The Differences between Permanent and Term Insurance

This is a guest post by CFP,  Brian Poncelet.

Life insurance is a critical component to every family’s financial well-being. And yet, over 10 million Canadians are underinsured, leaving their loved ones vulnerable to out of control expenses and runaway debt.

To protect your dependents, you need to first know that there are two types of insurance available – permanent insurance and term. In order to select an affordable policy that addresses your needs, understanding the differences between them is key.

1. Length of Coverage

The main difference between permanent and term insurance is the length of coverage. Term insurance provides coverage for a specific period of time – generally 5 to 30 years. The coverage ceases once the term has ended or the premiums are unpaid. Permanent life provides coverage until you pass away or the premiums are unpaid and the reserves are insufficient to cover the premiums.

2. Premiums

Permanent and term insurance both have level premiums. The premiums are usually higher for permanent life because they are averaged over your lifetime. Meanwhile, the premiums for term are only averaged over the length of coverage. If you’re in good health and purchase term insurance at a young age, premiums typically start much lower. However, once term coverage ends, premiums can increase dramatically upon renewal.

3. Cash Value

Term insurance is your plain vanilla insurance policy with no savings component – buy term and invest the difference, as the saying goes. If you cancel your policy, the coverage ends and there is no cash value paid. Permanent life may or may not include a cash value. Whole life has a cash value, while some universal life policies have an investment option.

4. Convertible

Besides the death benefit, the most important thing to know about your term life policy is whether it’s convertible. If you get sick, a convertible term policy allows you to convert to permanent insurance at any time up to the end of the term with no medical exam. Permanent life is not convertible.

5. Death benefit

This is the most important factor when choosing life insurance – how much will my beneficiaries receive when I pass away? Term only pays out a death benefit if the policyholder dies during the term the policy is in effect (if you outlive the policy there is no payout). Permanent life provides a death benefit to your beneficiary or estate when you pass away as long as the premiums are paid up.

6. Renewable

Term life is renewable, permanent life is not (you won’t need to renew since coverage is for your entire life).  With term life, the premiums remain the same throughout coverage. Most term policies only allow renewal up to age 75.

 Summary of the pros and cons of both types of insurance

Permanent Insurance

Pros

  • Level premiums for life or a fixed period and coverage for live
  • Can borrow from policy tax-free  in a number of cases
  • Can be used to enhance retirement
  • Can be used to pay Estate taxes at death (cottages, business, etc.)
  • Insurance can be structured to grow every year

Cons

  • Initially costs more than term for coverage

Term Insurance

Pros

  • Buy a lot of coverage for premiums paid
  • Can Convert to Permanent later
  • Can “buy term and invest the difference”

Cons

  • Insurance costs go up every year
  • If one does not die during term, premiums are wasted and a lost opportunity cost

Final Word

Term and permanent life aren’t mutually exclusive – a combination of both can be used for meet your insurance needs. Term life is best suited for short-term term expenses, such as income replacement, mortgages and car loans. Permanent life is ideal for long-term permanent expenses, such as funerals and estate planning.   There will be more quantitative articles coming up describing which type of insurance is better with different circumstances.

About the Author:  Brian Poncelet is  an insurance specialist and independent certified financial planner (CFP) who has been working in the financial services industry for almost 20 years.

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Vancity
8 years ago

A little late to the party, but the compensation numbers are incorrect. Both Whole Life & Term-20 offer a 50% First Year Commission.

Paul
8 years ago

LifeInsuranceCanada.com, we’re not going to agree. You’re sticking to your opinion, I’m sticking to mine.

You’re also arguing with ‘The Globe and Mail’ Dec 2010 (updated Dec 2012) article titled ‘What your insurance broker doesn’t want you to know’… Do a google on it.

The insurance industry should state what commissions (lead and trail) are paid on policies prior to and during any sales. The industry has fought strongly against doing so despite it being obviously in the consumer’s best interests.

Go ahead and deny it but you rightly know that the commission insurance salespeople make on life policies is hugely more than what they make on term policies. That creates a clear conflict of interest – sell a life policy and make a lot or sell a term policy and make a little…

Life policies are often 400%+ more than term policies, hence my use of the $1k versus $4k.

And yes many life policies do pay a trail commission, argue away that they don’t but many do.

You have a vested interest in ensuring consumers do not understand the commission picture, hence your repeated replies and false/very misleading info.

LifeInsuranceCanada.com
8 years ago

And one thing further before I discard your comments as nuts. Every time I’ve seen a commissionless life insurance product – without exception – it has cost more than a comparable product purchased through a life insurance broker. Unlike MER’s in the fund industry, in the life insurance industry the least expensive products are those that are purchased through a commissioned insurance broker.

LifeInsuranceCanada.com
8 years ago

>>>It is accurate FrugalTrader, There is also trail commission every year with many policies too.

Wrong on all counts. Wildly innacurate. False and misleading. I speak from experience as a life insurance broker. Where’d you get your numbers from – the internet? And if I had to guess, the internet of 1985?

How much I make specifically is none of your business frankly. It doesn’t affect the premiums a consumer pays, and my income isn’t open for your titillation, which is all this boils down to.

