Permanent life insurance: what it is and how it works
Life insurance policies fall into two primary categories: term life or permanent life. Both will pay an income tax-free benefit to your beneficiaries if you pass away, but with term life insurance, coverage only lasts for a limited amount of time (the policy "term" is typically 10, 20, or 30 years). Permanent life insurance policies provide lifelong coverage -- even if you live to 100, the policy will pay a benefit as long as premiums are paid.1 Permanent policies have another important feature: they build cash value.2 Premium dollars can contribute to a policy’s cash account while growing – tax-deferred – and can be used while you're still alive.3 Over time the cash account can grow into a sizable asset that can be borrowed against with tax advantages, used to pay premiums, or even surrendered for cash to help fund your retirement.
There are two main types of permanent life insurance: whole and universal
Both provide lifetime coverage and have a cash value component but differ in other ways.4
| Whole life insurance For people who want more guarantees |
Universal life insurance For people who want more flexibility |
|---|---|
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How does cash value accumulate in a permanent life policy?
Cash value grows on a tax-deferred basis. Still, growth varies depending on the type of permanent policy -- just as funds grow differently in a bank savings account versus a brokerage account. With whole life insurance, funds grow at a guaranteed interest rate -- but if you get your policy from a "mutual" insurer, you may receive dividends that can boost cash value growth beyond the guaranteed rate. That's because mutual insurance companies – like Guardian – are actually owned by their whole life policyholders, who may qualify for annual dividends based on policy cash value and company performance. While dividend payments cannot be guaranteed, Guardian has paid them to customers every year since 1868. These payments can further increase your cash value and have the potential to make a sizable contribution to your overall wealth.
Unlike whole life insurance, you don't receive dividends on universal policies, even with a mutual insurer. However, because the interest rate in a standard universal life policy (or UL) is variable, your cash value can grow faster or slower than for whole life. And, for those willing to accept a greater degree of risk, there are two variations on UL that offer the potential for even greater growth because the investment component is based on market returns:
- A variable universal life insurance policy (VUL) gives you the option to tie cash value growth to grouped stock market and bond investments called "subaccounts."6 However, growth in a variable life insurance policy is not guaranteed as in a standard universal or whole life policy. You, the policyholder, assume investment risk for any losses – just as you would with a brokerage account.
- An indexed universal life policy (or indexed UL) lets you tie all or part of your cash value growth to the performance of a broad securities index, such as the S&P 500.7 There's a floor and cap for the minimum and maximum rates of return, so while you won't realize all the gains of your reference index, you won't suffer all the losses either.
How different permanent policies calculate cash value growth
| Whole life | A guaranteed fixed interest rate, plus potential dividends with a mutual company |
| Standard universal life | Current market interest rates, but guaranteed not to go below a minimum set in the insurance contract |
| Variable universal life | Based on the performance of subaccount investments you choose, which are similar to mutual funds. You enjoy any gains and assume the risk for any losses. |
| Indexed universal life | Based on the performance of a broad market index, such as the S&P 500, with minimum and maximum caps to limit your investment risk. |
Four ways to use cash value while you're still alive
Money in your cash value isn't taxed as it grows, so it can grow faster. It usually takes a few years for cash value to grow into a usable sum, but once that happens, it becomes a financial asset with many advantages. Generally speaking, there are four ways to access the value of that asset:
| 1. Surrender | 2. Withdrawal | 3. Loans | 4. Premium payment |
| You cancel the policy and take the cash surrender value payment. However, you'll no longer have life insurance protection. With a newer policy, there also can be significant surrender fees and/or taxes, so it's generally not advisable before retirement age since there are other ways to use policy funds. | You can typically withdraw cash from your permanent policy, and the money is non-taxable as long as it's less than the amount paid into the policy. However, the death benefit will usually be reduced, and the reduction may be greater than the amount withdrawn, depending on the terms of your policy. | You can use your policy cash value to secure a loan that grows at a fixed or variable loan rate set in the contract. Rates can be competitive or lower than a personal loan and there is no application or credit check. You can even choose not to repay, but the outstanding loan balance will normally be deducted from your death benefit. | Want to stop paying premiums after you retire? You can often use the your cash value to pay part or all of your premiums. This can make it much easier to keep your coverage intact if your income declines when you are no longer working. |
Pros and cons: permanent vs. term life insurance
| Permanent coverage | Term coverage | |
|---|---|---|
| Yes | Income tax-free death benefit | Yes |
| Higher | Cost | Lower |
| Lifetime | Coverage length | Temporary |
| Yes | Cash value | No |
| Yes | Policy loans | No |
| Yes, typically | Health exam required | Yes, typically |
| Yes | Estate planning benefits | Not typically |
| Yes | Customizable riders8 | Yes |
How much does permanent insurance cost?
