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I can't tell you how many times clients have come to me and said some version of, "I know I need life insurance now that I bought a house and have kids, and this guy I went to college with is trying to sell me permanent life insurance — is that the right thing for me? It feels expensive." In most cases, my answer is simple: You do need life insurance, but you don't need permanent life insurance. Here's what I tell my clients.
How life insurance works
Life insurance is intended to provide a lump-sum cash payment after your death to your beneficiaries to help them with things like paying off debt, paying monthly expenses, and funding college for kiddos. You typically need it if someone depends on your income or your care.
If you're working, your income between now and retirement is likely a huge part of your family's ability to reach their goals, and life insurance is meant to help replace some of your lost income should you die prematurely. If you're not working but you're a primary caretaker for your kids, replacing you would be costly, too, so life insurance can help your family take care of the million things that you do in any given day should you die.
The difference between term and permanent insurance
Term life insurance lasts for a specific period of time, the term of the policy. It has a set premium for and a set death benefit that stay the same for the entire policy term. For example, if you're 35 and you get $1 million of 30-year term coverage, your premium, let's say $75 per month, would stay the same for 30 years. Term insurance has a much lower monthly premium than permanent coverage.
Permanent life insurance is intended to be in place for your entire lifetime, and provides the opportunity to invest in a tax-advantaged cash value account. However, most people don't need life insurance for their entire life, because at some point they retire and have enough assets and income from Social Security to live comfortably. And, after all of the commissions and substantial fees associated with permanent coverage, investing in life insurance isn't a very efficient way to reach your investment goals. Oh, and permanent life insurance premiums are much higher than term premiums.
Why I recommend term life insurance in most cases
So which type of coverage is the right kind to choose? For the vast majority of my clients, term is the clear winner.
My clients are looking to term insurance to provide a death benefit to pay off their mortgage, fund college, and cover expenses for their families until they reach retirement. Since most of my clients are in their 30s with young kids and plan to retire in their 60s, we typically use 30-year term coverage to last until they're ready to retire. Depending on the age of their kids, we'll split their coverage between two policies — a 20 year policy to last until their youngest child finishes college, and a 30-year policy to last until retirement.
All of that said, there are some special cases where permanent coverage makes sense. If you are buying insurance to provide for a special-needs child who will need care no matter when you die, permanent life insurance can be a good option.
Other times permanent coverage might make sense are when you're trying to maximize a pension payout, when you're funding a buy-sell agreement for a business, when you anticipate an estate tax issue (which means you're planning to die a multi-millionaire), or when you just really want to leave a specific amount to a certain beneficiary no matter what.
Financial planners and financial advisers get very heated about the old "term vs. perm" life insurance debate. For those who sell insurance, permanent life insurance pays huge commissions compared to term coverage. And those who sell insurance are not always required to look out for your best interest when they're selling insurance to you. Yup, you heard me right.
If you're working with an adviser who is trying to sell you insurance, ask them if they are bound to a fiduciary standard in the life insurance transaction, and inquire about how they get paid based on the various insurance policies they're pitching to you. If you don't get answers you like, RUN!
Natalie Taylor, CFP, BFA, draws on 15 years of financial planning experience, seven years in fintech, and a decade of professional speaking to share advice that works in real life.
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