What Is a Permanent Life Insurance Policy?

Permanent life insurance offers lifelong financial protection and a unique savings component. It provides coverage for an individual’s entire life, building monetary value over time that the policyholder can access.

Core Characteristics of Permanent Life Insurance

Permanent life insurance distinguishes itself by providing coverage that extends throughout the insured individual’s entire life, provided premiums are consistently paid. This means the policy remains in force regardless of how long the insured lives, ensuring a death benefit will eventually be paid to designated beneficiaries. This differs from term life insurance, which only provides coverage for a predefined number of years.

A permanent life insurance policy has two primary components: a death benefit and a cash value. The death benefit is the amount paid to beneficiaries upon the insured’s passing, typically free of income tax. This benefit provides financial support to loved ones and can help cover expenses, debts, or future financial needs.

The cash value accumulates over time as premiums are paid into the policy. A portion of each premium payment contributes to this cash value, which grows on a tax-deferred basis. This accumulating value distinguishes permanent policies, offering a potential financial resource in addition to the death benefit.

Understanding Cash Value

The cash value within a permanent life insurance policy represents a savings component that accumulates over the policy’s life. A portion of each premium payment is allocated to this cash value, which grows on a tax-deferred basis. This means that any earnings or interest credited to the cash value are not subject to income tax as they accumulate, allowing for potentially faster growth.

Policyholders can access the accumulated cash value through several methods, including policy loans, withdrawals, or surrendering the policy. Policy loans allow the policyholder to borrow money against the cash value, using the policy as collateral. These loans are generally not considered taxable income, provided the policy remains in force and the loan is not outstanding if the policy lapses or is surrendered. Interest typically accrues on policy loans, and any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

Another way to access cash value is through withdrawals. Policyholders can withdraw funds from their cash value, and these withdrawals are generally tax-free up to the amount of premiums paid into the policy, known as the cost basis. Any amount withdrawn exceeding the cost basis is typically considered taxable income. Withdrawals can also reduce the policy’s death benefit and, if substantial, might even cause the policy to lapse if the remaining cash value is insufficient to cover policy costs.

Finally, a policyholder can surrender the policy, canceling it entirely in exchange for the accumulated cash value, minus any applicable surrender charges. Surrendering the policy terminates all coverage, and the death benefit is no longer available. Any gain realized upon surrender, defined as the cash value received exceeding the total premiums paid, is subject to income tax. Surrender charges are fees imposed by the insurer for early termination, often decreasing over a period of 5 to 15 years from the policy’s inception.

Types of Permanent Life Insurance

Several types of permanent life insurance policies offer distinct features regarding premium structure, cash value growth, and flexibility.

Whole Life Insurance

Whole life insurance is a traditional form of permanent coverage characterized by guaranteed level premiums, a guaranteed death benefit, and guaranteed cash value growth. The cash value in whole life policies grows at a predetermined rate, ensuring predictable accumulation. This type of policy offers stability and certainty, with premiums that remain consistent throughout the policy’s life.

Universal Life (UL) Insurance

Universal life (UL) insurance provides more flexibility compared to whole life policies. Policyholders can adjust premium payments, within certain limits, and may also be able to modify the death benefit. The cash value in a universal life policy grows based on an interest rate set by the insurer, which may fluctuate but often includes a minimum guaranteed rate. This flexibility can be useful for individuals whose financial circumstances may change over time, allowing them to adapt their policy as needed.

Variable Universal Life (VUL) Insurance

Variable universal life (VUL) insurance combines the flexible premium and death benefit features of universal life with an investment component. With VUL policies, the cash value can be invested in various sub-accounts, similar to mutual funds, chosen by the policyholder. The growth of the cash value is tied to the performance of these underlying investments, offering the potential for higher returns but also carrying investment risk, meaning the cash value can decrease if investments perform poorly. This type of policy appeals to those comfortable with investment risk who seek greater control over their cash value’s growth potential.

Managing Your Permanent Policy

Consistent payment of premiums is fundamental to keeping the policy in force and ensuring the death benefit remains available. Most policies include a grace period, typically 30 to 90 days, during which a missed payment can be made without the policy lapsing. If premiums are not paid within this grace period, the policy may lapse, leading to a loss of coverage and potential forfeiture of accumulated cash value, especially if surrender charges apply.

Policyholders can customize their coverage by adding policy riders, which are optional provisions that enhance or modify the policy’s benefits. These riders come at an additional cost but can provide valuable flexibility. Common riders include:

• An accelerated death benefit rider, which allows access to a portion of the death benefit if the insured is diagnosed with a terminal illness.
• A waiver of premium rider, which waives premium payments if the insured becomes disabled.
• Guaranteed insurability, allowing for increased coverage without further medical exams.
• Long-term care riders, which permit using a portion of the death benefit for long-term care expenses.

If a policyholder decides to terminate their permanent policy, surrendering it involves canceling the coverage in exchange for the cash value, minus any surrender charges. Surrender charges can be substantial, particularly in the initial years of the policy, often declining over a period of 5 to 15 years. Any amount received from the surrender that exceeds the total premiums paid into the policy is considered a taxable gain.