Life Insurance: Term isn't always best

November 18, 2005

Yes, inexpensive term insurance is the answer for many doctors. But not for everyone.

Of course you know the primary purpose of life insurance: to replace your lost income and to provide for your survivors. You probably also know the conventional wisdom: Most people should buy term insurance (death benefits only) rather than pricier permanent life insurance (which adds a savings component) and invest the difference. If you follow this line of thought, term is all you need to provide for your family, and permanent life insurance is an evil plot hatched by greedy insurance companies.

But, according to some financial planners, there are situations where permanent insurance is a prudent purchase: when you need an extra tax-favored investment, when you're concerned about asset protection, and when you're looking to help your heirs with the high cost of estate taxes.

"Term" life and "permanent," how they differ

Term insurance is protection for a limited time period; it pays a death benefit but provides no cash build-up. Your coverage ends when the term ends, although, if the policy has a conversion feature, you'll be allowed to change your coverage into permanent insurance during what's known as the "conversion period." If your policy has this option, you can convert without undergoing a medical screening, which may be important if you plan to keep the coverage for the long haul. "In some cases, you can be better off by buying term with a conversion feature for a few years, investing elsewhere, and then putting the savings into a whole life policy," says Glenn Daily, a fee-only consultant in New York City.

Premiums for term life insurance are much lower than those for a permanent policy. That makes term attractive for people who need the insurance for a limited time-until the mortgage is paid, say, or the children are through college. But if you think you'll need coverage for more than 15 or 20 years, term may not be the best choice since the policy must be renewed periodically-sometimes every year-at increasingly higher premiums. Eventually, the cost may be prohibitive, and, with some policies, each time you renew you have to prove that you're still insurable. If your health has changed significantly, you may not be able to get coverage at all.

Permanent life insurance, on the other hand, provides a death benefit as well as a savings component. Part of each premium you pay is invested, and that money grows tax-deferred. Because it's designed to provide lifelong coverage and to cover sales commissions and administrative charges, permanent insurance always requires higher initial premiums than term contracts for the same amount of coverage. If you decide you don't need the insurance, you can cash in the policy and get back much of the cash value tax-free. Of course, any earnings are taxable as ordinary income. In addition, permanent insurance offers access to cash value through loans or withdrawals. Any withdrawals or unpaid loans will reduce the death benefit, though.

There are several basic types of permanent insurance. Traditional whole life policies have fixed premiums. The insurer chooses the investments and pays you interest on the cash value. With variable life, you get to choose the investments from a limited list of stock, bond, or money-market portfolios. The policy's cash value will fluctuate with your investment returns; the premiums and the death benefit may also vary. Adjustable and universal life give you flexibility to increase or decrease your premiums and death benefit as your financial situation changes. There are many variations on these basic policies.