When shopping for life insurance, you face the same decision you must make when you're in the market for a new car: lease or buy?
Those aren't the words used for insurance, of course, but the concepts of term and permanent life insurance are similar to leasing and buying.
Term insurance is like leasing a car. You purchase death benefits for a specified period --usually 5, 10 or 20 years. When the period is over, it's like turning in the leased car. The deal is done and you walk away.
Permanent insurance, on the other hand, is like buying the car you plan to drive forever. Permanent insurance stays in force as long as you live. It will pay a death benefit, and it accumulates a cash value, too.
The two kinds of life insurance are appropriate for different situations. Term insurance is designed for those who are interested solely in a death benefit; for example, a young father who wants insurance so that his child will be able to afford college if Dad is not around to pay the bills. There is no cash value to this kind of insurance, so often the premiums are lower than they are for permanent insurance. But as the insured gets older, the premiums increase.
Permanent insurance combines a death benefit with a cash value, or savings component, which grows tax-deferred. Many policyholders borrow from the cash value to pay for things such as a college education, or convert their cash value into a retirement fund.
Because of the savings component, permanent life insurance may cost more than term life, especially at the beginning. But the premium
remains fixed for the life of the policy.
Many people are familiar with the saying "buy term and invest the difference," which suggests going for the lower premiums and taking care of the savings component on your own rather than counting on the insurance policy for
investment growth. With recent high returns in the stock market, many investments are growing faster than cash values.
Various types of permanent insurance plans, however, do give the insured the option of deciding how the savings is invested.
While term insurance often starts out cheaper, permanent life offers several advantages
over a term policy, financial experts say.
- Because premiums don't escalate, a permanent policy is more likely to be held until death and actually pay a death benefit than is a term policy,
which can get quite expensive as the insured ages. And the death benefit will pass to
- There's a tax advantage to permanent life, because cash values
will grow at a tax-deferred rate. With no cash value, there's no tax advantage to term life.
- Besides, the "invest the difference" component of
that adage is often ignored. If you go with cheaper term insurance, you should make a
commitment to a regular savings and investment program.