There are two main types of life insurance, and their advocates are opposed as passionately as the Montagues and the Capulets. Term insurance is a simple product: It insures your life for a set length of time. Permanent life insurance products include a savings or an investment component, which over time generates cash surrender value.
Whole life is the most traditional form of permanent life insurance. Like a mortgage, it's a long-term financial commitment that builds equity slowly in the early years. The insurance company invests your premiums in its own internal investment portfolio, which grows at a stable and predictable rate over the years. After the policy has been in force for 15 or 20 years, the cost of insurance has been covered and the cash value begins to grow dramatically.
Universal life is a flexible version of whole life insurance, designed for those who want more premium or savings options. Universal life policies give their owner freedom to vary the amount of their premiums as needed, deposit additional funds, or vary the percentage of each premium that goes to generate cash value. It's a useful option for those with high but seasonal or erratic incomes, who can pay more when the money is flowing and then reduce or stop premiums temporarily when cash flow slows. Universal life is also a more potent savings vehicle for those who can afford to "over-fund" it during the early years, increasing the investment income.
Conventional whole life policies contractually guarantee their returns, which is one reason why the returns are typically lower than those for other investments. Variable life policies take a different tack, investing premiums in a portfolio of mutual funds. This creates the possibility of greater gains at the risk of potential losses. Such policies usually guarantee a minimum return on the investment and contractually limit the possible losses. Variable policies most often are written as universal life products to provide the maximum flexibility.
Choosing Cash Value Life Policies.
Permanent life insurance has many shortcomings as a savings or investment product. Most policies are canceled before they yield significant returns, and the returns even from mature policies usually lag behind many other investment instruments. However, if your parents or grandparents bought you a whole life policy when you were an infant, it will generate substantial cash value during your adult years. The returns from an insurance policy grow tax-free and there's no contribution limit, so if you've run out of room in your IRA or 401(k) it's a way to shelter more investment from taxation. Cash values also can pass to your beneficiaries without the time and cost of probate.
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