Quick overview
Life insurance is a contract that pays a death benefit to named beneficiaries when the insured dies. The two broad families are term insurance — protection for a fixed period — and permanent insurance — lifetime coverage that typically builds cash value. Each has clear strengths and tradeoffs. This article helps you translate your financial priorities into a practical choice, including cost comparisons, tax and cash‑value basics, common mistakes, and a step‑by‑step checklist for choosing a policy.
Key differences at a glance
- Cost: Term insurance generally offers the lowest premiums for a given death benefit, especially for younger, healthier buyers. Permanent policies have higher premiums because they include a savings component and lifetime coverage.
- Duration: Term covers a defined period (commonly 10, 15, 20 or 30 years). Permanent covers for life, as long as premiums are paid.
- Cash value: Permanent policies accumulate cash value you can borrow from or withdraw (subject to policy rules). Term has no cash value.
- Complexity and flexibility: Permanent products (whole, universal, variable) come with riders, flexible premiums, and investment choices; term is straightforward.
How premiums and costs compare in practice
- Term: A healthy 35‑year‑old can often buy a 20‑year term policy for a relatively low monthly cost per $100,000 of coverage. Premiums are level for the term in most policies but increase substantially at renewal (or become unaffordable) if you wait until later in life.
- Permanent: Premiums are higher but are designed to remain level for life (in many whole‑life and some universal products). The excess premium funds cash value growth. Over decades, permanent policies can become more cost‑effective if you need guaranteed lifelong coverage, but that depends on the policy’s performance, fees, and loans.
In my practice, I find clients underestimate how much term premiums rise if they wait to replace coverage in their 50s or 60s. A conversion feature (discussed below) can lock in access to permanent coverage without later medical underwriting — but often at a higher price.
Cash value and tax basics — what you need to know
Permanent policies build cash value that generally grows tax‑deferred (see IRS: Life Insurance Proceeds). Policy loans are typically tax‑free if the policy is not classified as a Modified Endowment Contract (MEC). If a policy becomes a MEC, distributions and loans may be taxable and subject to penalties (see IRS guidance on MECs). The death benefit on a properly structured life insurance policy is usually paid income‑tax free to beneficiaries under Internal Revenue Code §101 (see IRS: Life Insurance Proceeds), but there are exceptions when the policy has been transferred for value.
For consumer‑facing guidance on how life insurance works and what to watch for, see the Consumer Financial Protection Bureau’s life insurance resources (CFPB).
When term is usually the right choice
- You need protection only for a specific period: to cover a mortgage, child‑rearing years, or income replacement until retirement.
- You have limited budget and want the maximum death benefit per premium dollar today.
- You expect to self‑fund or invest surplus cash in other vehicles (401(k), Roth IRA, brokerage account) where you control liquidity and investment choice.
Example: A 30‑year‑old with young kids and a 30‑year mortgage often prioritizes a 20–30 year term policy sized to replace income and pay off the mortgage if they die unexpectedly.
For more on term mechanics and choosing term length, see our article on Term Life Insurance.
When permanent insurance can make sense
- You want guaranteed lifetime coverage because you want to leave a tax‑free death benefit for heirs or to fund estate taxes and final expenses.
- You value the cash‑value component for predictable, tax‑deferred accumulation or as a low‑volatility portion of your plan (whole life) or for flexible premium design (universal life).
- You have maxed out tax‑advantaged retirement accounts and seek additional tax‑deferred accumulation inside an insurance wrapper (with careful design to avoid MEC status).
Case example: A small‑business owner used whole life cash value as a conservative, accessible source for a business buyout loan. That worked because the owner understood loans reduce death benefit if unpaid and the policy’s performance assumptions.
To compare permanent policy types in more depth, see our Term vs. Whole Life Insurance article.
Common misunderstandings to avoid
- “Term is always the best deal.” Term is cheapest for pure death benefit over a fixed window, but not if you need lifelong coverage or want built‑in savings.
- “Cash value is a guaranteed return.” Only certain whole‑life guarantees exist; universal and variable policies depend on interest crediting or market performance and often include fees that reduce net return.
