Compare the Types of Life Insurance
Term Life Insurance
- Term life insurance is life insurance with a set maturity date denominated in years. An annual renewable term life policy, for example, matures in one year. This means that you must renew your life insurance every single year. Each year the premiums increase to reflect the new cost of insurance. A level term life insurance policy takes longer to mature. Level term may mature in 10, 20 or 30 years. The premiums stay level for that time period and then increase upon renewal.
Whole Life Insurance
- Whole life insurance is life insurance with a maturity that is denominated in terms of age. Whole life matures at your age 100. The policy builds a guaranteed cash value and provides guaranteed death benefits. The cash value acts as a reserve against the death benefit. As the cash reserve builds up in the policy, the actual amount of death benefit purchased goes down. In effect, the cash value replaces the amount of death benefit being purchased.
During your life, the cash value of the policy may be used for any reason. Access to the policy's values is normally restricted to loans. This means you must borrow against the value of the cash value. Insurers generally charge low or zero percent interest on policy loans to make the loans attractive to policyholders. The policy loans are open until your death and there is no loan qualification required. All loans are secured by actually existing cash values. When you die, the loan on the policy is deducted from the death benefit and the remainder of the death benefit is paid to your beneficiary.
Variable Life Insurance
- Variable life insurance is a permanent life insurance policy that works similar to whole life insurance. However, instead of guaranteeing the cash values, a variable life insurance policy invests the premiums paid into mutual funds. Cash value and death benefits are determined by the performance of the mutual funds. In some cases, only a portion of the premiums are directed to mutual funds and the policy may provide limited guarantees on cash values and death benefits.
Access to policy cash values is limited to policy loans (which function similar to whole life policy loans).
Universal Life Insurance
- Universal life insurance represents the only permanent life insurance that separates the cost of insurance from the cash value account. This means that the premiums paid to the insurer go directly into the cash value account instead of being held by the insurer. Because of this, the policyholder can withdraw money from the cash value account in addition to borrowing against the cash value.
The death benefit of the policy is paid for by an automatic deduction from the cash value of the insurance policy. Therefore, there must be enough money in the cash value account to pay for the policy's death benefit. When there is no more money in the cash value, or there is not enough to cover the cost of the death benefit, the policy lapses (it terminates) and you lose your insurance policy.
Unlike term, whole life and variable life, universal life insurance allows you to increase or decrease the death benefit of the policy at any time during your lifetime (within certain limits). Premiums may be increased to add more money to the cash value (within limits according to the policy design), reduced or stopped altogether at any time. Premiums may be invested into a fixed-interest account, mutual funds, or the policy may be set up to allow an investment in an equity-indexed strategy which credits the cash value with a percentage of the upward movement of a stock market index while ignoring any losses in the market.
This flexibility allow a policyholder to design his policy in any way he chooses. But, this flexibility also comes with complexity and responsibility in terms of making sure enough money remains in the cash value account to pay for death benefit costs.