There are a lot of people who own various kinds of permanent life insurance policies. Though they may be called whole life, universal life, variable insurance, or several other different monikers, they basically amount to the same concept. You get permanent life insurance, which you are guaranteed will pay up once you die (unless you cash the policy out or quit paying on it), and the insurance also includes a savings vehicle that offers cash value.

Term life insurance, on the other hand, is a simpler proposition. If you die within the term (most of us won’t, thankfully), your loved ones get a check. If you live through the term, the insurance company keeps your money.

On the surface, it probably sounds like permanent life insurance is a better gig, but appearances can be deceiving. First of all, permanent insurance is extremely expensive compared to term insurance. While exact rates vary depending on a number of factors, the same amount of premium payments offers us more coverage if we opt for term life. A lot more coverage.

But what about the cash value?

Whole life policies, and the various spins on them, do offer a savings vehicle which generally allows an interest rate that is above average, and may even lock in a t guaranteed rate or return. It can look pretty damned appealing.

The flaw in the system comes in this: we are not paid interest on the entire premium we pay. Insurance take out the agent’s commission (which is often more than double the commission rates for term life insurance). They then take out the actual cost of the insurance. Then they take out processing fees. We are paid interest on what is left.

How much time do you have?

Anyone with a calculator and a modicum of business sense can figure out that it takes many years for the amount of cash value to approach the amount paid in premiums, much less that amount with interest. It doesn’t take a genius to figure out that it’s better to have a slightly smaller rate of return on all of your investment or savings dollars than to have a larger rate on a small portion of them.

So, if you want a small permanent policy to cover permanent needs like burial, fine. But don’t use it as an investment tool. In the vast majority of cases, the numbers just don’t add up. And for your most important life insurance needs, the ones you have while you’re still raising a family and paying off bills, buy term life insurance. In most cases, it’s the only feasible way to obtain enough coverage to replace the financial loss your family would suffer if you were to pass away before your time.

Photo via RodrigoFavera