In our view, though, anyone who advocates 100 percent for or against any kind of life insurance structure is missing the point:
The best kind of insurance to own is the kind that is in place when the insured dies.
And here’s the corollary to that law:
The best amount of life insurance to buy is the amount you can easily afford.
There is definitely a place for term insurance, and definitely a place for permanent insurance. The most important principles to bear in mind are these: Use the policy that 1.) you can afford, that 2.) best fits your need, and 3.) is most likely to be in force when the insured dies.
Do these three things, and it’s tough to go wrong.
Term insurance is designed to be very affordable, with large death benefits available to young and healthy people at very low premiums. The tradeoff is that term insurance, as the name implies, is temporary. Your heirs get a large tax-free death benefit if you die during the term on the policy. If you die even a day later, your heirs get nothing.
Term premiums also must increase over time, to account for the higher mortality expectations for older people. Eventually, premiums will rise so high that they will be unaffordable. The cumulative premiums typically outstrip any death benefit if you live to your life expectancy and beyond.
But for younger families who need a large death benefit at an affordable cost, to protect them against the potentially catastrophic loss of a breadwinner at the beginning of his or her career, for example, term insurance is just the ticket.
Here are some common examples of temporary needs. Think term insurance to cover these needs:
- College funding
- Mortgage debt.
- Debts that would otherwise encumber your estate.
- Feeding and sheltering your widowed spouse and your children.
- Any needs that might be permanent, but you can’t afford permanent insurance premiums yet.
For these kinds of needs, term insurance is usually the most cost-effective way to provide large amounts of coverage for a finite period of time.
Permanent insurance is designed to pay a death benefit even if you live to a ripe old age. There are two basic varieties: whole life and universal life.
Whole life policies feature a guaranteed death benefit for life, guaranteed level premiums for life, and guaranteed growth in cash value as the carrier sets aside cash reserves to pay the nearly certain eventual death claim.
Universal life policies feature a guaranteed death benefit, along with a cash value component as well. However, they offer fewer guarantees than whole life policies, and occasionally lapse when contributions are not sufficient to keep paying premiums
Whole life and properly-designed universal life insurance policies are ideal to take care of needs that are permanent, rather than temporary. Some examples:
- Final expenses
- Estate taxes
- Equalizing an illiquid estate among heirs.
- Funding buy-sell agreements
- Creating non-qualified executive compensation plans, split-dollar arrangements, or”golden handcuffs” on key employees.
Term life insurance is the most affordable protection for young people. But at the same time, term policies are actuarially designed to lapse. Only about 2 to 5 percent of term policies ever pay a claim. So while term provides the most protection for new policy purchasers per dollar of premium, in the long run it can grow to be very expensive.
With permanent policies, it’s quite the opposite: Whole life policies, in particular, require a pretty big commitment for the same amount of death benefit. Very few young families can afford permanent insurance for the total amount of death benefit they need. Term works well here, on a limited budget – at least til the kids are grown, in most instances. A universal life policy costs more out of pocket, but if the policy owner contributes enough premium into the policy, they can build cash value very quickly. But in the long run, if you live to your actuarial life expectancy, you will get far more out of a whole life policy than you ever put into it – either via cash value or via the death benefit.