Life Insurance: A Policy Overview

All life insurance policies have one thing in common: They provide a tax-free death benefit to your beneficiary when you die. But, that’s where the similarities stop. Here, the New York Society of CPAs offers an overview of the most common types of life insurance to assist you in determining which best meets your needs.

Term insurance
Term life insurance policies offer death benefits only. Term insurance is simple to understand and it allows you to purchase the most coverage for the least amount of money. You buy a policy for a specific amount and term, 15 years for example. If you die during that term, the policy pays the death benefit to your beneficiaries. If you outlive the term of the policy, you get nothing. However, you can renew the policy at much higher rates or convert the policy to a permanent form of life insurance.
The two key types of term insurance are level term life insurance (premiums remain the same over a specified period of time) and yearly renewable (starts out with a lower initial premium, but the premium rises each year).

Whole life insurance
Rather than insuring you for just a part or a “term” of your life, a whole life policy is designed to cover you for your entire life. Whole life policies cost more than term policies because, in addition to providing a death benefit, a whole life policy builds up what is referred to as “cash value.” This is essentially an investment component that, after a certain number of years, you can withdraw or borrow against. (Unpaid loans against the policy are subtracted from the death benefit.)
The investment return on a whole life policy is likely to be lower than what you might earn investing on your own, because insurance companies typically invest conservatively.

Universal life insurance
Flexibility is the key selling point of universal life insurance. With this type of whole life insurance, you can increase or decrease the death benefit as your insurance needs change. You can, within limits, determine how much of your premium is used for insurance and how much goes toward the policy’s investment component. You can also increase or decrease the amount of premium payments and how often you pay them.

Variable life insurance
Variable life insurance differs from whole life insurance in that it allows you to invest the cash value of the policy in stocks, bonds, or money market funds within the insurance company’s portfolios. With a variable life policy, both the death benefit and the cash value depend on the performance of the investments you choose, but most policies guarantee that the death benefit will not fall below a specified minimum. A variable life policy is considered a security and sold only by prospectus.

Making the decision
The type of life insurance you buy will depend on your individual needs and what you hope to get out of your policy. It’s important to consider how much protection your family needs, how long you need coverage, and how much you can afford to pay in premiums.

If what you need is strictly income protection for a set amount of time, term insurance is the more appropriate and cost effective option. Term insurance works out particularly well if you follow the principle of “buy term and invest the difference.” This means you set aside and invest on your own the money you would have spent on a more costly whole life policy.

For people with more complicated or long-term needs, whole life insurance or one of its variations may make sense. For example, if you have contributed the maximum to your retirement savings and other tax-sheltered plans, you might consider whole life insurance because the cash value in the policy builds up tax-free.

As is the case with most important financial decisions, your life insurance choice should be made within the context of your overall financial plan and circumstances. A CPA can help you determine the type of policy that works best for you.