Combining Term and Permanent Life Insurance

What Is Blended Life Insurance?

A financial plan can include a combination of term and permanent life insurance, also known as blended life insurance. This strategic assortment of coverages can be established in various ways, but often begins with a foundational permanent policy and an add-on term policy that can optionally convert into permanent insurance.

Term insurance provides coverage for a specific period, usually between 10 and 30 years. If the policyholder dies during the term, their beneficiaries will receive a death benefit payout. If the policyholder outlives the term, the insurance coverage ceases to exist, and no death benefit is paid.

Permanent insurance works differently. A permanent policy provides coverage for the policyholder’s entire life, and the money paid into it funds two components – a death benefit and a cash value reserve. The death benefit provides a payout to the policyholder’s beneficiaries at their death (just like a term policy), and the cash value reserve gives the policyholder an equity stake in the policy.

The funds comprising the cash value reserve can be invested and are allowed to grow in a tax-deferred manner. Once the reserve is large enough, the money can be temporarily or permanently withdrawn, but permanent withdrawals usually result in a reduction of the policy’s death benefit.

The Benefits of Mixing Term and Permanent Policies

Term insurance is typically much cheaper than permanent insurance, but its finite nature is inadequate for some people, especially, those who desire the ability to invest a portion of their funds in a tax-advantaged and accessible manner. To strike the appropriate balance between cost, coverage and flexibility, many consumers elect for a hybrid solution.

Some permanent life policies also offer the potential for dividends that can increase the size of a policy’s cash value reserve and/or death benefit, making a blended plan more attractive.

When Should You Blend Term and Permanent Life Insurance?

Blending term and permanent life insurance is best suited for people who want to obtain a relatively high death benefit at an affordable price while having the ability to invest on a tax-deferred basis and take cash withdrawals as needed.

This life insurance strategy makes the most sense for high-income individuals seeking to shelter their income from high tax rates. It is not a great strategy, on the other hand, for low- to average-income people. For them, a simple “buy term and invest the rest” approach is advised.

Most people can get the financial protection they need with just term insurance. For optimal, net-of-fees return potential, leftover savings can be invested in publicly traded stock and bond funds, as well as annuities, if sensible.

Beyond the income-level guidance above, there is no hard-and-fast rule for when you should blend life insurance coverages. However, there are certain situations when it makes a lot of sense.

Unique Financial Needs

If you have a few young kids and want to make sure they will be financially secure until they reach adulthood, a term life insurance policy could be an adequate, cost-effective solution. However, if you have a special needs child that will require lifetime support or a spouse who is unable to work, a permanent life insurance policy is more appropriate.

Unfortunately, permanent life insurance can be cost prohibitive. An economical solution is to combine a term and a permanent life insurance policy. Doing so will extend the duration of your death benefit and give you the ability to build an accessible cash value reserve over time.

Family Planning

Even for a normal family, combining term and permanent life insurance can be a savvy strategy, especially when it allows you to adjust coverages as your budgetary situation evolves. For example, suppose you and your spouse each plan to work for another 30 years. Moreover, you determine that if either of you died, the survivor would need $400,000 to replace the lost income of the deceased.

You value the flexibility and enduring nature of permanent life insurance, but you are concerned about the cost of coverage. To save some money, you opt to purchase a $150,000 permanent life insurance policy and complement it with a $250,000, 30-year term policy on each of your lives. With an eye toward the future, you ensure the term policy has a conversion option that allows you to convert it to a permanent policy at any time.

As a result of your careful planning, you and your spouse have secured adequate coverage in an economical way and established a permanent foundation on which you can build as your fiscal position improves.

Business Succession

For many partnerships, life insurance is an integral aspect of business succession. It provides the means to finance a prearranged buyout in the event of a partner’s death. Oftentimes, the most economical solution entails combining term and permanent life insurance.

For example, imagine a simple partnership with four equal-share, female business owners. A term life policy is purchased on the life of each partner based on the current value of her share of the business, and the other three partners are specified as beneficiaries. If a partner dies, the others will use the death benefit to buy out her position and continue to operate the partnership with the new, consolidated ownership structure.

However, if the partnership grows and accumulates value, the term insurance may be inadequate over time. To remedy this, permanent life policies can be purchased to provide an additional death benefit and some flexibility to address unplanned developments.

Are There Risks With Blended Life Insurance?

Blended insurance is typically much cheaper than a standalone permanent life policy, but it is not without risk. As noted previously, it can expose moderate-income individuals to excessive opportunity cost and unnecessary complexity. For these types of individuals, buying term insurance and investing excess money in fund-style financial securities is the way to go.

For higher income individuals, blended insurance can make sense, especially for those that have maxed out contributions to other tax-advantaged vehicles, such as 401(k) plans and individual retirement accounts (IRAs). That said, before making any life insurance purchase, take care to focus on sound products sold by highly reputable insurance companies.

Along these lines, make sure products of interest complement the other aspects of your holistic financial plan and align with your tolerance for risk. If you need help making sense of things, you should work with a fiduciary financial advisor. They can help you determine an appropriate course of action