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Types of Life Insurance

There are two main categories of life insurance – term and permanent life insurance – and each has its merits. The type of insurance that is right for you will depend on your unique financial circumstances as well as your budget. With that in mind, here are the basic differences between the two.

Term Life Insurance

As the name suggests, term life insurance provides your loved ones with financial protection for a specific “term” or period of time (e.g., 10 or 20 years). Term insurance is the most affordable type of insurance, allowing you to get the greatest amount of coverage for the lowest initial premium. So if you have a significant need for coverage but not a lot of budget flexibility, term insurance is probably the right choice for you.

Here’s an analogy to help you understand how term insurance works. Think of it as renting a house rather than buying it. Let’s say that you purchase a 20-year, $500,000 level-term policy. If you die during the 20 years, your loved ones will receive the $500,000 death benefit. But if you outlive your policy, it will expire and your coverage will end. You essentially “rented” your policy for 20 years and were left with no “equity” when it expired. But that’s ok. It was affordable and it gave you peace of mind at a time when your family needed financial protection.

Permanent Insurance

In contrast with term insurance, permanent life insurance offers lifelong protection. As long as you pay the required premiums, your policy will remain in force. Permanent policies also have a savings component. They give you the ability to accumulate cash values on a tax-deferred basis, just like assets in most retirement and tuition savings accounts. In this sense, permanent insurance is sort of like owning your home. It’s builds up “equity” that you can access at any time and for any purpose. Some people will borrow from their policies to make a down payment on a home, to help pay for college or to fund a business opportunity. Just keep in mind that withdrawing or borrowing from your policy will reduce its cash value and death benefit if not repaid.

There are many different types of permanent insurance. Whole Life offers the greatest certainty. Your premiums will never increase, and the death benefit and rate of return on your cash values are guaranteed. Universal Life is generally the most affordable and flexible type of permanent insurance. It allows you to vary your premium payments, subject to certain minimums and maximums. Variable Life and Variable Universal Life allow you to allocate your premiums among a variety of investment options (e.g., stocks and bonds). You have the potential for higher cash values and death benefits if your investments perform well. But the opposite can occur as well.

It’s important to keep in mind that there’s a price to be paid for the extra features and benefits that you get with permanent insurance. Some permanent policies (e.g., Whole Life) can be considerably more expensive than term insurance when initially purchased.

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