Permanent Life Insurance Definition

What is Permanent Life Insurance?

Permanent life insurance, first and foremost, lasts forever, unlike term life insurance which eventually expires. Additionally, permanent life insurance plans often have additional savings or investment options, called cash value, built in.

There are two types of permanent life insurance, universal life and whole life. Both have many subtypes which we will discuss in detail.

Universal Life

Universal life policies vary tremendously and can be very complex, but they all have some of the same qualities.

Unlike whole life, explained below, most universal life policies do not have a level required premium. Instead, these policies have a minimum cost that must be met and a maximum allowed deposit for tax purposes. In order to keep the policy inforce, the minimum cost must be covered every year.

However, those dollars do not necessarily have to come out of the insurance policy owner’s pocket. If there is enough money within the cash value to cover the minimum required payment, that is fine as well.

The insurance cost of universal life policies rises every year as one’s mortality level goes up. Ideally, in order to outpace the jump in costs every year, one should invest sufficient premium dollars into the cash values of their policy to potentially grow faster than the elevated costs in later years.

There are four types of universal life insurance:

  1. Guaranteed
  2. Index
  3. Traditional
  4. Variable

The last three policies work in about the same fashion. The only difference is where the cash value is placed.

Guaranteed

Guaranteed universal life insurance (GUL) is the simplest type of permanent life insurance as it is essentially an extended term policy.

In the most inexpensive version, there is a level premium which must be paid until age 121. As long as those premiums are paid, you will have a fixed amount of life insurance. Both the premiums and the death benefit stay level for the life of the policy.

You can adjust the premium-paying years from paid in one shot to five, 10, age 65, age 100 etc. When a policy is paid up faster, it will usually have a minimal amount of cash value for a few years, only because you dumped in a bunch of money faster than needed. It should not be bought for cash value. In a situation where there is some cash value, it would be inadvisable to use the monies, as the guarantees will then become null and void.

GUL policies are the most inexpensive way to get permanent coverage on a month-to-month or year-over-year basis. However, in the long run, you will most likely dish out more money and receive less death benefit than other universal life or whole life policies.

Index

The cash value within index universal life insurance (IUL) is deposited into the insurance company’s general account. However, the growth is extrapolated from a given index or indices such as the S&P 500 or the Russell 2000.

There is usually a floor, so even if the market tanks, your cash values won’t go below a certain threshold, often 0-2%, and a Cap where the maximum you can earn in any given year tops out at a certain percentage such as 10-15 percent.

Often included is a participation rate. For example, if the market gains 10 percent,  and you have an 80% participation rate, you’ll make 8 percent.

Dividends are often not usually included in the growth calculation as the shares are not actually owned by the policyholder, rather tracked. The fine print of these policies often state that the floor and cap may be adjusted based on experience.

Here is a deep dive into the pros and cons of IUL policies.

Traditional

The cash value, or any amount of premium paid above the minimum amount, grows based on selected interest rates. (Usually Prime +/- something.)

Variable

Excess premiums, those above the minimum costs of insurance, are invested in actual shares of mutual funds. There is no floor or cap, so you rise and fall with the market. For those that have the means and believe in the market, this is often very enticing due to its tax-favored status.

Whole Life

As the name implies, whole life insurance lasts for the whole life of the insured. Like a level premium term policy, the premium stays the same throughout the life of the policy. Due to the length of the policy, i.e. the entire lifetime of the insured. But, the premiums are significantly higher than a term policy of the same benefit.

Aside from the premiums, there are multiple other factors to be aware of when considering a whole life policy.

Cash Value

  1. Guaranteed Cash Value – The additional money you paid to the insurance company above the cost of mortality, which goes to build up a reserve.The insurance company allows you to access that reserve while you are still alive. Accessing these monies will affect your death benefit proportionately as we will discuss shortly.This portion of the cash value is contractually guaranteed. The interest calculation of the guaranteed cash value is Premium (X) x Premium paying years (Y) = Death benefit. In simple terms, the guaranteed cash value will always equal the base policy death benefit at policy maturity.
  2. Projected cash value based on dividends – Most whole life policies have access to dividends from the insurance company. Mutual companies usually grant higher dividends than stock companies as the former do not have any shareholders. Whereas stock companies must pay dividends to their shareholders prior to paying their policyholders. In any case, dividends can be used in any of the following ways:
    • Cash
    • Interest earning account – the dividends are placed into another account where they grow based upon a set interest rate declared by the insurance company. The interest is taxable as it is being removed from the actual policy which is usually a tax haven.
    • Premium offset – wherein the dividends, once large enough, will pay all or some of the premiums of the policy.
    • Paid-up additions (default) – in this option, the dividends are used to buy more insurance, thus growing the death benefit and cash value of the policy exponentially.

