Many advisors almost exclusively advocate purchasing term life insurance while many insurance agents continue to recommend permanent life insurance (sometimes forcibly). Who's right? It depends. Term life insurance is likely the best option for most due to its temporary nature and significantly lower costs, but permanent life insurance has an important role as well. As we'll point out in this post, whole, universal, variable, and variable universal life insurance can all be suitable policies depending on circumstances.
The Basic Rule
At the heart of all of these situations where permanent life insurance makes sense it the basic principle that if you have a permanent insurable interest (say, taking care of a special needs child), then you should purchase a permanent insurance policy. It seems rather simple, but often, unwary individuals and families will buy a permanent policy to insure a temporary need. This is unfortunate because permanent policies are very expensive and the added costs are not easily recouped.
There is a small percentage of folks who are very wealthy and require life insurance to offset the effects of estate and inheritance taxes. Life insurance is income tax free, and if setup properly can also escape death taxes. Most commonly, wealthy individuals will purchase permanent life insurance of some form or another and own it within an Irrevocable Life Insurance Trust (ILIT). With the insurance owned by an entity exempt from estate taxes, the proceeds from the policy can be paid to the beneficiaries without taking a haircut from Uncle Sam.
I Own a Successful Small Business
Most businesses don't reach higher levels of success with only one owner; they usually have two or more. As a small business, there are two major life insurance needs that may arise in the form of insuring against the death of an owner or that of a key person whose loss would make a material impact on the business. These issues are nearly always best handled with permanent life insurance.
In the case of an owner's death, the surviving owner(s) typically will not want to be in business with the deceased's beneficiaries so a buy-sell agreement will be used to facilitate the sale of the deceased's interest in the company. This arrangement keeps the business functioning well because there is no interference from those unfamiliar with the company and it frees up equity to bring on a replacement in the company, if needed. The beneficiaries receive a cash payment and can then walk away from the business altogether.
With a key man that isn't an owner, life insurance may be important to insure against the possible loss in business should the key person die unexpectedly. These are usually executives or general managers of small businesses who have a great deal of responsibility and influence on the success or failure of the firm. By insuring this potential for loss, the business owners are better able to provide for a stable transition from the deceased to a new key person.
I Have a Special Needs Dependent
Another important use for permanent life insurance is for the provision of funds for a special needs dependent that will need money long after the provider dies. These are typically owned in a trust that has specific provisions associated with it, but having permanent life insurance in place ensures that money will be available to a dependent beyond the provider's lifetime.
I Am a M-I-S-E-R-A-B-L-E Saver
This last one is debatable, but we'll take a more behavioral approach to personal finance on this. For those that simply cannot save a nickel without being forced to do so, permanent life insurance may be a way to force savings into one's life. Make no mistake, insurance is an extremely expensive savings vehicle that will produce returns that are far below other alternatives and may even trail inflation. However, some folks seem to be able to commit to and stay with an insurance policy better than a 401k, IRA, or savings account. While we can only speculate, the highly inflexible provisions of permanent life contracts (like not being able to take out a dime for 15 years) and regular payment of premiums required appear to be a good combination for those that cannot save on their own.
We are major proponents of term life insurance, but permanent policies do have a place. We've pointed out four common issues that make permanent life insurance a suitable option. However, you should always remember the rule that permanent policies should only be used to insure permanent needs. By the way, if you're a miserable saver and generally can't hold onto money for any length of time, the odds are good that you have a more permanent problem on your hands, thus, permanent insurance could make sense.