Types of Life Insurance
There are two types of life insurance: term and permanent. Term insurance provides protection for a specific period of time. Permanent provides lifelong protection.
Term insurance covers a defined period (one to 30 years) and only pays benefits if you die during the defined time. Depending on the terms of the policy, premiums will remain constant or increase each year. Some policies can be renewed at the end of the term, but premium rates will usually increase.
Term insurance is designed to cover needs that will disappear in time, such as mortgage or tuition payments. Initially, premiums for term insurance are lower than for permanent insurance, which enables you to buy higher levels of coverage at a younger age. Term insurance does not offer cash value buildup.
Life insurance provided through an employer is most commonly term insurance. When an employee leaves, coverage is terminated. Most states require a conversion privilege, which allow employees to convert their policy to permanent policy when they leave their job.
Permanent insurance builds up cash value over time and provides lifelong protection as long as you pay the premiums, which can be flexible and paid periodically to meet your personal financial needs.
The cash value is different from the policy's face amount. The face amount is the money that will be paid to your beneficiary. Cash value is an amount that increases over time tax-deferred.
The cash value can be used to cover premium payments, to purchase additional insurance, or as collateral for a loan. Loans must be paid back with interest or the death benefit paid to the beneficiary will be reduced.
You also can convert the cash value of permanent insurance into an annuity, which can provide you with an income for life.
The policy also can be canceled or surrendered for its cash value. You may owe taxes on some of the cash value if the sum exceeds what you have paid in premiums.
A permanent life insurance policy is available with provisions (riders), such as those that permit the policyholder to purchase additional insurance without proof of insurability, to cover long-term care costs, or to collect death benefits if he or she becomes disabled or terminally ill. Riders and their costs vary among policies.
While term insurance is what is commonly offered in the workplace, some employers offer permanent life insurance to their employees as a self-funded benefit. Employees can retain coverage after leaving the company by paying premiums directly to the insurer.
Variations of permanent life policies:
Whole or ordinary life. This is the most common type of permanent insurance. Generally, the premiums remain constant over the life of the policy. The cash value grows based on a fixed interest rate.
Universal or adjustable life. A universal life policy allows you to pay premiums in any amount and at any time, subject to certain minimums or maximums set forth in the contract. It also may allow you to increase death benefits (usually subject to evidence of good health).
Variable life. A variable life policy provides death benefits and cash values that vary according to how premiums are invested. You choose among several investment options that reflect a range of risk including stocks, bonds, and accounts that guarantee interest and principal. By law, purchasers must be provided with a prospectus when purchasing variable insurance. The prospectus includes financial statements and outlines investment objectives, risks, and operating expenses.
The cash value of a variable policy is not guaranteed and the policyholder bears that risk. If the market does not perform well, your cash value and death benefit may decrease. Some policies guarantee that the death benefit does not fall below a minimum level.