What Type of Life Insurance Should You Buy?

October 11, 2002

Life insurance can provide protection in case of death, and can also function as an investment. Although many insurance companies offer a wide range of policies, there are really only two basic types of coverage: (1) term insurance and (2) policies that generate cash values. The choice of insurance product depends, of course, on what you wish to accomplish.

1. Term coverage: Term life insurance provides death protection for a specific time period. Premiums are based on the insured's age and may increase each year, but they are generally cheaper than other types of insurance such as whole life (discussed below). Some forms of term insurance include:

• Renewable insurance, which many be renewed at the end of the term without having to take a new medical exam. The renewal rate is usually higher than the original premium.
• Convertible insurance, which permits conversion into a cash-value policy without regard to changes in health.
• Decreasing term insurance, which is term insurance with a constant premium and a declining face value. Such policies are commonly used for paying off a mortgage.

2. Cash-value insurance: Life insurance may be used to generate a forced savings or a rate of return as an investment.

• Whole life: One of the most popular forms of insurance is whole (or permanent) life insurance. It provides coverage for the insured's life as long as a constant premium is paid. The premium both pays for the insurance and builds up a cash value return. Usually the policyholder has the right to (1) borrow the cash value at good interest rates, or (2) terminate the policy and receive the cash value.

  TIP: The cash value's rate of return may be below what is available from other investments.

• Universal life: Universal life insurance combines a renewable term policy with a cash value feature. Many such policies guarantee a minimum interest rate of return. After you pay the first year's premium, the accumulated cash value can be used to pay the premium. You have the choice as to whether to make further payments (within certain limits). Also, many such policies allow you to select either a death benefit that is constant while the policy is in effect, or one that increases according to changes in the policy's cash value.
• Variable life: This type of insurance provides a variety of investments for a fixed premium. The death benefit will reflect the investments' performance (i.e., the increase or decrease in cash value). These policies are securities that have prospectuses filed with the SEC.
• Universal-variable life: This combines the flexible premiums of universal life with the investment choices of variable life.
• Single-premium life: This is paid for only once. Its cash value can be invested in a variety of ways, but the return may not be guaranteed. A holder of this type of insurance may also be able to borrow against the cash value at low (or no) interest rates after the first year.

We have only outlined general considerations in analyzing the type of insurance that's right for you. You should seek the advice of a professional for your specific situation. Further, it is vital that the estate planning implications of owning life insurance (not addressed here) be discussed with your tax advisor.