What is Term Life Insurance?
Term life insurance is pure insurance. It offers protection only for a specific period of time. If you die within the time period defined in the policy, the insurance company will pay your beneficiaries the face value of your policy.
Term insurance differs from the permanent forms of life insurance in that it does not accumulate cash value. All the premiums paid are used to cover the cost of insurance protection and at the end of the policy period it simply expires.
Term life insurance is often less expensive than permanent insurance, especially when you are younger. It may be appropriate if you want insurance only for a certain length of time, such as until your youngest child finishes college or you are able to afford a more permanent type of life insurance.
Several variations of term insurance do allow for level premiums throughout the duration of the contract. You may be able to obtain 5-, 10-, 20-, or even 30-year level term, or level term payable to age 65. An advantage of renewable term life insurance is that it is usually available without proof of insurability.
What is Universal Life Insurance?
Universal life insurance was developed in the late 1970s to overcome some of the disadvantages associated with term and whole life insurance. As with other types of life insurance, you pay regular premiums to your insurance company, in exchange for which the insurance company will pay a specific benefit to your beneficiaries upon your death. As with whole life insurance, a portion of each payment goes to the insurance company to pay for the pure cost of insurance. The remainder is invested in the company general investment portfolio, with the potential to build cash value.
Most universal life policies pay a minimum guaranteed rate of return. Any returns above the guaranteed minimum vary with the performance of the insurance companys portfolio. The policyholder has no control over how these funds are invested; funds are managed by the insurance companys professional portfolio managers.
However, universal life policies are very flexible. As the policy owner, you can vary the frequency and amount of premium payments and also increase or decrease the amount of the insurance to suit changes in your situation.
Any cash you withdraw from your universal life policy is considered basis-first. You won’t incur a tax liability until your withdrawals exceed the premiums you’ve paid into the policy. Any amount that exceeds the premiums will be taxed as ordinary income.*
It is possible to structure many universal life policies so that the invested cash value will eventually cover the premiums. You would then have full life insurance coverage without having to pay any additional premiums, as long as the cash-value account balance remains sufficient to pay for the pure cost of insurance and any other expenses and charges.
Term insurance differs from the permanent forms of life insurance in that it does not accumulate cash value. All the premiums paid are used to cover the cost of insurance protection and at the end of the policy period it simply expires.
Term life insurance is often less expensive than permanent insurance, especially when you are younger. It may be appropriate if you want insurance only for a certain length of time, such as until your youngest child finishes college or you are able to afford a more permanent type of life insurance.
Several variations of term insurance do allow for level premiums throughout the duration of the contract. You may be able to obtain 5-, 10-, 20-, or even 30-year level term, or level term payable to age 65. An advantage of renewable term life insurance is that it is usually available without proof of insurability.
What is Whole Life Insurance?
Most people are familiar with whole life insurance. For many years, whole life policies were the predominant type of life insurance sold in America.When you purchase a whole life policy, you traditionally pay a fixed premium for as long as you live or for as long as you keep the policy in force.
In exchange for this fixed premium, the insurance company promises to pay a set benefit upon your death.In addition to providing a death benefit, a whole life policy can build cash value. Part of the premium pays for the protection element of your policy, while the remainder is invested in the companys general portfolio. The insurance company pays a guaranteed rate of return on the portion of your premium that is in its investment portfolio, building up the value of your policy.Guarantees are contingent on the claims-paying ability of the issuing company.
This buildup in cash value is part of the reason the premiums on a whole life policy generally remain fixed instead of escalating to match the increased risk of death as you age. As the cash value grows, the risk for the insurance company declines. Although the cash value in your policy is your money, you can’t simply withdraw it as needed, as you would cash from a savings account; but you do have limited access to your funds. You can either surrender the policy for its cash value or take the needed funds as a loan against the policy.*Access to cash values through borrowing or partial surrenders can reduce the policy’s cash value and death benefit, increase the chance that the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured. Additional out-of-pocket payments may be needed if actual dividends or investment returns decrease, if you withdraw policy values, if you take out a loan, or if current charges increase.
You should be aware that, in addition to charging a modest interest rate for loans against a policy, the insurance company may pay a lower rate of return for the portion of your cash value that you borrow. However, loans against the value of an insurance policy are generally not taxable and can provide the cash to help with unexpected expenses.The cash value of a life insurance policy accumulates tax deferred. If you surrender the policy, you’ll incur an income tax liability at that time, but only for those funds that exceed the premiums you have paid.The fact that whole life policies have fixed premiums and fixed death benefits can be either positive or negative, depending on the situation. To some people, it means one less thing to worry about. They know in advance what they’ll have to pay in premiums and exactly what their death benefits will be.
To others, whole life policies don’t provide enough flexibility. If their situations change, it is unlikely that they will be able to increase or decrease either the premiums or the death benefits on their whole life policies without surrendering them and purchasing new policies.