Life insurance is a key component of a properly constructed financial plan. At a basic level, it can ensure that your final expenses and debts are paid, and your family is cared for when you’re gone.
However, not all types of life insurance are created equal; they fall into two major categories:
- Term Life Insurance
- Permanent Life Insurance
What is Term Life Insurance?
A term life insurance policy is one where the policy premium is fixed for a set period of time—such as 10 or 30 years.
At the end of that period, the policy premium will generally automatically renew for another term of the same length, which can lead to sticker shock.
Renewal premiums on term life insurance policies can easily be more than twice the original amount, depending on your age when you first took out the policy.
Why would anyone buy a term life insurance policy?
There can be very good reasons to consider term life insurance: the best ones deal with situations where there is a known time horizon for the risk involved.
For example, a mortgage is typically amortized over 25 years. So if the purpose of a life insurance policy is purely to pay off a mortgage in the event of death, a term life insurance policy would be a great solution.
A term life insurance policy will provide the lowest cost over the time that coverage is needed.
On the other hand, your reasons for life insurance might not have known time horizons. Some of these expenses would include funeral expenses, income taxes owing on the final tax return, and specific bequests to individuals and charities.
Suppose you were to live until 100. A 20-year term policy would become prohibitively expensive by that time.
It is for these longer-term events that permanent life insurance is designed.
What is Permanent Life Insurance?
Permanent life insurance is coverage that exists as long as you do. If you live to 120, your permanent life insurance policy will still be honoured.
Examples of permanent policies include:
- Whole Life Insurance
- Universal Life Insurance
- Term to 100 Life Insurance. Yes, there is one type of term life insurance coverage designed for the long-term!
Benefits of Permanent Life Insurance
When you first purchase a permanent life insurance policy, it will be more expensive than a term life insurance policy with the same face value. However, it becomes more cost-efficient the longer it is held.
This is because the premium for most permanent life insurance policies is fixed throughout the life of the policy. That means there are no renewals like there are with most term policies.
Many permanent life insurance policies will build up cash values over time, which could be borrowed upon or used to fund premium payments in the event of a cash flow disruption—such as a world pandemic.
Furthermore, whole life insurance policies that are classed as “participating” policies can earn policy “dividends”. This means that you will receive payments when the insurance company’s experience regarding premiums, claims, and investment income is better than expected.
Such dividends can be taken in cash, but can also be used to purchase “paid-up” additional coverage, which would then generate its own dividends.
Apart from basic life insurance coverage, permanent life insurance options can be effective tools for long-term financial planning.
Combining Term and Permanent Life Insurance
You might get the sense that life insurance is either term OR permanent. That couldn’t be further from the truth.
Life policies can be constructed with multiple levels of coverage.
For example, you could purchase a policy that had permanent life insurance as the primary coverage, but had term insurance as an additional component. These additional policy components are referred to as “policy riders”.
Consider someone who wishes to have $50,000 for permanent purposes, but just took out a mortgage for $300,000. They could look at a policy with $50,000 of permanent, primary coverage, with an additional “term rider” to cover off the mortgage of $300,000.
Advantages of Term Life Insurance
- Suitable for short-term life insurance needs, or specific liabilities like a mortgage
- Provides more immediate protection because, initially, it is less expensive than permanent life insurance
- Can be converted to permanent life insurance without medical evidence (if it has a convertibility option), often up to ages 65 or 70
Advantages of Permanent Life Insurance
- Provides protection for your entire lifetime—if kept in force
- Premium cost usually stays level, regardless of age or health problems
- Has cash values that can be borrowed, used to continue protection if premiums are missed, or withdrawn if the policy is no longer required
- Other non-forfeiture options allow the policyholder various possibilities of continuing coverage if premiums are missed or discontinued
- If the policy is participating, it received dividends that can be taken in cash, left to accumulate at interest, or used to purchase additional insurance
Disadvantages of Term Life Insurance
- If renewed, premiums increase with age and at some point, higher premium costs may make it difficult or impossible to continue coverage
- Renewability of coverage will terminate at some point, commonly age 65 or 75
- If premium is not paid, the policy terminates after 30 days and may not be reinstated if health is poor
- Usually no cash values and no non-forfeiture options
Disadvantages of Permanent Life Insurance
- Initial cost may be too high for a sufficient amount of protection for your current needs
- May not be an efficient means of covering short term needs
- Cash values tend to be small in the early years. You have to hold the policy for a long time, say over 10 years, before the cash values become sizable
The Canadian Life and Health Insurance Association (CLHIA) has a useful brochure summarizing and explaining the various types of life policies.
Speak With Your Scrivens Advisor
Your life insurance coverage can be fine-tuned to reflect your specific time horizons. Talk to your Scrivens advisor to review your needs—it may not be the time of your life, but it will certainly be the right time for your life!