A life insurance policy is a contract with an insurance company. In exchange for premium payments, the insurance company provides a lump-sum payment, known as a death benefit, to beneficiaries upon the insured’s death. Typically, life insurance is chosen based on the needs and goals of the owner. Life insurance pays out when the insured person dies. The idea is to protect loved ones from a sudden loss of financial support. You could also use it to support your local charity. There are three basic types of life insurance that differ in their details.

Term life insurance: Term Life insurance is known as “pure” life insurance, because it pays out the death benefit if the insured person dies within the defined term, anywhere from one to thirty years. If the named person does not die, no portion of the premiums will be returned to the policyholder. It simply insures against loss of life and has a relatively low premium reflect this. Most term life insurance policies are renewable and convertible.

Term life insurance is considered to be the most basic of life insurance that can be purchased.

This is because term life offers just pure death benefit protection only, without any cash value builds up within the policy.

Because of this, term life insurance is often very affordable – especially for those applicants who are younger and in good health at the time they apply for the coverage.

With term life insurance, coverage is purchased for a certain length of time, it could be as short as a 5 year policy, if you purchase or a short term life insurance plan or longer terms such as for ten years, 15 years, 20 years, 25 years, 30 years – and in some cases, even longer.

There is also a 1-year renewable term life insurance option that is offered by many of the best life insurance carriers.

Typically, when purchasing a level term life insurance policy, the amount of the premium will remain the same throughout the period that the policy is in force. Provided that the insured survives throughout the time period of the policy, and he or she wishes to remain covered by life insurance, they will need to re-qualify for a new policy at their then-current age and health status.

At that time, the premium on a new life insurance policy may be quite a bit higher. In some cases, a term life insurance policy may have an option to convert the coverage over into a permanent life insurance plan.

Whole life insurance: Whole Life insurance has no predefined term; it provides death benefit protection over the “whole” life of the insured, as long as the premiums are paid. A whole life policy also combines an investment component with the insurance component: it accumulates a cash value which the insured may withdraw or borrow against during their lifetime. Compared to other forms of investing, life insurance policies tend to offer a relatively low rate of return. Consult with someone knowledgeable about financial planning before choosing a whole life insurance policy.

The simplest type of permanent life insurance coverage is whole life. With this type of coverage, the premium amount is locked in and will remain the same throughout the entire lifetime of the policy.

This can be helpful for those who need to stick to a budget. It also means that if a person purchases a whole life policy at a very young age, they will still pay the same amount of premium when they get older – regardless of advancing age, or even an adverse health issue.

In some cases, where a person’s pre-existing conditions require the individual to buy high-risk life insurance, some graded whole life policies are the only option.

The cash that is in the cash value component of a whole life insurance policy is allowed to grow on a tax-deferred basis. This means that the gain on these funds will not be taxed until or unless they are withdrawn – allowing them to compound exponentially over time.

At first, the cash in a whole life insurance policy will grow slowly. This is because the majority of the early premium dollars will go towards paying the agent’s commission and the insurance costs. However, over the years, the cash in a whole life policy can steadily grow, often with a minimum guaranteed rate of return.

Some whole life insurance policies will even provide dividends to their policyholders. Because these are considered to be a return of premium to the policyholder, they are also not taxed. Dividends can also help the cash value in a policy grow significantly – although they are never guaranteed.

Universal life insurance: Another form of permanent coverage is universal life insurance. Universal life insurance has a cash value determined by short-term interest rates verses the stated long-term rate of a whole life policy.  Premium payments in excess of the cost of insurance are added to the policyholder’s interest-bearing account.  Although interest rates will fluctuate, it cannot fall below the policy’s stated guaranteed interest rate.  Consult with someone knowledgeable about financial planning before choosing a universal life insurance policy.

This type of life insurance also provides a death benefit and a cash value component where the funds are allowed to grow tax-deferred.

Universal life insurance is more flexible than whole life coverage, though. This is because the policyholder is allowed – within certain guidelines – to choose how much of his or her premium dollars will go towards the policy’s death benefit, and how much will go towards the policy’s cash value.

Because universal life is a permanent life insurance policy, the policyholder will have access to their cash value account. So, just as with a whole life plan, the cash can be borrowed or withdrawn for any reason – including paying off debt, supplementing retirement income, or even going on a vacation.

There is also an Indexed Universal life insurance policy available that will can aggressively grow your cash value in the policy over time, but you have to be aware of the disadvantages of this type as well.

Term life insurance vs whole life insurance

Term life insurance only lasts for a set number of years before it expires. If you die before the term is up, a set amount of money, known as the death benefit, is paid to your designated beneficiary. Term life is considered the simplest, most accessible insurance policy. When you make your payments (known as your premium), you’re simply paying for the death benefit that goes to your beneficiaries in the event of your death. The death benefit can be paid out as a lump sum, a monthly payment, or an annuity. Most folks elect to receive their death benefit as a lump sum.

Term life insurance policies are more affordable than other types of life insurance policies, usually costing between $30-40 a month for a 30-year, $500,000 policy for healthy people in their 20s and 30s. They expire at the end of the term, which can last up to 30 years.

Whole life insurance, on the other hand, is considered a permanent type of life insurance policy because it never expires. It has a death benefit but also a cash value, which is a tax-deferred savings account that is included in the policy. The cash value accrues interest at a predetermined fixed rate. Each month, a certain portion of your premium will go into the cash value of the policy, which offers a guaranteed rate of return (The exact amount that goes into savings is determined by your individual policy). The policy’s cash value grows over time.

Due to the fees and the extra feature, a whole life insurance policy may cost six to ten times as much as a term life policy (for the same death benefit amount).

Whole life policies will last for as long as you pay the premiums. However, the cash value component can make whole life more complex than term life because you have to consider surrender fees, taxes, and interest as well as other stipulations.

However, it may be worth it if you need the cash value to cover things like endowments or estate plans, which might benefit from the greater options that a whole life policy provides.