Life insurance is a key component to physician estate planning and helps doctors protect their families in a worst case scenario. Many different types of life insurance policies exist, falling under two primary different categories: permanent life insurance and term life insurance. We are big believers that most physicians only need term life insurance policies. However, some financial advisors or insurance agents will try to sell doctors permanent life insurance products. The cynic in us believes that most of these recommendations are influenced by the large commissions and fees generated for the person selling the product (although there are a few instances where permanent life insurance may make sense). Therefore, it's important for physicians to be aware of these policies and why it doesn't make sense to mix insurance and investing in the vast majority of cases, so they can steer clear of predatory advice. There are several different types of permanent life insurance policies, and it's easy to get them confused, or need clarification on questions about which type of life insurance is the best fit. Below, we cover the features and differences in the types of permanent life insurance policies, including what physicians should know when assessing which type of life insurance.
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What is permanent life insurance?
Permanent life insurance policies cover you indefinitely from the effective policy start date until you either cancel the policy or the policy defaults for non-payment. This is unlike term life insurance, where the benefits expire after the length of the term. Under a permanent life insurance plan, you pay a premium that then provides you a determined death benefit amount that will be payable upon your death (so long as the policy is still in good standing) to your selected beneficiaries. Along with a death benefit, a cash value also builds throughout the life of your policy. This is a savings/investment component that you can borrow against or withdraw cash from once the balance has grown.
At the time of your passing, whatever cash value your policy has doesn’t matter, as the death benefit will be what is paid out to your beneficiaries.
The cash value portion generally grows tax-deferred, providing tax advantages while the balance remains in your policy. There are also some tax advantages on withdrawals. Since the money grows from the premium payments you make, generally you can make withdrawals tax-free up to the amount of total premiums you’ve paid. Think of it as a fancy piggy bank where you stash money monthly in the form of policy premiums. Withdrawals are like paying yourself back from the piggy bank.
How is permanent life insurance different from term life insurance?
Term life insurance includes just the death benefit side of permanent life insurance. In exchange for paying a set monthly premium amount, the insurance company provides a fixed death benefit for the term (hence the name) of the policy. Term life policies generally come in 10, 20, or 30-year options.
Term life insurance typically provides higher coverage at lower cost, though it only provides that benefit for the set length of the policy. If you outlive your policy, you don’t receive anything from the policy provider.
This is in contrast to permanent life insurance, where as long as you hold the policy and pay the premiums, you will have a tax benefit. In most permanent life insurance policies, you also have the option to borrow back a part of your premiums.
You may be reading this thinking, "Why wouldn't I want permanent benefits and this ability to borrow against the policy?" However, note that it can take several years for the cash value to build and provide this option. Additionally, permanent life insurance policy premiums are much, much higher than term life insurance premiums for the same amount of death benefit. This is because permanent life insurance policies typically have heavy fees within them, and pay hefty commissions to the insurance agents who sell them. In general, most physicians will find that they are better off paying the lower premiums for term life insurance and then investing the differences in premiums, which will grow at a much higher rate than the cash value of permanent life insurance policies based on historical data about average returns in the stock market. As such, we typically caution against mixing insurance with investment. For most physicians, life insurance should just be there to protect your loved ones in the event that you aren't able to provide for them anymore.
PSG resource: Insurance companies selling term life insurance
What are the different types of permanent life insurance policies?
There are a few primary different types of permanent life insurance. Whole life and universal life are the main two subtypes, and within universal life insurance, there are two main variations, variable universal life and indexed universal life. We'll also mention variable life insurance, which combines some elements of whole life and variable universal life.
Whole life insurance
Whole life insurance is the most common type of permanent life insurance, and also tends to be the most expensive.
With a whole life policy, guaranteed is the name of the game, and the word you should associate in your mind when differentiating it from other permanent life insurance policies.
Your premium payments are predetermined and then fixed for the life of your policy, as long as you keep the policy current. You have a guaranteed, fixed death benefit, as well as a guaranteed growth for your cash value at a predeterined baseline rate.
There may be some additional non-guaranteed cash value growth potential related to dividends. If the insurance policy is issued by an mutual insurance company, the policy holders actually are partial owners in the company, which means that if the company does well, you can get additional dividends. This is only the case for whole life insurance policies issued by mutual insurance companies - not universal life policies. Regardless, expect your cash value growth to be far less than what you would make investing in the stock market. The typical cash value growth rate for whole life is around 3-4% (far less than historic stock market returns of 7-10%).
The premiums for whole life policies are generally pretty high, and the death benefit is usually pretty low. As an example, whole life policies can typically run 10x what a term life policy would cost for the same amount of death benefit
Learn more about if physicians should buy whole life insurance. TL;DR: most of the time, term life insurance is going to be a better option for physicians.
Universal life insurance
The word you should associate with universal life insurance, on the other hand, is flexible. It is typically associated with lower premiums than whole life insurance.
