Life Insurance

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Simply, there are two types of life insurance:


Term Life Insurance provides life insurance protection for a specified period of time. Sometimes called "temporary life insurance", term life pays an agreed amount of money tax-free to your beneficiary if you die during the "term", typically 10, 20, or 30 years in exchange for a much smaller, monthly or annual amount of money. Term life insurance is sometimes "convertible" to permanent coverage, providing you with flexibility as your needs change.       



Permanent Life Insurance remains in force for your entire lifetime (or until age 100 or 120), provided premiums are paid as specified in the policy. Whole life and products like it (see below) are often called "Permanent life insurance", Permanent life insurance acts much differently than term.


With term, if you do not die during the term, the insurance company keeps the premiums you paid, and they do not owe a death benefit once the term ends. For coverage to continue, you may be able to convert your term to a permanent policy or another term policy would need to be purchased . Permanent insurance, conceptually, is a guaranteed  pay out from the insurance company. As long as you pay your premiums, your policy will be in force your whole life, and eventually pay a death benefit to your beneficiaries.


To fund this, premiums are usually much higher than term, yet still amount to much less than the eventual payout. Your premiums paid into the policy go into the account of the insurer (the general account, unless a variable life policy). The insurer takes your premium and invests it over the span of your life, earning interest. A portion of the interest earned gets credited to your "cash account" within the policy.  In a whole life poliyc, this amount is usually fixed; in a universal life policy, this amount can vary depending on the performance of a benchmark, like the S&P 500 index. Some of the premium you pay funds the likelihood the insurance company will pay a death benefit to you, the other portion earns interest and grows tax-deferred in your cash account. You can take loans from this account, as eligible, to pay for anything you want. The loan can be paid back with interest, to bring your account back up to par. If you die with any policy loans outstanding, the balance of the loan is subtracted from your death benefit. Typically the first 10 years of the policy or so, your cash account balance is less than what you have paid for the policy. This is called the "cash surrender" charge. After 10 years, it is not uncommon for the cost of the life insurance to be paid for while your cash account continues to grow tax-deferred with interest.

Universal Life Insurance is a form of permanent life insurance characterized by its flexible premiums, face amounts and interest rates. The cash account can be credited with a fixed interest rate like whole life insurance, or can be "indexed" to an equities market such as the S&P 500. Various strategies exist using "caps" and "participation rates". Higher interest rates are possible with universal life. Universal life, unlike "variable" life insurance, does not directly invest your premiums into securities. The insurance company invests their money in securities and credits your account positively based on the performance of their securities, but you do not risk losing value if securities do poorly. This is known as equity-indexed universal life insurance.

Understanding Life Insurance