Life insurance basically comes in two flavors: term and cash value. What flavor you choose will depend on your reason for buying it.
Need short-term protection?
If you’re looking for a basic low-cost life insurance plan that will provide protection for a limited time, then term life insurance is probably for you. The premiums are relatively cheap and it will do the job of taking care of your family should you die prematurely.
Need life-time coverage?
On the other hand, if you would like insurance that extends much longer, maybe even until death at an old age, then you probably want a cash value policy. Also known as “permanent” life insurance, a cash value policy can provide lifetime coverage. But at a steeper price — the premiums are much heftier.
At its core, life insurance is a risk management tool. This is true regardless of the type. With life insurance, you are simply shifting the financial risk of your untimely death to a life insurance company. While they can never replace you, they can replace your money.
Term and cash value explained
Let’s dig a little deeper into the basic types.
Term life insurance
Benefits: clear cut, affordable, no surprise increases
Term insurance is pretty clear cut. It will give you a specified amount of insurance for a specified time. Hence, it’s good for people with young families and fixed incomes. Here’s how it works.
You buy a low-cost term insurance policy that will last for a specified period, generally 10 to 20 years. You pay premiums for the length of the term. If you die during your specified period, your family will receive the policy amount (called the death benefit). If you don’t die and the term ends, you get nothing.
For a healthy person, term insurance premiums are generally quite affordable, especially at a younger age, like 35, 40, or even 50. Nearly all term insurance sold today comes with premiums that are fixed for the length of your policy. Thus, during the fixed term period, there are no unhappy surprises of gradual or steep increases.
Cash value (permanent) life insurance
Cash value (permanent) policies are less straightforward. There are two main types of cash value policies — whole life and universal life. (Admittedly, there are various ways to slice and dice life insurance products. You can break down universal life further into additional kinds of products — indexed, variable, no lapse, and so on.)
Benefits: life-long coverage, cash value, grows tax free
Cash value policies appeal to those who want something that covers beyond the early financially vulnerable years — like lifelong life insurance protection. Perhaps you want to leave your family a meaningful amount of money free of income tax. Or possibly your assets are tied up and you want to buy life insurance to create liquidity that will pay estate taxes so your heirs don’t have to sell or erode your assets to come up with the cash.
For those interested in such things, cash value insurance is the way to go. It comes with a “savings” component that accumulates cash value, free of income tax while it’s accumulating. This cash value element is what enables the policies to be in force until death (as intended), as opposed to for a certain term.
What to watch out for
Here is where it gets a little tricky. When it comes to shopping for permanent life insurance, cheaper (premiums) is not always better.
For example, universal life policies are often so poorly designed by the agents who sell them that not only will the policies not last until death, but they are on track to lapse in a few years. This is a function of the unbundled structure of universal life products.
We don’t have the space to devote to the mechanics and design of universal or whole life (nor do most people find it appealing to read about), but suffice it to say, when it comes to cash value life insurance (especially with universal life), policy design is critically important.
So, buyers beware.
The more you know the better
Choosing what life insurance is best for you can be an intimidating and confusing process. There is a long list of things to weigh — the insurance carrier’s financial stability (will they be around when you die?), investment performance, mortality experience, expense charges, etc…. Now throw in the issue of underwriting — getting approved at the rate you think is fair given your health status. That is another ball of wax.
Life insurance is a complex, wonderfully unique financial instrument with favorable tax rules. But before you jump in, make sure you know what you need and then carefully research the various kinds available. The more you know, the better chance you’ll have of getting just what you need, rather than too much or too little.
Advisory services are offered by Joslin Capital Advisors, LLC, an SEC Registered Investment Advisor.