Term vs. Permanent Life Insurance: Key Differences

Securing a life insurance policy ensures your loved ones are financially safe after your passing. When you're choosing coverage, you'll choose between two types: a term life insurance policy or a permanent life insurance policy. What's the difference?

The main differences between these two policy types are how long they last and whether or not they have an “investment” component.

With a term policy, you have coverage until the set term of the policy ends (usually 10 to 30 years). It's significantly cheaper but does not accrue any cash value. A permanent policy, on the other hand, offers coverage until the day you die and builds cash value, but is more expensive. 

In general, term life insurance is the best fit for more families. It's inexpensive and does exactly what it is expected to do.

What is term life insurance?

A term life insurance policy is the more affordable option when it comes to this type of insurance coverage. You'll purchase coverage for a specific period of time — most policies include options for 10, 20, or 30 years. Your beneficiaries receive a payout from the policy if you die during the term. Once your coverage ends, your beneficiaries won’t receive any money in the event of your death.

Typically, term life policies have a level term life, which means that your insurance premiums and the death benefit will remain consistent until the end of the term. In some cases, you may come across a decreasing term life policy where the death benefit decreases as the term progresses (although your premiums will remain the same). 

If you die during the policy term, your beneficiaries will receive the death benefit and won’t have to pay income tax on it. 

Related: What Is Term Life Insurance?

What is permanent life insurance?

Permanent life insurance policies tend to cost more than term policies. A whole life insurance policy will pay out at any time, regardless of when your death occurs, as long as you keep the policy active by making premium payments. 

These policies also come with a cash value that you can borrow against or withdraw funds from while living. That's what you're paying extra for and why permanent life insurance policies are so much more expensive: You're paying for the insurance portion of the policy and the extra is being set aside as cash value.

Note that in some cases, the money you borrow from your cash value will be deducted from your death benefit when you pass away.

Like a term policy, your beneficiaries won’t have to worry about paying income taxes on the death benefit. 

There is a unique tax advantage of a permanent policy in that when the cash value accumulates, it does so on a tax-deferred basis. If your policy pays out dividends or you choose to end your coverage and take a cash payout, you'll only pay taxes on the amount above what you paid in premiums.

Types of permanent life insurance

There are several types of permanent life insurance. The type you choose boils down to two factors: how much flexibility you want and how much risk you're willing to take.

Whole life insurance

With a whole life insurance policy, you'll make fixed premium payments and have a cash value component that accumulates slowly (but steadily) over time. 

How long you have to make payments on a whole life insurance policy varies by insurer. For example, some life insurance companies stop requiring customers to make premium payments when they turn 100. Others may choose to charge premiums for a set number of years. 

You can borrow or take money out of the policy, but if you fail to pay that amount back, the insurer will pay out a smaller death benefit. With a whole life insurance policy, your beneficiary receives the face value of the policy (the death benefit), not the cash value (the interest-earning amount you can borrow against).

Universal life insurance

If you want a lot of flexibility in your life insurance policy, you may find a universal policy appealing. Universal life insurance policies make it possible to alter your death benefit or premiums, which can be helpful if your budget changes over the years.

You will have the option of combining the death benefit and the cash value to make sure your beneficiaries receive the biggest payout possible. 

Variable life insurance

A variable life insurance policy gives you the chance to place the cash value of your policy into investments. You get to choose the investments that can lead to more growth, but you also take on a lot of risk by going this route. You may or may not be able to add the cash value to the death benefit depending on your policy, but you can typically expect fixed premiums. 

Variable universal life insurance

Shocker — variable universal life insurance policies essentially combine universal life and variable life policies. Like a variable policy, the investments you choose impact the cash value. Similar to a universal policy, you have the flexibility of being able to adjust your death benefit and premium payments.

While this sounds like a good combination, you do need to be careful. If your investments don’t perform well, you may end up losing your coverage or even owing money on the policy. 

Term insurance vs. permanent life insurance

To make it easier to understand how term and permanent life insurance policies differ, let’s take a closer look at the main differences between these two policy types. 

Coverage length

When you have a permanent life insurance policy, you have lifelong coverage.

If you choose a term policy, coverage ends when the policy term ends. When you sign up for the policy you choose how long you would like coverage for.

Cost

Since a permanent life insurance policy lasts longer and builds cash value, it is significantly more expensive.

According to Policygenius, a 30-year-old non-smoker would pay $472 per month for a whole life insurance policy with $500,000 of coverage. However, that same person would pay between $15 and $30 a month for a term policy with $500,000 of coverage.

Features

For both types of coverage, if you pass away during the policy term, your beneficiaries receive a lump-sum death benefit.

With term life insurance, you may be able to tap into your benefits early if you become terminally ill or disabled, depending on your policy.

When it comes to permanent life insurance, you can use the cash value component of the policy to pay for unexpected emergencies, retirement, or even a child’s college tuition. Keep in mind, however, that if you borrow from your policy, you do have to pay it back. Depending on the policy, if you pass away with a loan on the cash value, the amount your beneficiaries receive will be reduced.

Tax benefits

Both policy types lead to tax-free payments to beneficiaries, but a permanent policy offers more tax benefits. When you have a permanent life insurance policy, the cash value experiences tax-deferred growth.

Related: How Much Life Insurance Do I Need For My Family?

Who should get term life insurance?

A term life insurance policy is the best fit for most people. This policy type is a popular choice for parents who may only want coverage for 10 to 20 years until their children will likely be supporting themselves.

A term policy can also make a lot of sense if it isn’t the primary asset to leave a dependent beneficiary. If you own property and have decent retirement savings, you may not worry about having a death benefit to leave to a beneficiary once the policy term ends. 

Related: Do You Need Life Insurance?

Who should get permanent life insurance?

High-income earners who are looking for additional ways to get tax-deferred growth may be interested in a whole-life policy. Do the math and figure out if the additional cost will offset any taxes you would pay on your investments.

If you are looking to use life insurance to leave an inheritance, consider taking the difference in cost between a term policy and a permanent policy and investing it outside of your life insurance.

FAQs

What happens to term life insurance at the end of the term?

Once the coverage term of a term life insurance policy comes to an end, the policy becomes inactive. This means there will be no death benefit for your beneficiaries. You don’t need to take action when the policy expires and should receive a notice from the life insurance provider that the policy is no longer in effect. 

Can you have term and permanent life insurance at the same time? 

If you want to carry a term and permanent life insurance policy at the same time, you can choose to do so. You may or may not be able to take the policies out with the same provider, but there’s no reason you can’t hold two concurrent policies.

Related: What Is An Insurance Deductible?

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