Life insurance divides into two broad families. The Insurance Information Institute describes them as term and permanent, the second often called whole life or cash value life insurance.
Nearly every product on the market is a variation of one of the two, and the differences between them are structural rather than cosmetic.
Term life insurance
Term insurance is the simplest form. It pays a death benefit only if the insured dies during the policy term, which commonly runs anywhere from one to thirty years. Most term policies have no other benefit provisions.
There are two basic shapes:
- Level term, where the death benefit stays the same for the whole term. This is what most people mean by term insurance today.
- Decreasing term, where the death benefit declines over the term. It was historically sold alongside mortgages, since the balance also declines.
Because term insurance covers a defined period rather than a whole life, the rate per thousand dollars of death benefit is lower than for permanent coverage. That is why term is generally what someone buys when they need a large amount of coverage on a limited budget.
What term does not do: it does not build cash value. When the term ends, the coverage ends and nothing is returned unless the policy has a specific return-of-premium feature. Renewing at the end of a term is possible on many policies, but the premium is recalculated at your then-current age, and that increase can be substantial.
Two provisions are worth checking on any term policy:
- Renewability, which lets coverage continue at the end of the term even if your health has changed, at a new premium.
- Convertibility, which lets you exchange the term policy for a permanent one without new evidence of insurability, usually only before a stated age or policy year. That right can matter a great deal if your health changes during the term.
Permanent life insurance
Permanent coverage is designed to last for the insured's lifetime, as long as the policy is kept in force. Most permanent policies accumulate a cash value that the owner can access during life under conditions the contract sets.
The mechanism behind whole life is worth understanding, because it explains where the cash value comes from. The cost of insuring a life rises with age. To keep the premium level, the insurer charges more than the current cost of insurance in the early years, invests the excess, and draws on it later when the cost exceeds the premium. By law, once those excess payments reach a certain amount, they must be available to the policyholder as cash value.
The main varieties:
| Type | Premium | Cash value behavior |
|---|---|---|
| Whole life | Designed to stay level | Grows on a schedule set in the contract |
| Universal life | Flexible within limits | Credited with interest; account must cover policy charges |
| Variable life | Level | Invested in subaccounts; value and death benefit can fall |
| Variable universal life | Flexible | Combines the variable and universal features |
| Indexed universal life | Flexible | Credited by reference to a market index, subject to caps and floors |
Universal life allows more flexibility than traditional whole life. Once enough cash value has accumulated, the owner can adjust premium payments, provided the account holds enough to cover the policy's costs. That flexibility cuts both ways: a policy funded too lightly for too long can run out of account value and lapse, sometimes decades after it was purchased.
Variable life places the cash value in investment subaccounts. Value may grow faster, but poor performance can reduce the cash value and the death benefit, though some policies guarantee a minimum death benefit. These are securities products and carry their own disclosure requirements.
Indexed universal life credits interest by reference to an index rather than investing directly in it, typically with a cap on the credited rate and a floor below which it will not fall. The crediting formula is a contract term, and the details vary considerably by insurer.
Using cash value, and what it costs
Cash value is a living benefit. You can generally borrow against it or surrender the policy to collect the accumulated value. Interest credited grows tax deferred.
Three consequences people underestimate:
- A loan reduces the death benefit. An outstanding loan plus accrued interest is deducted from what beneficiaries receive.
- Surrendering ends the coverage, and any proceeds above your cost basis in the policy are generally taxable income.
- Cash value is usually not paid in addition to the death benefit. On most traditional designs, the beneficiary receives the face amount and the cash value stays with the insurer.
These mechanics are covered further in cash value, policy loans and nonforfeiture options.
Which one fits
The Insurance Information Institute frames the choice around what the coverage is for.
Term tends to fit when the need has a horizon: replacing income while children are dependent, covering the years remaining on a mortgage, or protecting a business obligation with an end date. It also fits when you need a large death benefit and the budget is the binding constraint.
Permanent tends to fit when the need does not end: providing for a dependent with a lifelong disability, covering estate costs, funding a buy-sell agreement, leaving a legacy, or covering final expenses. It also appeals to buyers who want to lock in coverage that will not expire or be repriced as they age, and who want a tax-deferred accumulation element.
There is no universally correct answer, and the comparison is not only about price. A permanent policy funded inadequately can lapse; a term policy that expires before the need does leaves nothing behind. Matching the structure to the actual obligation is the substantive work, and it is covered in how much life insurance do you need.
Before you decide
- Define the obligation first, then pick the structure. Buying a product and working backward to a justification is how people end up over- or under-covered.
- Read the illustration carefully on any permanent policy, and ask which figures are guaranteed and which are projections. The difference is the whole point of the document.
- Check conversion rights on term, including the deadline and which permanent products you may convert into.
- Ask what happens if you stop paying, at year five and at year twenty. The answers differ sharply across product types.
- Consider riders before issue rather than after, since some cannot be added later. See life insurance riders worth understanding.
Product availability, contract terms and pricing vary by insurer and by state, and the policy documents control. For advice on your own situation, talk to a licensed agent, the issuing insurer, or your state Department of Insurance.
To get connected with licensed carriers and agents who write life insurance in your state, you can request life insurance quotes.