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Term Life Insurance vs. Permanent Life Insurance: Is Cash Value the Best Value?

When in the market for life insurance, there are two types you can shop around for: term life insurance or permanent life insurance. The main “superficial” difference between the two is that term life insurance covers you for a set period of time, whereas permanent life insurance covers you for the remainder of your life. Though permanent life insurance costs considerably more than term life insurance, it is just because when taking a closer look at each, permanent life insurance gives your policy the chance to increase its cash value, which ultimately means a better value and more money for your beneficiaries when you die.

Which is best for you?
Permanent life insurance may offer you a better payout in the long-run, but what if your financial obligations are only short-term? When you really just want the most amount of coverage for the least amount of money, it’s better to purchase a term life insurance policy. The money you save from the premiums in term life insurance can be invested in stocks, mutual funds, or bonds.

The feature that makes permanent life insurance so desirable is its ability to gain cash value. A portion of the money you pay into your premium goes into a cash account that grows over time. “With any kind of insurance you are considering, it’s important to do research about the company you may be purchasing your policy through,” says David Roush, CEO of Insurance.com. “You’ll also want to be sure you fully understand how it works and that there are no hidden fees that may get you in the end,” Roush says.

How does cash value work?
Cash value accumulates very quickly in the beginning, because you are younger and your mortality rate is lower. But as time goes on, your cash value begins to slow down, not from anything that you’ve done, but because of time running its course on you and your body. The chances of you dying increase every year, which in turn makes the cost of insuring you go up, as well as increasing your mortality expense.

The mortality expense (a certain amount of money the insurance company takes out of your payments per year to pay for insurance costs and processing) typically doubles every decade. The more they take out, the less that goes into your cash value. Luckily, your premiums don’t increase because the life insurance company has taken your mortality into consideration. The only time your premium could possibly go up is if you have a universal life insurance policy with flexible payments—if you pay too little in the beginning, you may get hit with high bills later on.

On the average, cash value can build between four to six percent each year. If your money is in stocks, bonds, or mutual funds, you are at the mercy of the economy. At the end of the year, your cash value may be higher than expected, or if investments aren’t performing well, it may be considerably lower. When you die, unless you already specified that you want your cash value tied into your death benefits, your beneficiaries will not get the cash value you accumulated. So be sure to read all the fine print when applying for permanent life insurance, just to be sure there are no surprises when you die.

Is cash value a liquid asset?
Though cash value is like a liquid asset because you have the ability to withdraw money, you will be penalized and charged a fee if you decide to withdraw funds. A different option (and one that is not recommended) is partial withdrawal. It should be noted though, by taking out money this way, your death benefit gets reduced on a dollar-to-dollar basis.

A very common way people take money out of their cash value is by taking out a loan against it. You don’t have to pay it back, but the initial amount, plus the seven to eight percent interest that is tacked onto it, will be taken out of your death benefit when you die. This may short-change your beneficiaries depending on how much you owed.

Another thing to keep in mind is when you withdraw funds from your cash value, it may become taxable. If it is worth more than what you have paid on your life insurance policy, it may be taxed. Also, if you take out a loan against it, and you surrender the policy or it lapses before you pay it back, you will be taxed on the difference of the loan amount and the total amount of the premium.

Permanent life insurance and cash value do take a while to accumulate, so if you’re not very concerned about the distant future, a term life policy will be a better option.

When is whole life insurance the best bet?
If you need life insurance for the rest of your life, and you have a high income, a whole life insurance plan may be the right decision for you. Many older people like whole life insurance policies, because they use their cash value to pay off their premiums. Their life insurance stays active and their death benefits are reduced, but the amount left in the death benefits can be used by beneficiaries to pay off their estate or taxes that have been incurred.

Making the choice
“The choice is yours as to what kind of life insurance you should purchase,” says Roush, “deciding factors depend on what kind of time frame you’re looking at, and how much you are willing to pay in insurance premiums.”