| Life insurance policies can be divided into two broad categories: The basic distinction between them is that term insurance is pure life insurance protection. In other words, your premium buys coverage for only a specified period of time. Cash value insurance provides both insurance protection and a special savings/investment feature. Let's look at each category for a better understanding. Term Insurance Term insurance is designed for one purpose only: pure protection for your dependents if you die within the term specified. When comparing policies, you should be aware of the three basic types. - Level Term
- This is a policy in which the death benefit remains level and the premium increases throughout the life of the policy. The premium may remain level for five to 15 years but will eventually increase. It is very practical for people on a fixed budget. It is also the cheapest type of term insurance, but it becomes more expensive as the insured person gets older.
- Decreasing term
- This policy features a premium that remains the same each year, while the death benefit declines. People who do not need as much insurance as they get older sometines own this type of policy.
- Convertible term
- A convertible term policy gives you the option of transforming your insurance from term to whole life (discussed below) with no questions asked. This feature may not seem important now, but should your health condition decline, owning a convertible insurance policy could be advantageous since you could convert the term policy before it expires, thereby providing you with insurance for the rest of your life.
With newer term policies, you can increase or decrease coverage as your needs for protection change. Also, you should always request a policy that is guaranteed renewable so that you can keep the coverage even if your health deteriorates.Cash Value Insurance Your cash value premium not only buys insurance protection, but part of it is applied to a cash reserve, which supports the policy in later years. Over a period of time, the cash reserve grows and can be used as collateral for a loan from the insurance company or taken as a lump sum on surrender of the policy. One of the most attractive features is that this cash value accumulates tax deferred inside the policy. There are many varieties of cash value policies. - Whole life
- A whole life policy is designed to have a level premium as long as you live, which provides a guaranteed death benefit. However, current policies have either dividends or an interest- sensitive design that may increase the death benefit or decrease the premium over the life of the policy.
- Universal life
- This type of insurance product combines the protection of a conventional term insurance policy with the current yields available from short-term investments. But, unlike a whole life policy, the cash value of a universal life policy grows at a variable rate.
Universal life's advantage is the flexibility it offers. For example, you can buy additional insurance with the built-up cash value should the need arise. (A medical examination may be necessary.) You also can vary premium payments within the limits established by the policy--a useful feature if your income is subject to periodic fluctuations. - Variable life
- As with whole life and universal life insurance, a portion of your variable life premium buys pure insurance protection, while the rest is invested by the insurance company on your behalf. The variable life policyholder may choose from a range of investments. For example, you can direct the company to invest your premiums in a combination of stock, bond, and/or money market mutual funds.
There are two kinds of variable life policies. Straight variable life has a fixed annual premium, while universal variable life allows more flexibility to vary the premiums that are paid. In addition to deciding how the money will be invested, you can choose the amount of premiums you can afford to pay in a universal variable life policy. But you should realize that there are increased risks since stock and bond mutual funds fluctuate in value from time to time. The death benefit of a variable life policy is paid for by the pure insurance part of the policy and will never fall below a specified amount. However, the policy could lapse. The amount of cash value is not guaranteed, and it could be reduced if the investment portfolios perform poorly. The policyowner assumes all of the investment return risk. What Kind of Life Insurance Best Meets Your Objectives?Basically, it depends on your need for protection. For example, parents of young children often need so much protection that term insurance may be their only cost-effective alternative. Also, coverage on the life of the breadwinner(s) may be needed to provide a fund for education purposes. Decreasing term insurance also can be used to pay off a large home mortgage balance.Sometimes, using a combination of term and cash value insurance can provide both protection and a tax-deferred savings program. People who can't tolerate stock or bond market risks can use this approach. Before purchasing any type of life insurance, be sure to compare financial ratings on insurance companies. This can be done through the A.M. Best's Insurance Reports, available from your local library. You can find more helpful information about insurance planning in The ABCs of Managing Your Money, a financial planning guidebook from the National Endowment for Financial Education. This information is excerpted from The ABC's of Managing Your Money, by Jonathan D. Pond, C.P.A., published by the National Endowment for Financial Education. Copyright October 1993, National Endowment for Financial Education, Denver, Colorado. All rights reserved. |
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