Dividends

Dividends are explained in depth here.

When one buys an insurance policy, particularly from a Mutual Insurance company, they essentially become a partial owner of the insurance company. They are entitled to profit sharing, hence dividends.

Another way of looking at it is a return of excess premiums. Where the insurance company says, we charged you X dollars this year, but, due to lower mortality, good market returns, etc., it only costs us Y to insure you. So, here is a refund of those amounts.

Living Benefits

The cash value, both guaranteed and based on dividends, is accessible to the owner of the policy while the insured is still alive. You can access these monies in one of three ways:

  1. Loan – The insurance company will loan you the money in your cash value, up to the entire amount minus the following years premiums. Since it is a loan, it is (almost always) tax free, and you will get charged interest. The interest rate can be one of the following:
    • Variable – depending on the market rate. Policies that have a variable interest rate have a loan dividend rate that is not affected by the loan.
      For example, if someone has $100,000 of cash value in their policy, and they take a $50,000 loan, the dividends, which are paid as a percentage of total cash value, would remain the same as if the cash value was still $100,000.
      This is called “non direct recognition.” That is, the insurance company does not directly recognize that you have taken a loan from the policy and will continue paying dividends as if the loan was never withdrawn.
    • Fixed – A rate guaranteed in the contract. Policies with fixed interest rates will have a dividend rate that is affected by the loan. The insurance company will look at the loan interest rate, for example, 8 percent, and compare that to what market interest rates are. Based on that, the insurance company will pay a dividend. This method is called “direct recognition.”
  1. Surrender – If the owner of a policy surrenders their policy, the cash value will be paid out in full (minus any loans) to the owner.

The taxation will usually be based on the gains (if any) beyond the premiums paid into the policy. Even though policies have been accruing interest for many years, it will be taxed at the higher income tax rates, not the lower capital gains tax rates.

  1. Withdrawal – Applies specifically to the cash value acquired through dividends. It is surrender of the extra value provided by the dividends without affecting the base policy.

Payment Paying Options

Whole Life can be set up to be paid in a variety of different ways. The faster a Whole Life policy is paid up, the less total out of pocket premiums are required. However, the monthly or annual premiums will be significantly higher during the premium paying years.

As previously mentioned, another way to pay off a policy sooner is by using dividends to cover the cost. The difference between a paid up policy and a policy being paid off using dividends is on the growth of the death benefit and the level of the guarantee.

A fully paid up policy will grow much faster as it will not be stunted by the withdrawal of premiums. On the flip side, a policy paid off using dividends is not guaranteed and will have a cash value that does not grow nearly as fast. Additionally, at the beginning of the dividend usage to pay said premiums, you will notice a decrease in the death benefit, as part of the dividends are being cashed in to pay premiums, depleting the death benefit that was purchased beyond the base policy benefit.

The following are the premium paying options:

  1. Traditional whole life – paid until age 100.
  2. Shorter-pay whole life – Depending on the company, you may have options from as little as 1-pay, 5-pay, 10-pay, etc. Or, you can choose age 50, age 65, age 75, and other payment terms.
  3. Extended-pay whole life – The payment is extended until age 121.

FAQs

  • Can you cash out permanent life insurance?

    Yes, almost all types of permanent life insurance policies, dividend-paying or not, have a cash value component that can be cashed out. That being said, the main reason many argue that permanent life insurance is a bad investment and not worth it, is the relatively low returns in relation to the cost of a permanent life insurance policy, when compared to other investments.

  • How much does permanent life insurance cost monthly?

    Permanent life insurance quotes vary based on the age and health of the insured, the amount of coverage, and the insurance company.

  • Is permanent life insurance expensive?

    Compared to a term policy with an equal death benefit, yes, permanent insurance will cost significantly more. However, the advantages of permanent insurance outway term insurance as well.

  • What are the advantages of permanent life insurance?

    The best permanent life insurance policies will offer permanent coverage plus cash value growth and possibly even dividends. The cheapest ones will start as coverage that lasts forever and nothing more.

  • What are the different types of permanent life insurance?

    Universal life and whole life.

  • What is permanent life insurance coverage?

    Permanent life insurance is life insurance coverage that lasts as long as you do.

  • Who offers the best permanent life insurance?

    When looking for permanent coverage, especially whole life, a mutual insurance company will probably be your best bet, as they may provide higher dividends.

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