What Is Permanent Life Insurance?

Permanent life insurance is a type of life insurance designed to provide coverage for the policyholder’s entire life. This contrasts with policies that cover a specific period, aiming to offer protection that extends indefinitely. The policy remains active as long as premiums are paid, ensuring a death benefit will eventually be disbursed to beneficiaries.

Core Concepts of Permanent Life Insurance

The primary purpose of the death benefit is to provide financial protection, and it is paid out to beneficiaries free of income tax.

A distinguishing characteristic of permanent life insurance policies is their premium structure. Premiums for these policies are level, meaning the payment amount remains consistent throughout the policy’s duration. Beyond the death benefit, permanent life insurance policies also include a component that accumulates monetary value over time. This growing value is known as the policy’s cash value.

The Cash Value Component

A significant portion of the premiums paid into a permanent life insurance policy contributes to its cash value, which grows over time. This cash value accumulates on a tax-deferred basis, meaning policyholders do not pay taxes on the growth as it occurs within the policy. The cash value increases through interest accruals and, in some policy types, through dividends, with gains benefiting from compound interest over the years. Initially, a larger part of the premium covers administrative fees and insurance costs, but as the policy matures, more funds are allocated to the cash value.

Policyholders can access this accumulated cash value in several ways. One common method is through policy loans, where funds are borrowed against the cash value. These loans are not considered taxable income as long as the policy remains in force. However, policy loans accrue interest and, if not repaid, will reduce the death benefit paid to beneficiaries.

Another way to access cash value is through withdrawals. Withdrawals are tax-free up to the amount of premiums paid into the policy. Any amount withdrawn that exceeds this is subject to income tax. Unlike loans, withdrawals directly reduce the policy’s death benefit. Finally, a policyholder can surrender the policy entirely, terminating coverage and receiving the cash surrender value. If the cash surrender value received exceeds the premiums paid, the excess amount is taxable.

Distinguishing Permanent from Term Life Insurance

Term life insurance provides coverage only for a specific, predetermined period, such as 10, 20, or 30 years. Once this term expires, coverage ceases unless it is renewed, which comes with increased premiums.

A significant distinction lies in the presence of a cash value component. Permanent life insurance policies build this cash value over time, which can be accessed by the policyholder during their lifetime. Term life insurance policies do not accumulate cash value and are purely designed to provide a death benefit if the insured passes away within the specified term.

Term life insurance premiums are fixed for the chosen term, but if the policy is renewed at the end of the term, the premiums increase, reflecting the insured’s older age and increased risk. Due to the inclusion of the cash value component and lifelong coverage, permanent life insurance policies have higher initial premiums compared to term life policies for a similar death benefit.

Common Forms of Permanent Life Insurance

Whole life insurance is a traditional type that offers guaranteed level premiums, ensuring consistent payments throughout the policy’s duration. Its cash value grows at a guaranteed rate, providing predictable accumulation, and the death benefit is also guaranteed. Some whole life policies may also be eligible to receive dividends, which can further increase cash value or reduce premiums.

Universal life (UL) insurance provides more flexibility than whole life, allowing policyholders to adjust their premium payments and even the death benefit amount within certain limits. The cash value in a universal life policy grows based on interest rates declared by the insurance company, with a guaranteed minimum interest rate. This flexibility can be beneficial for individuals with fluctuating incomes.

Indexed universal life (IUL) insurance is a variation of universal life where the cash value growth is linked to the performance of a specific stock market index, such as the S&P 500. While the cash value is not directly invested in the market, its interest crediting is influenced by the index’s performance. IUL policies include a “floor,” which is a minimum guaranteed interest rate, protecting against market downturns, and a “cap,” which limits the maximum interest rate earned. This structure aims to offer potential for higher growth than traditional UL, while still providing some downside protection.

Variable universal life (VUL) insurance offers policyholders the ability to invest the cash value component in various investment sub-accounts, similar to mutual funds. This provides the potential for greater returns if the chosen investments perform well. However, it also carries market risk, meaning the cash value can decrease if the investments perform poorly. Like other universal life policies, VUL offers flexible premium payments, allowing for adjustments based on financial circumstances.