One of the more basic decisions you need to make before purchasing a life insurance policy is
whether to purchase term or cash-value insurance. There are advantages and disadvantages to each type of coverage.
Term Insurance
With term insurance, you purchase insurance protection only, with none of the premium set aside to build
cash value. Your beneficiary receives the policy proceeds if you die during the policy's term, but you get nothing if the
policy is canceled. Some policies are convertible, allowing you to convert to a cash-value policy at a later date. Any term
life insurance policies you are considering should be renewable regardless of changes in your health.
Premiums for term insurance are typically lower than those for a comparable amount
of cash-value insurance. For young families and those on tight budgets, term insurance may be the only way to obtain the amount
of insurance needed. However, premiums for term insurance are based on your age, so premiums increase as you get older. Thus,
term insurance is often recommended for situations where there is an insurance need that is likely to go away. For instance,
you might want insurance only until your minor children become independent.
With term insurance, it is often recommended that you invest the difference between the premiums
for term and cash-value insurance to earn potentially higher returns than those associated with cash-value policies. However,
for this strategy to work, you have to find investments that actually earn a higher return and discipline yourself to invest,
rather than spend, the difference.
Cash-Value Insurance
Cash-value insurance accumulates, from premiums paid and from investment earnings, a cash surrender value
that is your property. If you surrender the policy, you receive that value. Furthermore, you can borrow against the cash value
through a policy loan, but any outstanding loans are subtracted from the insurance proceeds when you die. A wide variety of
cash-value insurance policies exist, with numerous riders available to meet specific needs.
These policies are sold for indefinite periods, so renewability is not an issue. Premiums are usually
fixed for the policy's term, and, in some cases, premiums stop after the cash value starts generating enough income to cover
premiums. Most cash-value policies guarantee minimum earnings. These policies should generally be held for at least 10 or
20 years for the policy to outperform a strategy of buying term and investing the difference in premiums.
Cash-value insurance is often recommended in situations where you want insurance coverage for the rest
of your life at a predictable cost. Some possible uses include providing liquidity to your estate, ensuring a spouse or other
dependent has funds to support his/her lifestyle, leaving a significant bequest to heirs or a charity, or saving in a tax-advantaged
way for retirement.
Cash-value insurance policies also offer tax benefits. Earnings on the cash value accumulate tax deferred
as long as you don't surrender the policy. You can borrow against the cash value of some policies at relatively low rates
without creating a taxable event.
While neither cash-value nor term insurance proceeds are subject to federal income taxes, the proceeds
are subject to estate taxes unless the policy is properly structured.
