What Is True About Permanent Life Insurance?

Permanent life insurance offers coverage designed to remain in force for an individual’s entire life, distinguishing it from temporary policies that cover a specific period. This type of insurance provides a death benefit to beneficiaries upon the insured’s passing, regardless of when that occurs, as long as premiums are maintained. A distinct feature of permanent policies is the accumulation of cash value, a component that grows over time and can be accessed by the policyholder during their lifetime.

Foundational Characteristics of Permanent Life Insurance

Permanent life insurance policies are characterized by several core attributes. A primary feature is lifetime coverage, meaning the policy remains active for the insured’s entire life, provided the policy’s premium requirements are met. This contrasts with term life insurance, which provides coverage only for a specified duration, such as 10, 20, or 30 years.

Another foundational aspect is the cash value component. A portion of the premiums paid contributes to this cash value, which grows on a tax-deferred basis. This internal savings element can be accessed by policyholders during their lifetime, although the mechanics of its growth and access vary by policy type. The cash value is distinct from the death benefit, which is the sum paid to beneficiaries upon the insured’s death.

The death benefit, typically paid income tax-free to beneficiaries, is a guaranteed payout under permanent policies, assuming premiums are consistently paid. This benefit provides financial support to loved ones and can be used for various purposes, such as covering final expenses, replacing lost income, or leaving a legacy.

Premium structures for permanent life insurance are generally designed to be level, meaning the amount paid typically remains consistent throughout the policy’s life. A portion of each premium covers the cost of insurance and administrative fees, while the remainder contributes to the cash value growth.

Types of Permanent Life Insurance

Permanent life insurance encompasses several distinct types, each with unique characteristics regarding premium flexibility, cash value growth, and death benefit structure.

Whole Life Insurance

Whole life insurance is a traditional form known for its fixed premiums, which remain constant for the life of the policy. It offers guaranteed cash value growth at a specified interest rate and a guaranteed death benefit. Some whole life policies may also pay dividends, which policyholders can use in various ways, such as receiving cash, reducing premiums, or purchasing additional coverage.

Universal Life (UL) Insurance

Universal life (UL) insurance provides greater flexibility than whole life, allowing policyholders to adjust their premium payments and death benefit amounts within certain limits. The cash value in a UL policy grows based on an interest rate declared by the insurer, which can fluctuate over time but typically has a minimum guarantee.

Indexed Universal Life (IUL) Insurance

Indexed universal life (IUL) insurance links the cash value growth to the performance of a specific market index, such as the S&P 500, without directly investing in the market. IUL policies often include a floor, guaranteeing a minimum interest rate, and a cap, limiting the maximum interest rate credited to the cash value. This structure aims to offer potential for higher returns than traditional UL policies while providing some protection against market downturns.

Variable Universal Life (VUL) Insurance

Variable universal life (VUL) insurance offers the most investment flexibility, as the cash value is invested in sub-accounts that resemble mutual funds. Policyholders can choose from a range of investment options, and the cash value growth is directly tied to the performance of these chosen sub-accounts. This type of policy carries greater risk, as investment losses can reduce the cash value and potentially lead to policy lapse if not managed carefully.

Understanding Cash Value Accumulation and Access

The cash value component in a permanent life insurance policy serves as a living benefit for the policyholder. A portion of each premium payment, after accounting for the cost of insurance and administrative charges, is allocated to the cash value. This portion then grows on a tax-deferred basis, meaning earnings are not taxed until they are withdrawn. The growth mechanism varies by policy type, ranging from guaranteed interest rates in whole life policies to market-indexed returns in IUL or investment performance in VUL.

Policyholders have several methods for accessing the accumulated cash value while the policy is in force.

Policy Loans

One common way is through policy loans, where the policyholder borrows money using the cash value as collateral. Interest is typically charged on these loans, and if the loan is not repaid, it will reduce the death benefit paid to beneficiaries.

Withdrawals

Another method is to make direct withdrawals from the cash value. Unlike loans, withdrawals permanently reduce the policy’s cash value and typically the death benefit by the amount withdrawn. Withdrawals are generally tax-free up to the amount of premiums paid into the policy, often referred to as the cost basis. Any amount withdrawn exceeding the cost basis may be subject to income tax.

Surrendering the Policy

Policyholders can also access the entire accumulated cash value by surrendering the policy. Surrendering terminates the insurance coverage, and the policyholder receives the cash surrender value, which is the cash value minus any surrender charges and outstanding loans. The portion of the surrender value that exceeds the total premiums paid will be subject to ordinary income tax.

Policy Management and Operational Aspects

Policy riders are optional additions that can customize a policy to meet specific needs, providing enhanced benefits or flexibility. Common riders include a waiver of premium, which waives future premium payments if the insured becomes disabled, or an accelerated death benefit rider, allowing access to a portion of the death benefit if diagnosed with a terminal illness. These riders typically come with an additional cost, which is factored into the premium.

For participating permanent life insurance policies, policyholders may receive dividends. Dividends represent a share of the insurer’s surplus earnings and are not guaranteed. Policyholders typically have several options for how to use these dividends, such as receiving them in cash, applying them to reduce future premium payments, or using them to purchase paid-up additions. Paid-up additions are small, single-premium policies that increase both the death benefit and the cash value of the original policy.

A permanent policy can lapse if the cash value becomes insufficient to cover the ongoing costs of insurance and administrative charges, or if premiums are not paid within a specified grace period. Grace periods typically last 30 to 60 days, during which the policy remains in force even if a premium payment is missed. If the payment is not made by the end of the grace period, the policy may terminate.

Surrender charges are fees applied if a policy is surrendered, or canceled, particularly during its early years. These charges are designed to recoup the insurer’s initial expenses, such as underwriting and commission costs. The amount of the surrender charge usually declines over a period, often 10 to 15 years, eventually reaching zero.

Periodic policy reviews are important to ensure the coverage continues to align with the policyholder’s evolving financial goals and life circumstances. A review can help assess if the death benefit is still adequate, if the cash value is performing as expected, or if any riders need to be added or removed.