Buying life insurance is one of the most important financial decisions a person can make. In doing so, you're laying the groundwork for your future peace of mind by purchasing a product that guarantees your loved ones will receive a sum of money if you die that will help them move forward financially.
Though life insurance policies can have many different features, there are only two main types: term life insurance and permanent life insurance. In this article, you will learn what permanent life insurance is and how it works.
Permanent Life Insurance: Article Contents:
What Is Permanent Life Insurance?
Life insurance policies are relatively simple products: the client, or insured, purchases a policy from an insurance company that will provide a payout in the event the insured dies, in exchange for monthly payments called premiums. Building on this foundation, different products can be more or less complex, but they essentially work just as described.
As an insurance client, you can choose between two main types. First, there's term life insurance, so-called because it has an expiration date: the policy is only in effect for a set period of time. Term insurance is used to guarantee financial peace of mind for the insured and their loved ones for a specific time frame—for example, during your children's college education.
Then there's permanent life insurance, which is what we will cover in this article. Permanent insurance is the most traditional types of life insurance: the insured pays for the duration of their life, knowing that the insurance company will provide a payout when they die. Typically, this type of insurance is designed without an expiration date: it remains active throughout your life. But many of these insurance policies also have a significant savings component that can translate into investment and new benefits for the insured.
When taking out permanent life insurance, there are two basic concepts that will influence whether you will be granted life insurance and how much it will cost. The first is your age. The second is your health.
- Age. Age is perhaps the most important factor in purchasing permanent life insurance. The younger you are, the easier it is to buy and the less expensive it will be. This is because you have a higher life expectancy and a lower risk of dying sooner; as such, the insurance company will assume less risk and can offer you lower premiums. You can accumulate the payout capital little by little so you won't have to face any significant difficulties.
- Health. When qualifying for life insurance, you will need to submit medical reports. If your health is poor, the insurance company has two options: either they deny you the life insurance policy, or they impose higher premiums to cover the risk of your poor health. The same applies if your lifestyle (occupation, hobbies, etc.) involves risks. For example, if your hobby is mountain climbing, this might make your policy more expensive, or could be a reason for the company not to insure you. Smoking can also influence these conditions.
How Does Permanent Life Insurance Work?
Once an insurance company assesses your age and risks, it will offer you a policy that you will have to read closely to understand how your permanent life insurance works.
All of these policies have similar components: the insured or policyholder (you); premiums, which are the monthly amounts you will have to pay; the payout or death benefit, which is the money that will be paid upon your death; and beneficiaries, the people you designate to receive this money.
Practically all life insurance policies include these elements, but in the case of permanent life insurance, there are some variations you should be aware of. They are:
- Beneficiaries. It's very important to select your beneficiaries for your permanent life insurance policy. You will have to decide who they are, and you can also select alternate beneficiaries if the primary beneficiaries die before they can collect the payout. Moreover, you can change them at any time and determine in what proportion the death benefit money will be distributed.
- Payout. The amount your beneficiaries will collect is one of the points you should keep in mind when you sign the contract. This money constitutes a tax-free benefit that can be used for any purposes.
- Premiums. Since these permanent life insurance policies tend to be long-term, their premiums are usually higher than for term life insurance. This is because companies level off premiums to maintain their stable cost. Therefore, premiums at the start of the insurance policy's life are higher compared to the risks the company takes. In contrast, the premiums you pay when you're older are relatively low in relation to the risks.
- Cash value. This surcharge that you pay during the start of your insurance policy's life is invested by the company. With the investment profits, it can also offset the price of your insurance premiums. However, there will come a time when you will pay more than what's required to offset this. The law mandates that, once a certain amount is reached, the money must be given to you. This is called cash value, and you can use it as you see fit, including to pay premiums in advance or take out a loan. Remember that only you, as the insured, can use this cash value; it will not be part of the payment your beneficiaries receive.
Cash Value in Permanent Life Insurance
This last point on cash value is the main difference between permanent life insurance and term life insurance. The different types of permanent insurance are based on this feature.
You must keep in mind that this insurance cash value is designed as additional savings for the insured. As you can't always dedicate your income to investment products because you're paying for your insurance, the insurance company offers this savings product, which will provide you with a more comfortable future.
This money can help you with many things. For example, you can use it to build capital that you can enjoy in the future. Or, you can use it to leave extra money to your family and help them with their long-term finances. Alternatively, your beneficiaries can use it to pay for your funeral when you die, or to manage estate taxes if they need to be paid.
In short, this savings product associated with insurance, which is paid in the form of cash value, is one of the main arguments for purchasing a permanent insurance policy.
On the other hand, you should be aware that some policies will enable you to withdraw money against the total accumulated value to apply for a loan. However, remember that if you withdraw or commit amounts that exceed the cash value of the policy, the company can cancel your insurance.
Types of Permanent Life Insurance
Now that you know how permanent life insurance works, it's time to choose what type of policy you should get. In reality, there are four main types of permanent life insurance, which differ primarily in how they manage the cash value and savings mechanism. They are traditional, variable, universal, and variable universal permanent life insurance. Their features are as follows:
This is the most flexible type. As the insured, you can increase or reduce the death benefit, and thus adjust the premiums you pay according to your current financial situation. What's more, you can pay them as you wish: at any time and for any amount above the minimum payment, as long as you respect the maximum advance payment allowed by your policy.
With this type of policy, the life insurance can be used to make periodic cash withdrawals against the final payout amount, or as a guarantee for a loan.
The portion of the capital intended for investment is subject to market rates, which may vary. Lastly, in some universal life insurance policies, the cash value may be included in the final payout.
With this type of life insurance, the money intended for savings is invested in variable income financial products. This can lead to higher profits, but it's also less stable and can result in losses. With these policies, the payout or death benefit is often determined based on the yield of these market investments, though there is always a guaranteed minimum.
Lastly, variable universal life insurance is a combination of the last two types. In this case, the money intended for savings is also invested in the stock market and the insured can adjust the amount of their monthly premiums over time to suit their needs.
With these options, selecting a permanent life insurance policy is very easy. You just have to select the option that's right for you, pay attention to the details, and have peace of mind knowing that your loved ones will receive a payout that will help them when you're gone.