences. However, it’s worth comparing it to other options like final expense insurance or dedicated savings accounts to make sure it aligns with your long-term financial goals.
- Dedicated savings account for end-of-life costs: If you prefer a straightforward, no-strings-attached option, consider setting up a dedicated savings account for funeral and end-of-life expenses. By consistently contributing to this account, you can build a nest egg to handle these costs while maintaining complete control over the funds. This approach avoids insurance premiums but requires discipline and a long-term commitment to saving. Note: Consider that if you die prematurely, your savings may be underfunded.
- Group life insurance: Often provided as a workplace benefit, group life insurance can offer a low-cost way to secure coverage. While coverage amounts are usually limited and tied to your employment, it’s a good supplemental option for those who want a safety net without the higher costs of an individual policy. Keep in mind that group life insurance typically ends if you leave your job, so it may not serve as a long-term solution.
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