The argument boils down to “agents are motivated to sell permanent’, and that’s speculation at best on your part (and demonstratibly false, as I’ve already indicated that probably 95%+ of my clients have term insurance), and this idea that because premiums heaped up front instead of levelized that’s another strike. That’s absolutely bizarre, because if any companies could get a finger pointed at them about permanent insurance sales, it’s the ones with levelized commissions. In direct contradiction to what’s being stated here.

Further, what’s obvious to everyone in the industry is that commissions are based on premiums, not the heebeejeebie math that’s been touted in the comments here. If a consumer has a $1000 budget for life insurance, then they have a $1000 budget for life insurance no matter what product they get with . You don’t just magically sell a consumer $4000 of life insurance because you think permanent insurance is better. Any consumer is going to simply tell you sorry, $1000 is the end of it. If you think you can get a consumer with $1000 term budget to buy a $4000 permanent policy, you really should be selling life insurance for a living, because that’s a pretty unique skill set you’ve got right there.

What makes this even more complex is that there’s a variety of factors in commission. Volume is a huge one. The wholesaler you use is another one. Company is another one. There are absolutely companies that pay more on their term policies than other companies pay on their permanent policies. Does that somehow sway every insurance agent out there to start selling one companies term plans to every consumer out there? I gotta think, not the case. Again, the inference is simply not true.

As I’ve stated before, until you have some proof of your claims, all they are is hysterical gibberish intended to elicit an emotional hatred of life insurance agents. And you won’t find that proof, because your numbers are incorrect.

Brian Poncelet, CFP
8 years ago

Sampson,

That’s a great question. CIBC tried this years ago and failed. The big thing they would advertise is “no commission” the price was a little less but not a lot.

Who would be interested in getting insurance? A number of people who’s health was not the greatest. So a nurse would go over get the blood work etc. This cost CIBC and insurance companies hundreds of dollars to this.
The underwriters would look at the results and rate the client. The client would say “that’s too much” and would not take it. This went on for a few years and CIBC got out of the market.

Investments are easy. Everyone is an expert. Insurance is a topic no one likes and generally males dislike it the most.

The average age for an insurance agent I believe now is 56. I see people in their 40’s and 50’s who have never discussed or being approached to get insurance. Since most people get a little bit of information on the internet insurance is not a hot topic.

Since we are getting into tax season, here is tip for self-employed from CRA:

Subsection 148(9) of the Act defines a disposition in relation to an interest in a life insurance policy. This definition specifically excludes “a payment under a life insurance policy that… is an exempt policy in consequence of the death of any person whose life was insured under the policy”. Consequently, a death benefit from an exempt life insurance policy is not considered a disposition and is therefore received tax-free by both individuals and
corporations. Virtually all life insurance contracts currently available in Canada are structured to be exempt life insurance policies.

Stu
8 years ago

I am shocked as to how high first-year commissions are in comparison to trail commissions. There is so much incentive for sales agents to churn customers from one policy to another.

I also received much pressure to purchase permanent insurance from my agent when I specifically sought out term insurance. Permanent insurance is absolutely not appropriate for my situation.

Sampson
8 years ago

I wonder if the salesman will ever be removed from this equation.

Just as discount brokers have increased accessibility and reduced the cost of investing, if sales commissions are this high in the insurance industry, how low would premiums be if that was reduced or out of the picture?

Paul
8 years ago

“From what I’ve been reading online, it appears accurate that insurance commissions are about 60%-70% of the first year premiums. ”

It is accurate FrugalTrader, There is also trail commission every year with many policies too.

But as a buyer, you’re not told any of this. You should be.

The advisor / salesperson should indeed be compensated but with perm life policies being 400%+ the cost of term insurance, you can see why many would be very keen to sell you perm life, not term.

And this article was very badly slanted/biased towards perm life, that’s what pressed my buttons. Particularly when 100+, 1000+ people are reading it. And like many, I come to this site for informative and (hopefully) unbiased advice.

Brian. You raise a good point, for me, term insurance was by far the best option. For some people indeed, perm life is the better option – see Peter’s points etc.

FT
8 years ago

From what I’ve been reading online, it appears accurate that insurance commissions are about 60%-70% of the first year premiums. Is this accurate? I believe that insurance agents should be paid for their work, but it is good to know what the compensation is.

Brian Poncelet, CFP
8 years ago

Paul,

Here is a great example of buy term and invest the difference does not work in some cases.

A new client who has a great pension had two policies one was Primerica the other was Transamerica Life.

His situation was his health was poor and he was not insurable. Also his wife who had heart problems also had a Policy with Primerica and also is now not insurable.

In that situation (we applied to other insurance companies but were turned down). The best we could do was convert the Transamerica policy into a permanent one. With Primerica (buy term and invest the difference) there is no option to convert to a permanent policy to protect the family.

The problem is people’s health it changes over time and sometimes rates of return do not pan out the way we want it to.

The media and others make a big deal out of one size fits all. We can all be self-insured. If that was the case why not drop insurance on the house? The odds of it burning down is very slim and if you have money in bank you can build a new one.

Insurance is transfering Risk to an insurance company for a small amount of money. Life insurance does this. Permanent coverage is more expensive because the insurance must pay out at death which is 100% vs term coverage which becomes more expensive over time and many people drop coverage. Since some people have limited cash flow, they should be educated on where best to get the best coverage for a limited time frame.