Many factors impact the cost of life insurance, including age, gender, tobacco use, overall health, and the amount of coverage. But in general, permanent life insurance costs significantly more than term life insurance because it provides considerably more benefits – and can be used in ways that term life can't. Also, whole life insurance rates tend to be higher than universal life. Your specific policy cost will vary, but the following charts show typical rates for healthy male and female nonsmokers at different ages. Note that no matter what kind of coverage you want, the younger you are, the less you'll pay.
$500,000 coverage - Average Monthly premiums for women
| Term1 | Universal2 | Whole2 | |
| Age 30 | $16 | $125 | $313 |
| Age 40 | $24 | $187 | $467 |
| Age 50 | $54 | $320 | $733 |
$500,000 coverage - Average Monthly premiums for men
| Term1 | Universal2 | Whole2 | |
| Age 30 | $19 | $144 | $355 |
| Age 40 | $28 | $219 | $541 |
| Age 50 | $69 | $359 | $856 |
1 Source: https://www.nerdwallet.com/article/insurance/average-life-insurance-rates Accessed 06/15/2022
2 Source: https://www.nerdwallet.com/article/insurance/universal-life-insurance Accessed 06/15/2022
Permanent life policies can be tailored to your needs
Most term life and permanent policies offer "riders" – optional provisions that give you added protection and benefits. However, permanent insurance policies typically offer more riders and customization because they're designed to cover a lifetime of different possibilities. Here are some of the options to discuss with your financial professional:
- Waiver of premium rider9 If you become disabled and can't work, this rider will pay your entire premium, allowing you to keep your policy in effect. A similar rider, called "Waiver of Cost of Insurance,"10 only pays the death benefit portion of your premiums, not the cash value portion.
- Accelerated benefit rider This rider provide an option to accelerate a portion of the death benefit while you are still alive if you become terminally ill or chronically ill (not able to perform at least two out of six Activities of Daily Living (ADL).
- Guaranteed insurability rider This allows you to increase the size of your death benefit at certain times without providing evidence of insurability or undergoing a new medical exam – effectively letting you lock in lower rates now and get a bigger policy later. Guardian gives you up to eight option dates throughout your life to purchase additional coverage.
Talk to a life insurance professional about your needs
Life insurance costs go up with age, so there's no better time than the present to consider getting a policy. Permanent life insurance can be a powerful financial resource that helps to protect your family and lifestyle now, and builds cash value for needs later in life. However, your situation is unique, and professional guidance is needed to build a permanent life contract designed for the specific needs of you and your loved ones. So it helps to discuss your situation with a financial professional who has helped others get whole life insurance coverage. If you need help finding such a person, Guardian can connect you to a financial representative who can help.
Frequently asked questions about permanent life insurance
What is permanent life insurance, and how does it work?
A permanent life insurance policy is a contract with a life insurance company to provide protection throughout your entire life, as opposed to term insurance that just provides coverage for a specified number of years. As with term coverage, the death benefit is typically paid out income tax-free to beneficiaries. Most permanent life policies also build tax-advantaged cash value: a portion of premiums goes to the cost of insurance, another part goes to administrative costs, and the rest is put in the policy's cash value, where it grows tax-efficiently over time. The cash value can be used for a policy loan or accessed in other ways to supplement retirement savings and help meet future financial goals.
What are the 4 types of permanent life insurance?
The four most common types of permanent, cash value life insurance are whole life, standard universal life insurance (UL), variable UL, and indexed UL. All these policies can provide life-long insurance protection and a tax-advantaged financial asset. The main differences have to do with how premiums are structured, and how cash value grows:
- Whole life: Premiums never change; Cash value grows at a guaranteed fixed rate, and may be eligible to receive annual dividends.
- Standard UL: Premiums can vary within a certain range; however, you may eventually have to pay higher premiums to keep your policy in force; Cash value grows at an adjustable market interest rate
- Variable UL: Premiums can vary within a certain range (with the caveat noted above); Cash value growth is based on the performance of subaccount market investments – but you assume the risk for any losses.
- Indexed UL: Premiums can vary within a certain range (with the caveat noted above); Cash value growth is tied to the performance of a broad market index, such as the S&P 500, with minimum and maximum caps to limit your investment risk.
Different companies offer variations on these permanent life insurance categories. There are also other types of permanent life insurance policies that don't build cash value that can be accessed as an asset, including low-face value "end-of-life" policies with death benefits designed to pay final expenses.
Can you cash out permanent life insurance?
Yes. A whole or universal permanent life insurance policy builds cash value that can be accessed in a number of ways depending on the terms of the policy. One way is to "surrender" or cash out the policy. However, you will lose your life insurance protection, and cashing out a policy before retirement age may result in costly surrender penalties. Fortunately, there are other ways to access policy cash, such as taking out a loan (which doesn't have to be repaid) or using cash value to pay your premiums.
