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I think you’ll agree with me when I say:
Life insurance products are WAY too confusing for the layman.
Or is it?
Well, it turns out that the vast majority of life insurance products fall under 1 of 2 categories: term and permanent.
Two categories – much easier to remember than dozens of products, right?
In this post, I will do a thorough comparison between them – the ultimate term vs permanent life insurance showdown.
And in the end, I’ll also help you answer the question:
“Which one is right for me?”
What Is Term Life Insurance?
Term life insurance is simple to understand.
You choose a term and the premium is level for the entire initial term. After that, the premium increases for the next term. This premium increase is guaranteed from the outset.
Using a term-10 policy as an example, the premium is level for the first 10 years. It then increases to the next step at year 11 and stays the same until year 20, increase at year 21 until year 30, and so on.
The premiums are very low during the initial term but hike up on renewal.
It’s not uncommon to see an increase of 15-20x the original premium! An affordable $50/month now can skyrocket to an eye-popping $1,000/month in 20 years!
The most common terms are 10, 20 and 30 years. Most term policies expire after a certain age, usually 80 or 85.
Because of its short-term nature and low initial cost, term insurance is essential for young families that need to cover debt and provide an income until the children are grown up.
There is no cash value within a term policy. Once terminated, you lose the coverage and don’t get anything in return. That’s why it’s known as ‘pure life insurance‘.
You can also convert term insurance to permanent insurance up to a certain age. This is extremely useful in case you don’t qualify for insurance anymore because of a medical condition and need some permanent protection.
You can convert a portion or the entire amount – it’s up to you.
If you choose to convert, the rates will be based on your attained age.
Lastly, term insurance is perfect for joint first-to-die life insurance, a type of policy that pays out on the first of 2 people’s deaths.
Now let’s take a look at permanent life insurance.
What Is Permanent Life Insurance?
Permanent life insurance is the opposite of term.
Whereas term covers short-term needs, permanent covers permanent needs.
Term has no cash value, but permanent does (most of the time).
Term is perfect for joint first-to-die insurance, while permanent is essential for joint last-to-die.
What else is different about permanent life insurance?
Typically, the premium is level for the life of the policy. There are exceptions, such as limited pay policies, which only require payment for a limited period of time before the policy is paid-up.
There are also policies where the premium increases annually until a certain age (such as 85), at which point it is paid-up.
With most policies, there’s also a savings component. This lets you grow your investments tax-deferred, like with an RRSP.
The cash value accumulated is paid out at death tax-free. You can also withdraw or borrow against it while living, usually to supplement retirement or for a large purchase.
If you cancel your policy before the payment period is over, you get the cash surrender value paid out to you.
Because of its long-term nature, permanent insurance is most often used by retirees for funding final expenses (funeral costs), estate planning, and charitable donations.
The simplest permanent insurance is one where you pay a level premium for life.
The complex ones let you choose the length of the payment period, the investments, the cost of insurance, the type of death benefit, and more.
You might have heard of a number of different permanent life insurance products: whole life, participating whole life, universal life and term-100.
What’s not important right now are the differences between them.
You just need to understand that they are all permanent life insurance and share most of the traits above.
Term or Permanent? (Why Not Both?)
So, which one is right for you?
To answer this question, you have to ask yourself why you are buying life insurance in the first place.
Let’s consider a few different scenarios. What should you get when you:
1. Are a younger individual simply looking for the most cost-effective way to protect your family?
2. Have maxed out your RRSP and TFSA, belong to the highest tax bracket, and need another means of investing in a tax-sheltered environment?
3. Are in your 60’s and want to make sure you don’t burden your loved ones with final expenses?
4. Are concerned about the impact that tax will have on your estate upon your passing?
5. Are a business owner concerned about the death that a key employee will have on your profits?
If you answered term, permanent, permanent, permanent and term in that order, then you have a solid grasp of the type of policy that is suitable for different scenarios.
Review your main reason for buying life insurance, and see which product fits that need best.
Cost analysis
That was a qualitative analysis. How about a quantitative analysis?
Having concrete numbers always makes comparisons easier to process.
Let’s take a look at the monthly premium of a non-smoking 30-year-old male for $500,000:
As you can see, the premium for the term products starts off ridiculously low at $24.3/month for term-10 and $33.75/month for term-20.
The term-10 triples to $72/month in years 11-20 and increases to $179.1/month in years 21-30.
The term-20 increases almost tenfold to $322.65/month in years 21-40.
Meanwhile, the permanent policy stays at $232.58/month for its entirety. This policy does not have any cash value, making this a direct apple to apple comparison between term and permanent life insurance.
Overall, he would have paid $559,332 for the term-10 policy and $449,226 for the term-20 policy until expiry at age 85.
He would have paid only $153,503 for the permanent policy until age 85. Of course, he can continue paying for another 15 years until age 100, when his policy would be paid up.
Does this mean that permanent is a better deal compared to term?
Not necessarily.
It’s true that if you are planning to buy insurance and hold it until you die, then the permanent policy gives you more cost certainty.
But what if you want to hold it until the typical retirement age of 65?
Going back to our example, he would have paid $66,204 for the term-10 policy, $66,177 for the term-20 policy and $97,684 for the permanent policy.
This tilts the balance back in term insurance’s favour.
Of course, this is just one comparison. But overall, you will find a similar pattern no matter your age, gender, and smoking status.
How about both?
Nobody says you must pick one over the other.
If you have both a temporary and a permanent need, then you should get both types of insurance.
For example, what if you belong to both scenarios #1 & #2 above? Or what if #3 fits your situation, but you also have some debt and dependents?
In these cases, you would be better off getting both term and permanent insurance.
For instance, a common strategy is to buy a smaller permanent policy for the savings component and attach a larger term-20 rider to cover your mortgage.
After 20 years, you terminate the term-20 rider and keep the permanent policy. This lowers your coverage substantially, but your premium also drops to an even more affordable amount.
The general idea is that you don’t need that much coverage after 20 years since your debts will be paid off by then and your children are grown up.
In the meantime, you can contribute more than the minimum amount to the permanent policy. This builds a sizable cash value inside the policy to supplement your retirement.
Here’s what that looks like for a non-smoking 30-year-old male for $550,000 of coverage, comprised of $50,000 of permanent and $500,000 of term-20 coverage:
In this example, the term-20 rider is dropped after 20 years, leaving just the permanent policy.
This strategy is called laddering life insurance.
You buy policies of different terms and layer them one on top the other, canceling each when the policy is up for renewal.
This lets you stack insurance coverage, giving you the most coverage now when you need it, and dropping it as your need for insurance falls.
Why stop at layering 2 coverages?
There are no limits on how many form your ladder, so it’s common to see up to 3 or 4 coverages of different terms layered on top of one another.
For example, term-10, term-20, term-30 and permanent coverages can be layered together.
This will give you comprehensive coverage guaranteed to cover you over both the short and long term.
Now It's Your Turn
Now you know the differences between term and permanent life insurance.
What do you think? Are you going to buy term life insurance? Or are you leaning towards permanent life insurance? How about a laddered strategy?
If you need help making a decision, we are always available at info@briansoinsurance.com or a quick phone call away at 604-928-1628. We will help you find the best solution based on your unique situation and give you a free quote.
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