When it comes to life insurance, the decision between permanent cash value life insurance and term life insurance can be a perplexing one. While term life insurance may seem like an attractive option due to its affordability, cost is just one factor upon which to base a decision to buy life insurance. In fact, in most situations, there is a compelling case to be made for the advantages offered by permanent cash value life insurance. The life insurance specialists at Cedar Point Financial Services LLC work with clients and their advisors to help them understand the differences between term and permanent life insurance coverage as well as advising them when each is appropriate.
A Choice of Policy Type
The primary purpose of all life insurance is to provide immediate liquidity to meet a financial need. This liquidity can come from either the death benefit, or in the case of many permanent policies, the cash value.
There are two general types of life insurance policies: term and permanent. Term insurance only lasts for a specified time period — 10, 15, 20, 25, or 30 years, for example.
Permanent insurance is as it sounds — coverage that remains in place until the death of the insured. In addition, permanent life insurance can be a financial tool that can help the policyholder build additional wealth by accumulating cash inside the policy on a tax preferred basis.
Term Life Insurance
Term life insurance is a simple, relatively inexpensive way to obtain life insurance coverage. If the insured dies during the term of years that the coverage is in force, the beneficiaries receive the death benefit proceeds. If the insured does not die during the term, the policy expires, and its coverage goes away.
For simplicity’s sake, think of term life insurance like leasing an apartment. There are a lot of similarities:
- The policyholder plans to need the policy only for a limited period of time.
- A term policy almost always requires lower premium payments than purchasing a permanent one.
- The policyholder does not build equity.
- At the end of the term, the policy like the apartment at the end of a lease is gone.
It may seem odd that anyone would purchase life insurance that ends after 10, 15, 20, 25, or 30 years, but there are circumstances in which it may make sense. For example:
- If the client is young, they may simply require inexpensive coverage to pay off debts, replace income for their significant others and/or provide for the education of young children, or to absorb funeral costs.
- If the client is fiscally minded, they may want to lock in a 20- or 30-year premium at a relatively low rate, while they are still young and healthy.
- If the client is in the final decade of their career, they may want coverage in an amount that will replace lost income if they unexpectedly die, enabling the clients’ spouse to still achieve retirement goals.
In each of these situations, it may be in the client’s best interest to consider convertible term life insurance. Convertible term life insurance is a term life insurance policy that includes a rider that allows its policyholder to convert their policy to permanent policies without additional medical underwriting. Most term life insurance in today’s marketplace is convertible.
Also, instead of allowing a term policy to lapse and become worthless, it is important to realize that it may be possible to sell it on the secondary market for significant proceeds through a life settlement transaction. This allows the policyholder to receive a lump sum payment, providing a valuable liquidity option for unforeseen circumstances or changing financial needs. Life settlement options may also be available for permanent cash value policies where coverage is no longer needed, wanted, or affordable and/or a current need for liquidity arises.
Among affluent clients, term life insurance applications are generally limited. Cedar Point Financial Services LLC is able to determine if a term life insurance policy is suitable for a prospective policyholder’s unique situation.
Permanent Life Insurance
Permanent life insurance provides protection for the policyholder’s entire life and does not expire like term life insurance so long as required premiums are paid.
If term life is like leasing an apartment, permanent life insurance is like purchasing a forever home. Here are some similarities:
- The client owns it for life as long as required premiums are paid to keep the policy in force.
- Premiums are typically higher than term insurance in the same way a home’s upkeep and repair adds costs relative to leasing.
- Permanent policies accrue equity in the form of cash value that can significantly grow over time on a tax preferred basis.
- It is an asset that a client can borrow from or against.
- It will benefit the client’s family or business (in the form of the death benefit).
Although permanent life insurance generally requires more cash flow than term insurance, it can be put to use as a valuable financial tool during the policyholder’s lifetime.
For example, it holds a cash value that can be withdrawn or borrowed against to meet an expected or unexpected need for liquidity, such as medical expenses, a child’s education or wedding, to purchase a second home, or supplemental retirement income. When permanent cash value policies are held by a business for succession planning or key person coverage, the cash value can be used to fund liabilities such as shareholder (living) buyouts or disability payments or as a sinking fund to meet other obligations. In some situations, policies purchased for business applications can be transferred or restructured to meet the personal estate planning needs of a company’s owners and/or key executives.
Many permanent life insurance policies have optional riders that permit policy proceeds to be advanced and used to cover long-term care and critical illness costs. These riders are often included at little or no additional cost and are an excellent way to provide supplemental financial support.
Perhaps of equal importance to the lasting protection a permanent cash value policy provides is its role as a significant asset. The policy’s cash value sits as an asset on a personal balance sheet or as a stable, low-risk asset class in a client’s investment portfolio. This is not the case with a term policy where the premiums are just an expense without a corresponding asset.
For many clients, a permanent life insurance policy may fit more than just one planning goal. The team at Cedar Point Financial Services LLC can explain how permanent life insurance may provide a multitude of benefits beyond a lasting death benefit.
Help is Here
Cedar Point Financial Services LLC has decades of experience in coordinating with clients and their advisors in implementing life insurance solutions. Regardless of whether a term or permanent policy has been purchased, there are additional steps to integrating life insurance into a financial plan. How the policy is owned – personally, by a trust, or by a company -- may have income and estate tax consequences. The source of premiums and how they are paid to the insurance company is important for not only the sustainability of the policy, but also in avoiding unnecessary gift taxation.
In addition, having the correct beneficiaries identified and accurately listed will prevent ambiguity when it comes time for the death benefit to be paid. Cedar Point Financial Services LLC works closely with clients and their other advisors to assist in structuring a life insurance solution to meet established goals and objectives.