Breaking down the different choices.
When it comes to life insurance, there are many options. You may have heard terms like “whole life insurance,” “term insurance,” or “variable insurance,” but what do they really mean? And what are the differences between them?
—Kevin B. Perlberg, CFP®
Well, first let me point out what they have in common: all life insurance policies provide payment to a beneficiary in the event of your death. Aside from that basic tenet, the differences between policy types can be major.
Whole life insurance. This type of insurance covers your entire life (not just a portion or “term” of it) and is sometimes called “straight life insurance” or “permanent life insurance.” The premium payments on a whole life policy are fixed from day one and so is the dollar amount of the coverage.
Whole life policies accumulate cash value. Just how does that happen? An insurer takes in much more money than it pays out on recently issued whole life policies, as the premium payments are higher relative to the actuarial risk the insurer assumes (those new policyholders are relatively young). The insurance firm directs a portion of these early premium payments into a reserve account, putting those funds into investments (typically conservative ones). The policyholder receives an interest credit linked to the investment performance – and that is how the cash value builds up over time.
When you have held a whole life policy for more than a few years, you can borrow against its cash value, and you can even cancel it and receive its surrender value. The longer you wait, the greater the cash value becomes. Whole life generally isn’t a good choice for young families, who may find the premiums unduly high.