Term vs. Permanent Insurance: What’s Better?

For insurance brokers, the eternal question they hear all the time is when it comes to term or permanent insurance, which type is better? Our LSM Insurance team fields this question constantly, and though we will continue to answer it ad infinitum, we decided for this article that we’d ask the question to some of the heavyweights in the financial world.

Canadian financial celebrity Gail Vaz-Oxlade answers the question this way: “Whether you buy ‘term,’ ‘whole life,’ or ‘universal life’ insurance will be dependent on two primary factors — the amount of insurance you need, and how long you need that insurance to be in place.”

She points out that while term insurance is designed to be in force for a specified length of time or until a certain age, like 65, with men and women living longer, policyholders could easily outlive the term. Plus, if you renew the term, the premium goes up automatically.

As for permanent insurance, Vaz-Oxlade writes that with a whole life policy, the insurance company does the investing of your premium, while with universal life, you have much more control over the types of investments your money goes into. In comparing the premiums between term and permanent, she says that term insurance can be compared to rent, while permanent insurance premiums are like mortgage payments, though the premium doesn’t change for the life of the policy.

Overall, she recommends looking at the amount of coverage you’ll need first and how long you’ll need it. Term insurance is best for short-term needs like mortgage debt and permanent insurance is best for more long-term concerns like funeral expenses.

You then have to compare the lifetime costs of both term and permanent plans you are considering, as term insurance is cheaper at first but gets more expensive as you renew the policy, while permanent premiums remain the same throughout the life of the policy. Don’t forget to also compare the various benefits that come with each plan before making your decision. Oh, and Vaz-Oxlade will also tell you to shop around and get several quotes.

On her CNBC show, America’s first lady of finance, Suze Orman, suggested that variable life, universal life, and whole life insurance do more for the insurance advisors that sell those plans than they do for the people that buy them. She has major hate for those insurance varieties and instead says “that the only insurance that you should have is term insurance. Insurance that’s good for stated period of time.”

She believes that life insurance was never meant to be a permanent need and was only meant to cover you in your younger years in case something happened before your assets built up. Of course, it is Suze Orman, and her advice is directed squarely at the American market, so we recommend taking anything she says about life insurance with a large grain of salt.

The experts at MSN Money have also weighed in on the term versus permanent insurance question and offer a few simple guidelines to clear up the clutter around this issue. They say that if you need insurance for under ten years, then term insurance is your obvious answer. If it’s over 20 years, then they say permanent is the way to go. The in-between, they admit, is the grey area requiring an advisor’s expertise.

They also recommend you categorize your insurance by what you will use the policies for by giving the following example: “If you need $60,000 for college and your youngest child will graduate in three years, you need $60,000 of term insurance as a short-term hedge against your death, thus insuring that your child can finish his or her education. Meanwhile, if your estate will owe $200,000 in taxes at your death, you probably need permanent insurance, because you’re not likely to die in the next 20 years (you hope). You also may want to re-evaluate your estate plan, but that’s a different issue.”

Once you know what you need and how much, then you can decide what type of insurance to go for. They point out that some term plans go all the way up to age 70 and that most term plans can be converted into a permanent plan if you are able to maintain your good health.

They say permanent insurance “is the real wildcard,” with so many varieties and premium amounts, and they warn that you should never use life insurance as only an investment tool.

MSN Money offers a different, much more cautious route instead: “Some of your premiums are being used to buy death-benefit coverage and to cover other expenses (including sales commissions). Life insurance should not be purchased on children as a way to save for college, and make sure you (and your spouse) have all the coverage you need on yourselves before you buy any coverage on a child. When you make your purchase, avoid all of the fancy riders, but do consider the waiver of premium, which suspends your premium payments but keeps the policy in place if you become disabled. If you find that you cannot afford all of the permanent insurance you have decided you need, consider a combination term-plus-permanent policy.”

Tim Cestnick, writing for The Globe and Mail, outlined the benefits of permanent life insurance, saying that you’ll probably want a permanent life insurance policy because since term insurance can’t be renewed after age 80, if you die before then, you’ll need something to leave behind.

He also points to the advantage of accumulating investments from within the policy. He offers this rule of thumb: “For every one dollar in mortality charges (the portion of the premium that covers the pure cost of insuring your life) you can add about three to four dollars to the accumulating fund (the investment component of the policy).”

By the way, these investments grow on a tax-sheltered basis and are paid out tax-free, along with your coverage, to your beneficiary when you die.

For whole life policies, he highlights the level premiums and the fact that some policies have limited-pay options where you pay the premiums over a concentrated period of time and then premiums end.

He talks about Universal Life as well, advising people on where they should choose to invest their money in these policies. “These investments should be factored into your overall asset allocation when designing your investment strategy,” he writes.

“Further, to the extent you are going to hold fixed income investments in your portfolio, holding them in your insurance policy (and your RRSP) makes sense to shelter from tax the interest income that would otherwise be highly taxed.”

Still, despite the advantages, there are others firmly in the “Term Insurance only” camp with Suze Orman. Fox Business’s David Ramsey believes “permanent insurance is a rip-off” and that people are much better off buying insurance for a stated term and then investing the rest of their money. In the example he outlines as the basis for his reasoning in this video, he makes a lot of assumptions about the trajectory of the life of the policyholder that may not work out in the way he thinks.

Yahoo Finance acknowledges that the debate over term insurance against permanent insurance is almost a moot point because, for many, permanent insurance is much too confusing. They try to sift through the confusion by saying, “Term insurance can be a good fit for younger individuals and families, who need protection against the loss of income of a primary earner for a stated period of time, at an affordable cost.”

They also investigate who should consider permanent insurance and under what circumstances they should consider it. They outline those circumstances in the following way: “Permanent insurance can make sense for consumers who need to create liquidity in order to pay projected federal estate taxes. He also recommends permanent insurance to those concerned about asset protection, where state law provides that the cash value and death benefits of insurance policies are not subject to claims by creditors.”

LSM’s Take: Both plans definitely have their place. The most important thing is to first make sure the need is covered. A husband and wife with two small kids are likely well served by a $50,000 Whole Life policy. The next step is to determine how the life insurance is needed for. A term 10 plan is likely not the best to cover a 30-year mortgage or someone looking to use life insurance for estate planning purposes. Bottom line: There is no cookie-cutter solution to determine which plan is best. You really have to dig into what type of coverage is best based on your needs and budget.