Permanent Life Insurance: What Is It and How Does It Work?

Trying to understand the ins and outs of life insurance can be a headache, and worrying about the security of your loved ones after you die is stressful. Which type of policy will be the most helpful to you and your family? This article breaks down everything you need to know about permanent life insurance so you can decide if it’s right for you.

What is permanent life insurance?

Permanent life insurance policies are insurance plans that last for the duration of the insured’s life. Contrast this with a term life insurance policy, which only lasts for a specified period (usually 10-30 years).

How permanent life insurance works

Permanent life insurance policies pay out a death benefit to the policyholder’s beneficiaries upon their death. While still alive, the policyholder makes regular premium payments, usually on a monthly basis.

Permanent life insurance policies also have a cash-value savings account, which works like an investment account. A portion of your regular premium payment goes into your policy’s cash value account, which accrues interest over time. The money you contribute is non-taxable and can be used during your lifetime.

One important distinction between your death benefit and your cash value account is that your beneficiaries do not receive the money in your cash value account when you die. They only receive the death benefit payout stated in your policy. However, you are free to withdraw money from your cash value account at any time during your life.

Types of permanent life insurance

There are actually four types of permanent life insurance you may encounter when you look for a policy: whole life and three varieties of universal life insurance. Those are standard universal, variable universal, and indexed universal. We’ll go over the similarities and differences below.

Whole life insurance

Whole life insurance plans have the two main pieces of any permanent life insurance policy: a death benefit and a cash value component. What distinguishes whole life insurance from the other three types is a fixed premium rate. This means that once you start paying regular premiums on your whole life insurance policy, your rate will never change. Your premium payments go toward your death benefit and your cash value account.

Since whole life insurance costs and premiums are fixed, these policies are more expensive than universal life insurance.

Standard universal life insurance

Universal life insurance has the same two pieces as whole life insurance, but it has a flexible premium rate. Your regular premium payments will still be allocated between your death benefit and your cash value account, but you have the option of adjusting your monthly payment amount. That way, if you have a sudden decrease in income during the course of your life, you can lower your premium amount as needed.

Variable universal life insurance

Variable universal life insurance, or variable life insurance, is similar to standard universal life insurance. The difference is that with a variable life insurance policy, your cash value growth depends on the health of the stock market. Also important to note is that your money is directly invested in stock securities. The result is that you pay higher fees to cover the insurance company’s management of your subaccounts.

Your cash value account is divided into “subaccounts,” which can be used like mutual funds to generate returns on investment. Each year, administrative costs are deducted from these subaccounts, and the remaining funds stay in the accounts and continue accruing interest.

These accounts are helpful when the market swings in your favor, but they’re also an investment risk. If your subaccount incurs a loss, your premium payment may have to increase to rebuild the lost cash value.

Indexed universal life insurance

Indexed life insurance is like variable life insurance, but your money is not invested directly on your behalf. Instead, you have a say in the securities where you invest your funds (i.e. an index like the S&P 500). The result is that you pay lower fees since you have a hand in managing your money, as well as the potential for more stability in gains and losses.

One downside is that indexed life insurance policies have limits on how much a subaccount can earn each year. But there are also caps on losses, which helps protect your account from unfavorable dips in the market.

What does permanent life insurance cover?

Permanent life insurance covers a payment to beneficiaries up to the amount that the policyholder’s plan states. In other words, whatever policy you choose while you’re still alive will have a certain death benefit payout when you die. The premium payments you make each month are put toward that payout amount. The amount you should choose for your policy’s death benefit depends on a couple of factors, including your income level and the needs of your beneficiaries. For example, if you died, how much would your beneficiaries need to replace your income, plus debts, college tuition, medical expenses, and so on?

Where do the premium payments go?

Your regular premium payment will partially go toward your death benefit payout and partially to your cash value account. In a sense, your premium is divided between one fund to be used before you die and one to be used after. Carl Jensen, founder of CompareBanks, explains it further. “The death benefit is primarily increased by your premium, which also helps to initially defray the insurance organization’s expenses,” he says. “The cash value of the insurance coverage is the remaining portion of the premium. After this investment has grown to a specific level, you may withdraw money or obtain a loan based on its financial worth.”

How does the death benefit work?

The death benefit works the same for all permanent life insurance policies; the amount of the death benefit’s payout depends on your policy and is fed by your regular premium payments. Your beneficiaries receive your death benefit in the form of a lump sum at the end of your life, which is not taxable. However, keep in mind that if your beneficiaries do not claim your death benefit payout quickly, it will accumulate interest, which is taxable.

Who should get a policy?

Since permanent life insurance policies have a cash value component, this type of policy benefits younger individuals the most. Taking out a permanent life insurance policy earlier means your cash value savings account has more time to accrue interest and grow.

Pros and cons

Now that we’ve covered some of the finer details, here’s an overview of the pros and cons of permanent life insurance.

How much does permanent life insurance cost?

How much you pay depends on the amount of coverage you want to buy, your health history, your age, your lifestyle, and other factors. A policy for $100,000 can cost anywhere from under $100 per month to more than $1,000 per month.

Find a policy that fits

Trying to choose a plan can be overwhelming. It might help to peruse our lists of the best life insurance companies and the best life insurance rates, plus tips on finding the best whole life insurance policy and some more facts about life insurance.

FAQ

What are the four types of permanent life insurance?

They are whole life, standard universal life, variable universal life, and indexed universal life. Only whole life insurance policies have fixed premium rates.

Where can you get permanent life insurance?

Any insurance agency offering life insurance will have permanent life insurance policies for you to choose from. Be sure to consider all your options carefully and work with your insurance company to choose a plan that fits you best.

How long does permanent life insurance last?

Like it sounds, permanent life insurance lasts for your entire life, unless you decide to cancel or surrender the policy by withdrawing the cash value.