Life insurance is a type of insurance that pays a cash benefit to your family (or another person you name on your policy) when you pass away. Life insurance can help your family pay for living expenses or college tuition and other educational expenses. The insurance benefits can even help pay for your burial or outstanding debts. With certain types of life insurance policies, you can take advantage of the money you’ve paid into the insurance policy even while you are still living.
Types of Life Insurance Policies
There are two basic types of life insurance – term and permanent. In general, term life insurance policies only last for a specific amount of time known as a term. A term life insurance policy only pays a benefit to your survivors if you pass away while the policy is still in effect. Once that term has ended, the policy also ends.
You have the option of renewing some term policies when the term ends. But, your premium will increase when you renew. The longer the term of the policy, the higher your premium will be.
There are some types of term life insurance policies that will pay a premium benefit when the policy ends even if the policy doesn’t pay a death benefit. You’ll pay a higher monthly premium for these policies than those that end without paying a benefit.
Permanent Life Insurance
Unlike term life insurance which ends after a certain period of time, permanent life insurance provides a lifelong benefit as long as you pay your insurance premiums. These policies are also known as cash value policies because you can build cash value in the insurance policy in addition to the death benefit.
Permanent life insurance policies have a higher monthly premium because part of the premium pays the cost of the death benefit, while the other part is accumulates your cash value.
There are a few things you can do with the cash value in a permanent life insurance policy. You can borrow against the cash value without a credit check, cancel the policy and receive all the cash (less any taxes due), buy more coverage using the cash value, use the cash value to cover premiums, or exchange the policy for an annuity that will disburse fixed payments for a period of time.
If you take a loan against your insurance policy, you must pay interest. Since it’s not technically considered a withdrawal in this case, loans can provide significant tax benefits. You must repay the loan before your death or the amount due will be subtracted from your death benefit. With most policies, your beneficiaries receive only your death benefit, not the cash value of the policy.
Types of Permanent Life Insurance
Permanent life insurance policies get even more complex with whole, variable, and universal life insurance policies.
Whole life insurance is the traditional type of permanent life insurance. With whole life insurance, the premium and the death benefit remains the same throughout the life of the policy. The cash value of the policy grows at a fixed rate so it’s easier to predict the cash value of the policy than it is with variable life which is explained next.
Variable life allows you to choose how the cash portion of your policy is invested. For example, you can choose to invest your cash in stocks, bonds, or other types of investment accounts. Because the investment can go up and down, the cash value in your policy isn’t set in stone. Your cash value may decrease based on how the market moves. The same could happen with the policy’s death benefit, depending on the policy you choose.
Universal life insurance lets you set your premium payment and death benefit. You can make changes to the policy at certain times, if you have good health. Some universal life insurance policies have a variable life component, allowing you to select the types of investments in which your cash value is placed.
Before you choose term or permanent life insurance, be sure to evaluate the pros and cons of each of these types of life insurance and choose the one that’s right for you and your beneficiaries.