Life insurance 101: Understand term vs. permanent policies
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Key takeaways:
- Term insurance is typically the most affordable coverage.
- Permanent life insurance also carries cash value along with the death benefit.
Physicians generally use life insurance to achieve certain wealth planning goals — from protecting the family against the risk of a breadwinner’s early death to providing an estate for heirs and more.
To achieve these goals, physicians have two types of life insurance policies: temporary (term) and permanent (cash value).
Term life insurance
Typically, term insurance, which is the most affordable coverage, offers peace of mind for a limited time. For those nervous about investing in something that follows them through the rest of their lives (an understandably daunting aspect), term insurance offers a compromise between providing something vs. nothing for their loved ones in the event of death.
As the name implies, term coverage lasts a finite time (usually between 10 and 30 years), with the average policy being a 20-year term.
During this time, your premiums are an expense that doesn’t accrue any value. But should you or your covered family members pass while the policy is active, the beneficiary or beneficiaries receive a payout.
For physicians, this can be a cost-effective way to ensure that, if they die, their families receive a short- or long-term (depending on the payout amount) income replacement. This gives the beneficiaries the time they need to mourn and regroup without worrying about finances.
Term insurance is also beneficial because its affordability lets you invest the extra money in other options. But, as mentioned, once the policy period ends, if you haven’t used it (which is the best-case scenario), you have lost the money you paid in premiums.
Permanent life insurance
Looking at life insurance as an investment instead of a cost opens you up to a plethora of other long-term options that fall under the umbrella of permanent life insurance.
Like term insurance, permanent life insurance policies offer a payout to the beneficiaries in the event of the covered person’s passing. However, this category of insurance also carries cash value along with the death benefit. Provided the premiums are paid regularly, permanent insurance can last for the policyholder’s entire life.
Although permanent life insurance premiums are higher than term policy premiums, this type of coverage will eventually move from an expense to an investment. As you pay your premiums, your policy should begin to accrue tax-free cash value, which is attractive to many physicians. After a pre-determined period (covered in your policy terms), you can access this cash value if you need funds.
Within the permanent life insurance umbrella are five different types of policies, but only three are commonly used:
Whole life
In the discussion of life insurance, term’s competitor is usually whole life. This coverage type has existed for decades, becoming the preferred policy in the 1940s and beyond. Whole life has evolved since its inception, but the original “til death” policy continues to remain popular.
Whole life insurance premiums are fixed and can’t increase throughout your lifetime, as long as you pay them on time. The coverage pays a death benefit to the policy’s beneficiary (named by you) and provides a cash value account into which you can invest part of your income while ensuring tax-deferred cash accumulation.
Whole life coverage is frequently used to complement a savings account once your emergency safety net is covered. If you don’t need to access your funds and want them to grow faster than in savings, the whole life premium does the work for you — typically increasing with the insurance company’s annual dividends.
If you need to borrow from the cash value of your policy, you can. Provided you have structured the policy correctly, the earnings are accessible tax free. Whole life insurance is ideal for those looking for benefits such as:
- tax reduction;
- asset protection;
- estate planning;
- wealth accumulation; and
- asset class tax diversification.
However, whole life insurance is tied to the insurance company’s investments. You don’t get to diversify where your premium goes or move it between accounts. And once you have chosen a death benefit amount, you can’t change it.
If these factors are important to you, whole life’s evolution, universal life insurance, may be a better fit.
Universal life
Universal life insurance works similarly to whole life coverage. The major difference lies in universal life insurance’s flexibility in premium and death benefit choices.
With universal life, your cash value should grow as interest paid by the insurance company. If the company’s investments do well, you’ll reap the benefits of your policy’s cash accumulation.
On the other hand, should the company’s investments do poorly, your interest return will most likely reflect this. When that happens, less money is available to cover your chosen death benefits, and you’ll need to pay more premiums to meet this gap.
Equity-indexed universal life
Like universal life coverage, equity-indexed universal life insurance provides the policyholder with premium and policy flexibility.
You can choose from a list of stock market indices in which the insurance company will invest your premium and grow your cash value at the same rate as stock market returns with a cap and a floor. There are numerous investment options and elements to select with equity-indexed universal life insurance policies, and they need to be managed closely. As such, it is essential to work with an insurance specialist when investing in this type of policy.
Conclusion
The phrase “life insurance” encompasses several types of policies, each with its potential pros and cons. Finding the right coverage is not always easy, and a trustworthy life insurance agent can help physicians determine whether term or permanent products make the most sense, and then, within those parameters, which specific policies are the best solution.
Reference:
Mandell and OJM Group partners are pleased to announce the 2024 publication of their newest book, Wealth Strategies for Today’s Physician: A Multi-Media Playbook. The playbook’s innovative format features more than 90 links to videos and podcast episodes to enhance important financial topics for physicians. To receive a free print copy or ebook download, text HEALIO to 844-418-1212, or visit www.ojmbookstore.com and enter code HEALIO at checkout.
For more information:
David Mandell, JD, MBA, is an attorney and co-founder of the wealth management firm OJM Group www.ojmgroup.com, where Jason O’Dell, MS, CWM, is the managing partner and an insurance specialist. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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