With a standard universal life insurance policy, you still have a guaranteed minimum death benefit, but unlike whole life, you have some flexibility when it comes to your premium payments and potentially what the death benefit is. You are typically given a range of payments that are allowed, which means that depending on what's going on in your financial life at any given time, you can modify how much money you want to put into the policy as long as you put in the minimum. The caveat is that your paid premiums have to be able to cover the guaranteed death benefit to receive it. Essentially, you have to pay the insurance portion of your policy, which will be deducted from your premiums, and the remainder will go towards your cash value.
In this model, while you have flexibility from year to year, you could have to pay higher premiums later to keep your policy in effect if you choose to pay lower premiums at the beginning. If you don’t keep up with the minimum payments for your guaranteed death benefit, you could either fall into a situation where your death benefit amount reduces, or find yourself with a lapsed policy.
Because your premium payments may change and because your interest rates are variable, your cash value will change according to how much money has been put into the policy. Unlike whole life insurance policies, even if your policy is issued by a mutual insurance company, you don't get dividends.
Depending on the policy, you may also have the flexibility to change the death benefit.
Within universal life insurance, there are two main variations that allow for potentitally better growth in the cash value because of the ability to tie the return to how the stock market is performing. These are indexed universal life insurance (indexed UL) and variable universal life insurance (VUL).
Indexed universal life insurance (indexed UL)
Indexed universal life couples the flexibility for premiums and guaranteed death benefit of a universal life policy with a higher cash value growth opportunity. The cash value growth of an indexed universal policy is linked to an external index. A common one, similar to stock market investing, is the S&P 500 index.
But don’t expect your cash value growth to match the S&P index. Cash value growth for indexed universal life policies usually have return caps and floors, which can help minimize risk with large stock market dips by guaranteeing a certain minimum return, but also limits the growth by capping the returns. The maximum return cap is usually 8%-12%. While this may sound pretty great, remember that while you won't take losses on down years, you will get lower returns during those years, and during up years, you'll be limited, so the average returns overall will likely be lower than historic returns in the market, as the max return you can make in a given year is at average market returns.
Variable universal life insurance (VUL)
A variable universal life insurance policy adds even more flexibility and options to the cash value component of a permanent life insurance policy. Instead of being limited to following a specific index for growth, a variable life insurance policy allows you to invest into grouped stock and bond investments which are sometimes referred to as "subaccounts." This provides a greater opportunity for growth -- but also increases the risk. Similar to investing in the stock market, there is the potential for losses. There is no guaranteed growth of the cash value portion in the way you would have with a standard universal life insurance poicy or whole life insurance policy.
Keep in mind here, if you have very significant losses and your cash value gets so low that it can't cover the cost of the insurance portion, it may be necessary to make larger premium payments just to cover the cost of your life insurance and rebuilding your cash value. If your cash value reaches zero, you may find yourself in a situation where your policy terminates.
Along with a potential decrease in your cash value, a downturn in your investments could mean a decrease in the death benefit as well. Typically, if your cash value exceeds a certain amount with a variable policy, the death benefit will increase as well.
In exchange for this flexibility and the ability to invest in what you like, there are typically more fees associated with variable life insurance policies. In addition to paying all the fees related to running the permanent life insurance that are greater than in term life insurance, the "subaccounts" will also deduct management fees for their investment options. These can range from 0.5% to 2%. Again, this speaks to the danger of mixing insurance with investing in terms of the fees eroding away at returns on the premium, as opposed to paying for term life and investing the difference.
Variable life insurance
Another form of permanent life insurance you may hear about is a variable life insurance policy. Similar in many ways to a variable universal life insurance policy, a variable life insurance policy adds more flexibility and options to the cash value component of a permanent life insurance policy by allowing you to invest in the market through subaccounts. However, it usually provides a guaranteed death benefit. It does this by requiring a set monthly premium that allows you to keep the guaranteed death benefit as long as you pay your premiums.
As with variable universal life insurance, in exchange for the ability to invest within your policy, you can expect to pay more fees for a variable life policy than a similar universal one. This means it won't match your returns when investing directly in the market secondary to the fees and the cost of insurance component.
What can you do with the cash value of a permanent life insurance policy?
Those that sell permanent life insurance products will tout the cash value portion of the product as having a few main benefits. As we mentioned above, the cash value grows tax deferred, which in theory allows for faster growth. However, note that the fees and upfront costs associated with these plans (including the large amount paid to the person selling you the product as a commission) means that it takes years for the cash value to exceed what you put into it for premiums.
That said, once it does grow to a usable amount, there are some theoretical advantages to having this money accessible. Some options that those selling these products will tout include:
Taking a loan against the cash value: Those selling the policies will say this is like having a line of credit. Depending on the terms of your policy, you can essentially take out a loan according to the fixed or variable loan rates in the policy, and these rates tend to be lower than what you would get if you took out a personal loan. Additionally, you don’t have to apply for this, and technically you don’t even have to repay it (though the loan balance will likely be deducted from the death benefit payout at the time of death if there is an outstanding loan).
Withdrawing against the cash value tax free: If you need the money, you are able to withdraw up to the amount that you have paid in premiums thus far tax free. Note that this will typically reduce the death payout of the policy, in many cases by a greater amount than you withdraw.
