Before you buy life insurance, consider whether you need coverage for a specified time period or for your lifetime. Decide whether you want flexibility in your premium payments or if you'd prefer to pay a fixed amount each month. Then, learn the differences between term insurance and cash-value insurances to help you decide which type to buy.
Term Life Insurance
Term life insurance is issued for a specified time period and is most often chosen when the loss of your income would impose a hardship on your survivors. For example, if you have children who are approaching college age and you want to be sure their tuition is covered in case of your death, you might choose a term policy that will span their college years. Term insurance, unlike whole life, variable life or universal life insurance, does not accumulate a cash value. You can't borrow against your policy, and you won't get any money back when the term ends or if you cancel the policy. Some insurance companies, however, offer a term policy with a "return of premium" option. With this option, you have to pay your premiums for the entire term of the policy, at which time the insurance company will refund all of your premiums to you. If you cancel the policy before it expires, you'll lose your premiums.
Cash Value Insurance
Insurance policies that accumulate a cash value are issued for the life of the policy holder. You might want to choose one of these policies if your dependents rely solely on your income, and your death would result in financial deprivation for them. Unlike term insurance, these policies accumulate a cash value that you can borrow against to fund major purchases or even to pay for future premiums. If you don't repay the money, though, your policy has a reduced cash value, and your death benefit is also reduced. There are four types of cash-value insurance: whole life, variable life, universal life and variable universal life.
Whole Life
Whole life is structured so your premiums remain the same for the life of the policy, the death benefit is paid according to the terms of the policy, and you receive a guaranteed return on the cash value. If the company that issued your policy makes a profit, you might also receive annual dividends, which add to the policy's cash value and eventual death benefit if you let them accumulate.
Variable Life
Variable life insurance is funded by investing your premiums in stocks, bonds or a fixed account that pays interest. You're responsible for choosing how to invest your money, and you decide how much risk you're willing to take for the possibility of higher returns on your premiums. If your investments perform well, your policy will have a higher cash value and death benefit. When they perform badly, you'll receive a lower cash value and death benefit.
Universal Life
Universal life allows you to adjust your premiums rather than paying a fixed premium every month. If your income is uncertain or seasonal, you can choose to pay lower premiums during your "off" months and higher premiums when your income increases. Your policy will set minimum and maximum allowable premium amounts, but you can work within them to give yourself flexibility. Your policy will probably accumulate a cash value, but there are circumstances in which it won't. For example, if your policy costs more to administer than the premiums you've paid, if mortality assumptions change, if your insurance company loses money on its investments or if you haven't paid enough premiums to cover costs, your policy will have no cash value. Mortality assumptions affect the costs of your policy because the Internal Revenue Service might lower the maximum amount of premiums you can pay tax free.
Variable Universal Life
As its name implies, variable universal life combines features of both types of insurance. You can adjust your premiums to meet your needs, as you do with universal life, while choosing among different degrees of investment risk, as you do with variable life. You'll probably be able to change your coverage amount if you need more or less insurance, and you can make a lump sum payment to add to your policy's cash value. The maximum amount of this payment is limited by the Internal Revenue Service. You can also move your money from one type of investment to another without tax penalties.
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