This is a guest post by CFP, Brian Poncelet.
Life insurance is a critical component to every family’s financial well-being. And yet, over 10 million Canadians are underinsured, leaving their loved ones vulnerable to out of control expenses and runaway debt.
To protect your dependents, you need to first know that there are two types of insurance available – permanent insurance and term. In order to select an affordable policy that addresses your needs, understanding the differences between them is key.
1. Length of Coverage
The main difference between permanent and term insurance is the length of coverage. Term insurance provides coverage for a specific period of time – generally 5 to 30 years. The coverage ceases once the term has ended or the premiums are unpaid. Permanent life provides coverage until you pass away or the premiums are unpaid and the reserves are insufficient to cover the premiums.
Permanent and term insurance both have level premiums. The premiums are usually higher for permanent life because they are averaged over your lifetime. Meanwhile, the premiums for term are only averaged over the length of coverage. If you’re in good health and purchase term insurance at a young age, premiums typically start much lower. However, once term coverage ends, premiums can increase dramatically upon renewal.
3. Cash Value
Term insurance is your plain vanilla insurance policy with no savings component – buy term and invest the difference, as the saying goes. If you cancel your policy, the coverage ends and there is no cash value paid. Permanent life may or may not include a cash value. Whole life has a cash value, while some universal life policies have an investment option.
Besides the death benefit, the most important thing to know about your term life policy is whether it’s convertible. If you get sick, a convertible term policy allows you to convert to permanent insurance at any time up to the end of the term with no medical exam. Permanent life is not convertible.
5. Death benefit
This is the most important factor when choosing life insurance – how much will my beneficiaries receive when I pass away? Term only pays out a death benefit if the policyholder dies during the term the policy is in effect (if you outlive the policy there is no payout). Permanent life provides a death benefit to your beneficiary or estate when you pass away as long as the premiums are paid up.
Term life is renewable, permanent life is not (you won’t need to renew since coverage is for your entire life). With term life, the premiums remain the same throughout coverage. Most term policies only allow renewal up to age 75.
Summary of the pros and cons of both types of insurance
- Level premiums for life or a fixed period and coverage for live
- Can borrow from policy tax-free in a number of cases
- Can be used to enhance retirement
- Can be used to pay Estate taxes at death (cottages, business, etc.)
- Insurance can be structured to grow every year
- Initially costs more than term for coverage
- Buy a lot of coverage for premiums paid
- Can Convert to Permanent later
- Can “buy term and invest the difference”
- Insurance costs go up every year
- If one does not die during term, premiums are wasted and a lost opportunity cost
Term and permanent life aren’t mutually exclusive – a combination of both can be used for meet your insurance needs. Term life is best suited for short-term term expenses, such as income replacement, mortgages and car loans. Permanent life is ideal for long-term permanent expenses, such as funerals and estate planning. There will be more quantitative articles coming up describing which type of insurance is better with different circumstances.
About the Author: Brian Poncelet is an insurance specialist and independent certified financial planner (CFP) who has been working in the financial services industry for almost 20 years.