- Life insurance provides a lump sum cash payout (called a death benefit) to a beneficiary upon the death of the insured. Life insurance is a contract between the owner or insured and the insurance company. Life insurance companies offer many different types of life insurance, and understanding some of these differences can help you choose which one is best for you.
- Term life insurance, also known as temporary insurance, provides death benefit protection for a level premium payment over a certain number of years. Typically, term life insurance policies are sold as 10, 20 and 30-year policies, meaning the premium remains level until the term has expired. At that point, the insurance company raises the premiums. Term life insurance carries no cash value.
- Whole life insurance provides a level premium payment guaranteed for the rest of the insured's life. It also builds cash value that grows based on declared dividends or a declared interest rate by the insurance company. Whole life costs more than term life insurance, but the owner has the opportunity to borrow against the policy's cash value.
- Universal life insurance resembles whole life insurance more than term life insurance because of its cash value-building component. However, unlike whole life insurance, universal life may not be guaranteed for the rest of the insured's life. Once the cost of insurance and policy fees and expenses deplete the cash value, the policy may lapse. The insured may have to increase the premium or lower the death benefit to make the policy last longer. Cash value grows based on a declared interest rate by the insurance company.
- Indexed life insurance is very much universal life insurance in how the policy works. The main difference is how the cash value grows. Instead of a declared interest rate like universal life, indexed life insurance cash value grows based on the performance of an underlying index. The most commonly used one is the S&P 500. The performance of the index is measured over the term (usually one year), and a corresponding interest rate is credited to the policy. If the index goes down over the term, however, the policy cash value does not decrease.
- Variable life insurance most closely resembles universal life and indexed life in how the policy is structured. The main difference is how the cash value grows. In a variable life policy, the owner chooses mutual funds to have the cash value mirror. These are called investment divisions within the policy. If the investment divisions increase in value, so does the cash value of the variable life policy. However, if the investment divisions lose value, so does the cash value of the policy.
