Money Talks, So Should You

How to choose between term life or a permanent policy

Jeff Brown
by Jeff Brown, MainStreet contributor

NEW YORK (MainStreet) — Hey, here’s a deal: Convert your no-frills term life insurance policy to a permanent policy that could add decades of coverage and, on top of providing a death benefit, function as an investment for retirement!

If you’ve had a term life policy for a while, you may find your agent or insurer pushing you toward this kind of move.

But is it such a good deal? Well, it’s one of the many financial options a responsible person might consider, but it’s far from a slam-dunk. Some of the alternatives might be cheaper and more flexible, as well as more profitable.

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A term policy, typically lasting 10 to 20 years, provides a set death benefit if the insured dies during the coverage period. It works just like car or homeowner’s insurance: Pay a premium, get coverage; stop paying, either because you don’t want the policy anymore or the term has ended, and you don’t get coverage. Simple.

With term, there’s no investment component or “cash value” to draw on, but term life is very cheap. You might get a $500,000 death benefit for $100 to $200 a month, depending on your age and health.

Permanent policies have no end date — they pay the promised benefit no matter how long you live. Many types build up cash value as a type of investment, and after a number of years earnings on this asset pay the policy’s premiums. But you pay a lot for this. Premiums can be 10 times what you’d pay for a term policy with the same death benefit.

Consider this opportunity recently presented to a man in his early 60s. He had four years to go on a 20-year term policy with a $500,000 death benefit and an annual premium of only about $1,500. His insurer offered a chance to convert this to a permanent policy that could provide lifetime coverage even if he lived to 100, while his current term policy would terminate at age 66.

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But the premium on the new policy would be about $17,000 a year — 11 times what he was paying on the old policy. Would the extra years of coverage and chance to build cash value be worth that much?

For a man with a lifetime dependent such as a wife who did not work, it could be. Under his old term policy, she’d get nothing if he died after the policy expired when he was 66. If the couple had skimpy retirement savings, a permanent policy might make sense. Also, the current insurer might permit a conversion with no questions asked — a benefit if the policyholder’s poor health would keep him from getting a new permanent policy from another insurer.

But before signing up for such a deal, policyholders should explore several topics:

Need. Term life is ideal for people who need coverage only for a given period — while their children are growing, for example. Ideally, the insured has investments that will grow sufficiently to cover retirement, making the investment component of a permanent policy unnecessary.

Cash value. Is the growth of this account guaranteed, or is it subject to the fate of the stock and bond markets? How does that growth compare with what you might earn on investments such as mutual funds? That may be very hard to figure out. One of the problems with permanent policies is they can be very opaque, making apples-to-apples comparisons extremely difficult.

New term policy. It could be considerably cheaper to take out a new 20-year term policy. A healthy man in his early 60s might get a $500,000 term policy for 20 years for $3,800 to $4,500 a year, about a quarter of the cost of the permanent policy. Because he is older, this new term policy would not be as cheap as the one he got in his 40s, but in exchange he’d get coverage into his early 80s instead of losing it in his mid-60s.

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Investing the difference. If the policyholder chose one of the cheaper options — a new term policy or going without coverage after age 66 — the savings could be invested. Compared with permanent life insurance policies, mutual funds are easier to understand and compare, and money can be taken out at any time without the penalties sometimes attached to early cash withdrawals from life insurance policies.

Adviser’s motives. An insurance agent who is pushing a term-to-permanent conversion may be putting his interests ahead of yours, as he could be after a juicy commission built into the new policy’s hefty premium.

Competitors’ offers. Before doing a conversion with your current insurer, find out what competitors would charge for a brand-new permanent policy.

Bottom line: Permanent life insurance policies can make sense for people who really need coverage into old age.  For those who need coverage only while rearing their children, or until other investments grow big enough to fund retirement, a term policy is generally the best deal.

 

For the past 20 of his nearly 40 years in journalism, Jeff Brown has written about personal finance, economics and the financial markets. He has been a staff writer at The Philadelphia Inquirer and other papers, and in his six-year freelance career has been a columnist for TheStreet.com and the Nightly Business Report on PBS and blogged for The New York Times, MSNBC.com and other Internet sites.