There are three sources of cash that increase the value of a permanent life insurance policy. The first source is the premium payments that you make on a regular basis on a permanent insurance policy. The second source of cash is the investment yield (also known as the dividend or investment earnings) from the cash-value portion of the policy. The third source of cash is available only on some policies; these “participating” policies allow you the option of receiving tax-free dividends from the insurance company as a legal return of premium. Dividends that exceed the premium are taxable, however. You can typically receive tax-free dividends on your insurance if you own insurance from a mutual company. This is because you own part of the company and receive a dividend as an inflow to your account each year based on your ownership of the company’s earnings. However, should insurance company profits decline, these dividends are likely to decline as well. If your insurance policy comes from a stock company, then you have no ownership; however, the credits and costs of your policy will still be affected by the company’s performance.

Figure 5

Permanent insurance provides life insurance that cannot be cancelled and can be maintained for as long as you live. It provides a death benefit similar to term insurance, as well as an opportunity to accumulate tax-deferred savings; these savings can be used for retirement and estate planning. Also, as the cash value of the insurance policy accumulates, it becomes a valuable asset that can be borrowed against—a loan that is very inexpensive and possibly tax-free. If you fail to pay back the loan, the face value of your policy is decreased by the value of the loan at payment to your beneficiaries.

Because permanent insurance is designed to maintain a constant premium throughout your life and because this type of insurance is designed to build cash value, the premium is naturally higher. To put this concept in perspective, the premium for a permanent policy may be five to ten times higher than the premium on the same amount of term insurance; the premium is much higher because a portion of your premium goes towards creating cash value. Unless you maintain the policy by continuing to pay insurance premiums to cover costs and build cash value, the policy can expire, and you may lose much of what you have already put into the policy. Regarding some of the newer products, like variable life insurance, your investments could potentially lose money, which would likely increase the amount of money you would have to contribute each year. Also, depending on the type of permanent insurance you have, there may not be a guaranteed return each year.

Expenses are another important aspect of buying a life insurance policy that should be taken into consideration. Expenses can be divided into two classes. The first type of expense is the mortality cost, or the cost of the death insurance or term insurance. The second type of expense is the fees that accompany the purchasing process. These fees include sales commissions (often substantial), state insurance costs, deferred acquisition taxes, administrative fees, and investment fees (if applicable). These costs vary depending on which type of contract you have, so you should be sure to ask your agent to disclose these issues to you during the decision-making process. For a representation of the process of understanding permanent insurance, see Figure 5.

After you have paid the premiums on your permanent insurance for many years, the investment yield and dividends on your insurance may be sufficient to fund the policy (after expenses); when this happens, you will no longer need to continue paying the premiums. However, there is a risk that you will have to continue paying the premiums depending on the type of account, the investments chosen, and the economic environment.