Permanent life insurance is just what the name implies – as long premiums are paid on time, coverage will always be there, as opposed to term insurance which ends at a pre-determined age.
Although there are less common types and hybrids, the most popular types of permanent life insurance are:
WHOLE LIFE INSURANCE: This is the basic type of permanent life insurance. A premium is determined at the time the policy is issued based on sex and age and whether or not the insured is a tobacco user. Health issues can also affect the premium. The premium will never increase. After the cost of insurance is deducted from premiums, the remainder goes into a cash value on which the company pays a set amount of interest. The insurance company makes it’s money from the excess interest earned by investing the premiums above the interest it pays to the insured’s cash cash value. The cash value can be borrowed against, or the policy can be cashed in, in which case coverage ends. At death, any outstanding loan amount is deducted from the death benefit. The loan is usually repaid by annual payments, but regardless, interest is charged which must be paid.
UNIVERSAL LIFE INSURANCE: This is similar to whole life, except that the interest rate paid on the cash value can fluctuate according to market conditions. It can go up or down, but never below a guaranteed rate, set at the time the policy is issued. So let’s say a policy is issued with a five percent interest rate, with a guaranteed rate of 3.5 percent. After the first year, market conditions are better than at the time of policy issue. The interest rate could be increased to six percent or even more. In “down” market conditions, the rate may also go down, but never below the 3.5 percent guaranteed rate. Another difference is that the premiums are flexible. An insured can send in extra money at any time, which is applied directly to the cash value. (Your insurance agent should be consulted, as too much extra money can affect the status of the life insurance contract, causing negative tax implications.) Conversely, as long as your cash value is sufficient, you can skip payments occasionally. When this is done, the cost of insurance is deducted from the cash value.
VARIABLE UNIVERSAL LIFE INSURANCE: Whereas the insurance company sets the interest rates for whole life and universal life, the cash value of a variable life policy are invested in stocks, bonds, money markets, etc. Therefore, the insured takes on the investment risk, because the cash value can increase or decrease based upon the performance of the investments. The insurer credits the cash valuewith the actual investments earnings and makes it’s money from fees taken from the cash value (also called the separate account). This type of life insurance has the most potential for gain, but also carries the highest risk, as the cash value can actually decrease. Some people prefer to buy term insurance at lower premiums and invest the difference directly in mutual funds, because they have more control over the investments and usually have lower fees than those charged within a variable life insurance policy.