Term vs. permanent life insurance: what you need to know

By: Robb Engen on June 8, 2016

Insurance is a must if you have a spouse or children who depend on your income to get by. Life insurance comes in two flavours: term and permanent. Both are designed to help provide your loved ones with financial security in case you die. Which works best for you depends on your finances and your goals.

Term life insurance basics

Term life insurance is the most common type of life insurance. It provides protection for a specific number of years – typically in 10-or-20-year terms – in exchange for a regular fixed payment.

With term life, if the policyholder dies within the period of coverage, the death benefit gets paid out to the beneficiary. You can renew the policy when the term expires, but note that your premiums will increase based on your age, gender, and health. You can compare life insurance rates without too much trouble to see what changes to expect if you renew.

Permanent life insurance basics

Permanent life insurance is exactly that: a policy that remains in place until death. The advantage with permanent life insurance is that your premiums generally stay the same for the duration of the policy. When you first buy a permanent policy your premiums can be much more expensive than a term life policy. However, your premiums might actually become lower than term life in your later years.

Permanent insurance combines life insurance with an investment component. A portion of your premium goes towards the insurance coverage, while the rest goes into the investment plan. There’s also a cash value portion of the plan that can be refunded to you if you cancel the policy before your death. Keep in mind, though, that if you cancel you (or more specifically your beneficiaries) are giving up the death benefit.

Term vs. permanent: which should you choose?

Term life insurance is likely to be the best choice for most people due to its flexibility and affordability. I’m a 36-year-old male non-smoker and a quote for a $500,000 20-year term life policy would cost me between $40 and $45 per month.

A permanent life insurance policy with the same $500,000 death benefit could cost between $200 and $250 per month.

Just because term is cheaper doesn’t mean it’s always the best choice for everyone.

There are a couple of situations where permanent insurance might be appropriate:

If you expect to hold life insurance well into old age, perhaps because you want the death benefit to help settle estate taxes, or because you want to leave a lump sum to an heir. Buying permanent insurance now is likely to be cheaper in the long run than buying term insurance and renewing it every time the term expires.

Or, let’s say you have a rare blood disorder that your children have a high probability of inheriting. They are too young for the disease to be detectable now, but if it shows up later in life, there’s a good chance they will be unable to get affordable coverage when they need it most. Buying permanent insurance for them now would offer peace of mind and relieve that anxiety.

Bottom line

There’s another question you need to ask yourself before deciding between term life and permanent life insurance: How much life insurance do you actually need?

A good rule of thumb to start with is a policy that covers 10 times your income, but there are other factors to consider. Ideally, you want enough life insurance to pay off your mortgage and other debts while still providing your beneficiaries with income for a period of time.

Once you’ve determined how much you need, use your age, gender, health, and financial situation to decide whether term life or permanent insurance is right for you.

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