By: Aristata Financial

Life insurance is ultimately designed to provide financial protection when someone dies, but not every policy works the same way. One of the biggest decisions is whether that protection should be temporary or permanent.

Term life insurance is relatively straightforward. You purchase a certain amount of coverage for a defined period, often 10, 20, or 30 years. If you die during that period, your beneficiaries receive the death benefit. If the term expires while you’re still living, the coverage generally ends. Because term insurance is designed primarily to provide a death benefit without building cash value, it can be significantly less expensive than permanent coverage.

Permanent life insurance is designed to potentially remain in force for your lifetime, assuming the policy is properly funded and contractual requirements are met. Depending on the type of policy, it can also accumulate cash value. That combination comes at a cost. Permanent policies typically require substantially higher premiums and may include mortality charges, administrative expenses, surrender charges, and other costs.

What About “Buy Term and Invest the Difference”?

You’ve probably heard the phrase “buy term and invest the difference.” The idea is simple: instead of paying the higher premium for permanent insurance, purchase less expensive term coverage and invest what you save.

Consider a hypothetical healthy 40-year-old looking for $1 million of coverage. Suppose a 30-year term policy costs $1,000 per year while a permanent policy requires $10,000 annually. Actual premiums would depend on health, underwriting, policy design, the insurance company, and several other factors.

If that person purchases term insurance and invests the $9,000 annual difference, earning a hypothetical 7% annual return, the account could grow to approximately $850,000 after 30 years. At an 8% return, it could grow to approximately $1.02 million. Those returns aren’t guaranteed, and taxes, investment expenses, and market volatility could affect the actual results.

There’s another important distinction. The investment account belongs directly to the investor. They decide how it’s invested based on their goals and risk tolerance, and the money can generally be used for whatever they choose, subject to any taxes or account-specific restrictions.

The cash value inside a permanent insurance policy is different. Its growth depends on the type of policy and its specific terms, and shouldn’t be assumed to match the return of an investment portfolio.

Access is different, too. Depending on the policy, cash value may be accessed through withdrawals, partial surrenders, or policy loans. A withdrawal can provide cash without creating a loan balance, but it generally reduces the policy’s cash value and may permanently reduce the death benefit. Depending on the policy and circumstances, withdrawals can also have tax consequences.

A policy loan allows the owner to borrow against the policy’s value without selling investments or necessarily recognizing taxable income when the loan is taken. However, interest is charged on the loan, and an outstanding balance generally reduces the amount ultimately available to beneficiaries. If too much is borrowed and the policy later lapses or is surrendered, there can also be significant tax consequences.

None of that means cash value is inherently bad. It simply isn’t the same as owning an investment account directly.

The Part People Often Miss

There’s also a practical problem with “buy term and invest the difference”: you actually have to invest the difference.

If someone buys the $1,000 term policy but spends the remaining $9,000 each year, they haven’t followed the strategy. They’ve simply purchased less expensive insurance.

Permanent insurance can create a form of forced savings because maintaining the policy requires consistently funding it, with a portion potentially contributing to cash value. For someone who values that structure, it can be beneficial. But you’re also accepting the costs and restrictions of an insurance contract to create that discipline.

This raises an important question: Are you buying permanent insurance because you want the cash value, or because you need the death benefit?

If your primary goal is accumulating accessible wealth, it may make sense to compare the policy closely with simply owning investments directly. If you’re solving a financial problem that will exist whenever you die, permanent coverage may serve a very different purpose.

When Permanent Insurance Can Make Sense

Many life insurance needs are temporary. A family may want to replace income while children are young, cover a mortgage, or protect a spouse during someone’s working years. If the financial risk eventually goes away, term insurance can be an effective and relatively inexpensive way to address it.

Other needs don’t necessarily disappear with time. An affluent family may want permanent insurance to provide liquidity for estate taxes, particularly when much of the estate consists of a business, real estate, or other illiquid assets. A policy could provide funds to help equalize an inheritance when one child receives the family business while other children receive different assets. Business owners may also use permanent coverage as part of a strategy to fund a buy-sell agreement or provide liquidity following an owner’s death. Permanent coverage can also play a role when providing for a lifelong dependent or pursuing certain charitable and legacy objectives.

The decision, then, isn’t simply whether term or permanent insurance is “better.” Start by asking what financial risk you’re trying to protect against, how long that risk will exist, and whether you’re primarily looking for insurance or an accumulation vehicle. Once those questions are answered, the right type of coverage often becomes much clearer.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Aristata Financial and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC, marketed as Aristata Financial. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Aristata Financial is not a registered broker/dealer and is independent of Raymond James Financial Services, Inc.