- “All permanent policies are identical.” They vary widely: whole life is more conservative with stronger guarantees; universal life offers premium flexibility; variable life shifts investment risk to the owner.
Conversion options and renewals — preserve options when you can
Many term policies include a conversion privilege allowing you to switch to a permanent policy without new medical underwriting, usually within a conversion window or before a certain age. This preserves insurability if your health declines. Likewise, some term policies offer guaranteed renewability, but renewals typically have sharply higher premiums.
If you think you may want permanent coverage later, choose a term policy with a generous conversion window and read the conversion rules carefully.
Decision checklist: practical steps before you buy
- Define the purpose: income replacement, mortgage protection, estate transfer, business continuity, or savings vehicle.
- Calculate coverage need: use rule‑of‑thumb multiples of income plus specific liabilities (mortgage, education). Consider an online calculator or work with an adviser.
- Compare the net cost: get quotes for term and for a permanent policy sized for the same death benefit. Compare cash‑value projections, fees, and surrender charges.
- Check policy features: conversion privilege, riders (waiver of premium, accelerated death benefit, disability income), loan rules, and surrender periods.
- Review insurer strength: use ratings from AM Best, S&P, or Moody’s for the insurance company’s claims‑paying ability.
- Read exclusions and definitions: look at suicide clauses, contestability periods, and how beneficiaries are designated.
- Revisit annually or after major life events: marriage, home purchase, birth, divorce, or business sale.
Questions to ask an agent or advisor
- How does this policy’s projected cash value look under conservative assumptions?
- What are all fees and surrender charges, and how do loans affect the death benefit?
- Is there a conversion option if I buy term now? What are the time limits?
- If I plan to use the policy for estate planning, how does it interact with my trust or beneficiary designations?
Two short case studies
- Term example: A 28‑year‑old parent buys a 25‑year term policy sized to replace 10 years of salary and cover the mortgage. The low cost allows saving the difference into retirement accounts.
- Permanent example: A 58‑year‑old concerned about estate taxes purchases a universal life policy to guarantee a legacy for heirs and keep assets accessible via policy loans.
Mistakes that cost money
- Buying more insurance than you can afford long term and surrendering a permanent policy early (surrender charges and lost guarantees are common).
- Overlooking riders that matter (accelerated death benefits can provide liquidity in terminal illness without a costly claim process).
- Assuming your agent’s recommendation is unbiased — some agents are captive to one carrier. Ask for comparable quotes from at least two companies.
Legal, tax, and regulatory notes
Life insurance tax rules are complex. The death benefit is generally income‑tax free to beneficiaries under Internal Revenue Code §101, and cash value growth is usually tax‑deferred, but loans, withdrawals, and transfers can trigger taxation or MEC status (see IRS: Life Insurance Proceeds and IRS guidance on Modified Endowment Contracts). For consumer guidance on shopping and policy comparisons, refer to the Consumer Financial Protection Bureau (CFPB).
Final recommendation
Start by identifying the primary purpose for coverage and your budget. For time‑limited needs and maximum near‑term coverage per dollar, term is usually the right choice. If you need lifetime coverage, want a guaranteed death benefit, or want built‑in tax‑deferred accumulation and are comfortable paying higher premiums, consider permanent policies. Use the checklist above, compare multiple carriers, and get illustrations and a second opinion if a permanent policy is proposed.
Professional disclaimer: This article is educational and does not constitute personalized financial or tax advice. Consult a licensed insurance agent, a fee‑only financial planner, or a tax professional to evaluate how a specific policy fits your situation.
Authoritative resources
- IRS, “Life Insurance Proceeds”: https://www.irs.gov/businesses/small-businesses-self-employed/life-insurance-proceeds
- Consumer Financial Protection Bureau, “Life insurance”: https://www.consumerfinance.gov/consumer-tools/life-insurance/
Related reading on FinHelp
- Term life basics: Term Life Insurance
- Compare permanent forms: Term vs. Whole Life Insurance
- If you have dependents: What to Know About Life Insurance When You Have Dependents
