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Permanent Life Insurance 101

All permanent life insurance policies are not created equally. Yes, all permanent life insurance policies provide protection for your lifetime and yes, they typically have some capacity to build cash value. How these policies build cash value and how great their potential is for the amount are key differences among them.

Let’s take a look at each type of permanent policy:

Whole life: this is the insurance policy that most people think of when they hear permanent insurance. It also happens to be the policy that will have the highest premiums. If you pay your premiums on time, your coverage will stay in force and your policy will build cash value. This type of policy works great for the individual who is going to buy a policy and stash it in their filing cabinet.

Variable life: this policy provides death benefits and cash values that vary with the performance of a portfolio of underlying investment options. You can allocate premiums among a variety of investment options offering different degrees of risk and reward: stocks, bonds or a fixed account that guarantees interest and principal. A variable policy is good for someone who is willing to assume investment risk to try and achieve greater returns.

With such a policy, you are shifting the investment risk from the insurance company to yourself. Good investment performance would provide for the potential for higher cash values and death benefits. However, if the underlying investments perform poorly, cash values and death benefits will drop accordingly.

Universal life (UL): this policy can be great if you would like to earn interest within the policy while getting more flexibility than a traditional whole life policy allows. You can choose your premium payment schedule and you might have the potential to earn more cash value. Most UL policies will earn a minimum interest rate, giving you a level of security about the earnings. You can also borrow or take withdrawals from the cash value that accumulates in your policy.

Indexed Universal life (IUL): IUL’s can credit interest based on the performance of independent financial indices, unlike other universal products, which credit interest based on rates declared in advance by the insurance company. The most popular indices used for IUL’s are stock indices calculated without dividends. Please note, the money in an IUL policy is not directly invested in any of the indices.

IUL policyowners may decide how much of the policy cash value is allocated to the index feature and how much is allocated to a fixed-interest option. Cash value allocated to the index is usually credited with interest based on the change in the index value from one year to the next (Annual point-to-point). Each index option includes a maximum (cap) and minimum (floor) rate that protect consumers from loss but limits upside growth. Generally, these are subject to change by the insurance company, though they will never be reduced below a contractual minimum.

Variable Universal life (VUL): a VUL can give you the flexibility of a universal policy but adds an investment element. You oversee how the parts of your premium payments not needed for your actual cost and charges (net premium) are invested. You have a choice of investment options (called subaccounts), and you decide how much of your net premiums should be allocated to each of the options you select. The subaccounts can invest in stocks, bonds and other funds.

Since the cash value of your policy may be tied to the financial market, this policy provides the potential for returns higher than a universal policy, but it can also lose value if the investment results are poor. A VUL is good from people who like the investment element, can fund the policy properly and have adequate time to allow it to potentially build cash value.

Survivorship or Second-to-Die: this policy is designed to cover two people. It will pay a death benefit once both insured people have died and is often less expensive than two separate policies.

These types of policies are often used in estate conservation strategies, especially in conjunction with an Irrevocable Life Insurance Trust (ILIT), to pay estate taxes; this can be used to preserve a wealthy couple’s estate so it can be passed on to the next generation or to a charitable organization. Survivorship policies are often recommended if one person would otherwise not be able to qualify for life insurance.

Whole, variable, universal and variable universal life policies come in survivorship versions.

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