Paying for the life insurance policy: You may hear, “The policy will eventually pay for itself.” This is because once you have enough cash value, you can choose to have part or all of the policy premiums paid for by the cash value, allowing you to maintain life insurance without annual premiums when you are no longer earning money or if your income decreases. Keep in mind though that this is not free money - this is money that you would have had invested if you had a term life policy and paid lower premiums, so money that you would have had access to regardless.
You can surrender the policy and take the cash value out if you need access to the money: Well, technically. The problem of course is then you no longer have life insurance, and that there can be significant tax implications and surrender fees that will decrease the amount of your cash value that ends up in your hands.
As we've alluded to in these bullet points, there are counterarguments to most of these point. In reality, for most physicians, investing the difference in premiums between term life insurance and whole life insurance would give you similar or greater amounts of money, even when accounting for taxes, because of the lack of fees and upfront costs associated with mixing insurance and investing.
Is permanent life insurance a good fit for me?
For the overwhelming majority of physicians, a term life insurance policy will be a better option than a permanent life insurance option. Though term policies do not provide any benefit should the policy expire before you die, insurance is supposed to be a hedge against the unknown. The primary goal of life insurance is to provide for your family if something should happen to you, and they don’t have the means to provide for themselves.
In fact, by the time physicians are at retirement age, many doctors have achieved financial independence, At this point, most are self insured for any finanical assistance that they want to provide surviving family members and no longer need life insurance. This is also a big reason why we recommend laddering life insurance to phase out life insurance as you become more financially secure, which allows you to save on life insurance premiums.
Insurance is intended to be on the defensive side of personal finances for protection purposes, not offensive to help you make money. Mixing insurance with investing is usually the most expensive way to do both, which is why most of the time, it’s better to keep them separate.
That said, there are a few specific situations where a permanent life insurance policy may be worth considering (often in addition to term life insurance) for estate planning, tax planning, or asset protection reasons. These include:
The cash value in a permanent life insurance policy usually provides some asset protection for physicians, while certain investments (like taxable brokerage accounts) don’t usually. This can benefit high wealth physicians, such as those with more assets than umbrella insurance can protect.
Can provide some high level estate planning options to potentially reduce taxes for ultra-wealthy doctors.
If you have a dependent with special needs that will always require your finanical assistance, a permanent life insurance policy can provide peace of mind and is often used by estate planners specializing in this space.
If there is a family history that may make life insurance harder to secure in the future, securing a permanent life policy at a young age can provide some protection versus not having any coverage.
In each of these scenarios, we recommend talking to an unbiased source that doesn't make money from selling you the policy such as a fiduciary financial advisor that DOESN'T sell insurance products or an estate planning attorney to assess whether the permanent life insurance policy makes sense in your scenario, and who can suggest alternative options for you to choose from.
What if I already have a permanent life insurance policy? Can I cancel it?
You can easily cancel a permanent life insurance policy or let it lapse. Whether you should do so is a more complicated question that is going to depend on how much money you have invested in the policy, how much cash value you have, and what the surrender fees and taxation will look like. If you're early in the policy, many physicians find that it’s usually still a better financial decision than continuing to pay high premiums for a low benefit amount versus a term life insurance policy.
Before making any decisions, ask for an illustration of what you will get back if you surrender the policy. For some who have had the policy for a while and have passed the point where they're paying all the fees and upfront costs of the policy, it may make sense to hold on to the policy as a conservative return part of your portfolio rather than take the losses. If you have any doubts about what the right decision is for you, speak to a financial advisor who can help you work through the options.
Also, before you cancel your permanent life insurance policy, make sure you have a replacement term life insurance policy in place if you still need life insurance coverage and don't have a separate term life insurance policy from before. You don’t want to end up in a situation where you cancel your permanent life policy, then realize you’re disqualified from being able to purchase a term policy.
Where can I buy life insurance as a physician?
It’s easy to find an agent willing to sell you a permanent life insurance policy, as they make a lot of money off the commissions they receive on these products.
If you’re part of the vast majority of physicians better off with a term policy, check out our insurance agents for physicians page for our partnered independent insurance brokers that can help walk you through the life insurance process, including shopping policies to help you get the best deal possible.
Conclusion
Physicians are commonly pitched the benefits of permanent life insurance. It's important for physicians to realize that those selling these policies make large commissions for selling them and approach the decision to purchase them critically. Nobody will look out for your finances better than you will, so take the time to educate yourself on whether adding permanent life insurance makes sense for you. We are big believers that for 99%+ of physicians, term life insurance is sufficient to cover your insurance needs. In general, we discourage mixing insurance with investing, as investing the large difference in premiums for permanent and term life insurance will likely yield far higher returns over the course of your lifetime than having these expensive and complicated products. However, if you fall into the category where permanent life insurance. Each type varies in cost and flexibility, so assessing how much life insurance coverage you need in your situation as well as what your estate planning and tax planning needs are can help determine which type would be the best for you with the cost/benefit trade off.