should-i-choose-term-or-permanent-life-insurance-2Let’s face it: few people like to talk about life insurance, let alone buy it. Benjamin Franklin, who was instrumental in creating the first life insurance company, the Presbyterian Ministers’ Fund, subsequently found that various religious authorities were outraged at the practice of putting a value on human life. Criticism cooled, however, when it was seen that life insurance protected widows and orphans.

While the fear associated with life insurance has also calmed, choosing the right type of life insurance can be daunting. Here are some guidelines that can help you narrow down your options.

Consider term life insurance if:

  • You need life insurance for a specific period of time. Term life insurance enables you to match the length of the term policy to the length of the need. For example, if you have young children and want to ensure that there will be funds to pay for their college education, you might buy 20-year term life insurance. If you want the insurance to repay a debt that will be paid off in a specified time period, buy a term policy for that period.
  • You need a large amount of life insurance but have a limited budget. In general, this type of insurance pays only if you die during the term of the policy, so the rate per thousand dollars of death benefit is lower than for permanent forms of life insurance. If you are still alive at the end of the term policy, coverage stops unless you renew the policy or purchase another one. Unlike permanent insurance, you will not build equity in the form of cash savings.

If you think your financial needs could change, you may also want to look into “convertible” term policies. These allow you to convert term life insurance into permanent life insurance without a medical examination, in exchange for higher premiums.

Keep in mind that premiums are lowest when you are young and increase upon renewal as you age. Some term life insurance policies can be renewed when the policy ends, but the premium will generally increase, and a medical examination may be required at renewal.

Consider permanent life insurance if:

  • You need life insurance for as long as you live. A permanent policy pays a death benefit whether you die tomorrow or live to be more than 100.
  • You want to accumulate savings that will grow on a tax-deferred basis and that could be borrowed for a variety of purposes. You can borrow against these funds even if your credit is shaky. The death benefit is collateral for the loan, and if you die before it’s repaid, the insurance company collects what is due before determining what goes to your beneficiary.

Keep in mind that premiums for permanent policies are generally higher than those for term insurance. However, the premium for a permanent policy remains the same no matter how old you are, while the premium for a term policy can increase substantially every time you renew it.

(Click here for tips on estimating how much life insurance you need)

In the case of permanent insurance, also known as traditional whole life, the life insurance company charges a premium that, in the early years, is higher than what’s needed to pay claims. The company invests that money and uses it to help pay the cost of life insurance for older people. The life insurance company could charge a premium that increases each year, but that would make it very hard for most people to afford life insurance at advanced ages, so they level the playing field.

By law, when these “overpayments” reach a certain amount, they must be available to the policyholder as a cash value if he or she decides not to continue with the original plan. The cash value is an alternative, not an additional, benefit under the policy.

That may seem like a lot of life insurance information to consider, but as Ben Franklin said, “By failing to prepare, you are preparing to fail.”

Loretta Worters is vice president with the Insurance Information Institute, a non-profit organization whose mission is to improve public understanding of insurance—what it is and how it works. Follow her on Twitter: @LWorters.