Life Insurance
A contract that pays a death benefit, with term (temporary) and permanent (cash-value) structures.
What is it?
Life insurance is a contract where an insurer pays a death benefit to named beneficiaries in exchange for premiums. Term life covers a set period with no cash value; permanent life (whole, universal, indexed universal, variable universal) covers the insured's whole life and includes a cash-value component.
How does it work?
Term premiums are generally lower and pay only a death benefit for a fixed term. Permanent policies charge higher premiums, part of which builds cash value that can grow (per the policy's crediting method), and against which the policyholder may be able to borrow or withdraw, subject to contract terms and potential tax consequences.
Why do people use it?
Used for income replacement, debt/mortgage protection, and (for permanent policies) potential cash-value accumulation or estate/legacy planning.
Potential advantages
- Death benefit is generally income-tax-free to beneficiaries
- Term life is typically inexpensive for the coverage amount
- Permanent life can build cash value and cover a lifelong need
Potential disadvantages
- Term coverage ends when the term expires (unless renewed or converted, often at a higher cost)
- Permanent life premiums are significantly higher than term for the same death benefit
- Permanent policies can lapse if cash value and premiums don't cover ongoing costs
Risks
- Lapse risk if premiums aren't maintained or cash value is depleted
- For indexed/variable permanent policies: the non-guaranteed elements of cash-value growth
- Opportunity cost of premium dollars versus other uses
Quick facts
- Liquidity
- Term life has no cash value. Permanent life's cash value may be accessible via loans or withdrawals, subject to contract terms, surrender charges (especially early on), and potential tax consequences.
- Fees
- Cost of insurance charges, administrative fees, and (for permanent policies) potential surrender charges, especially in earlier policy years.
- Taxes
- Death benefits are generally income-tax-free to beneficiaries. Cash value grows tax-deferred; loans are generally not taxed as income unless the policy lapses or is surrendered with a gain.
- Guarantees
- Varies by product — term life generally guarantees the death benefit and premium for the term. Permanent life guarantees depend on the specific product and are backed by the issuing insurer's claims-paying ability.
- Non-guaranteed elements
- For universal and indexed universal life: the actual interest credited to cash value (subject to caps, floors, and current insurer crediting rates) and the cost of insurance charges, which can change within contractual limits.
- Time horizon
- Term: matches a specific need's duration (e.g., years remaining on a mortgage). Permanent: designed for lifelong needs.
- Who typically considers it
- Anyone with dependents, debts, or income that would need replacing; permanent life is also considered for estate/legacy planning purposes.
- Who regulates it
- State insurance departments regulate life insurance products and licensed agents.
Questions to ask a professional
- Is this coverage convertible, and what happens at the end of a term?
- For permanent policies: what are the guaranteed vs. non-guaranteed elements?
- What are the surrender charges and how long do they last?
- What is the insurer's financial strength rating?
This is educational information, not a recommendation to buy, hold, or avoid this product. Whether it fits your situation depends on your goals, other holdings, and circumstances a licensed professional can help you evaluate.