If you decide to purchase cash-value life insurance, you must next decide which type of policy is best suited to meet your needs. Four basic types of policies include whole life, universal life, variable life, or variable universal life.

Whole-Life Insurance

Whole life insurance is the most conservative type of policy. It offers lifetime, permanent coverage with level premiums. Premiums that are both fixed and level will be higher than term insurance premiums in the early years. However, the total cumulative cost may be lower if you keep the policy in force for a long time, for example, if you plan on keeping it through retirement. Whole life policies are most appropriate for those who want lifetime coverage, fixed premiums, and fixed death benefits.

Key features of whole life insurance:

• It provides permanent protection.
• The premiums are generally higher than those for other forms of cash-value insurance.
• The policy has a fixed death benefit and fixed premiums, which remain level.
• It includes a savings element. The policy accumulates a guaranteed cash value from which you can borrow. The increase in cash value grows tax-deferred.
• The policyholder has no say in how the savings element is invested by the insurance company; dividends, which are not guaranteed, are based on the overall mortality, expense, and investment experience of the company.
• If you want to increase the amount of insurance you own, you need to apply for a new policy.
• It is suitable for needs that are permanent; when you are considering keeping the insurance throughout your entire life, for example, to replace income that could be lost in your later years.

IMPORTANT NOTE: Single-premium insurance policies issued after June 20, 1988, as well as other policies that allow a fast cash buildup, are known as modified endowment contracts (MECs). If you own one of these policies or are considering buying one, be aware that there are special tax consequences. These include owing income tax on policy loans (up to the amount the policy has earned) and a 10% penalty on loans or withdrawals made before age 59½ in addition to the income tax).

Universal Life Insurance

Universal life insurance offers a flexible death benefit and flexible premiums. Cash value in the policy varies with the market rate of return and generally can be used to pay policy premiums. Universal life is especially attractive to middle-income individuals who want to vary premiums to reflect changing life situations and needs. Universal life allows you to withdraw money from its cash value (in addition to borrowing); with whole life, you must borrow against the cash value. However, borrowing from life insurance does pose risks, which could negatively impact your policy and your finances. If you let unpaid interest on the loan accumulate or pay it out of the life insurance dividends, you run the risk of the unpaid amount accruing as income, which then must be reported on your income taxes. If you die with the loan outstanding, the death benefit your beneficiaries receive may be decreased. With universal life, you get a statement each year which shows you a month-by-month breakdown of the mortality charges, contract charges, the portion of your premium that goes into your accumulation account, and the amount of interest earned.

Universal life insurance is most appropriate for individuals with changing financial needs, long-term needs, or for individuals willing to give up guarantees in exchange for greater flexibility.

Key features and drawbacks of universal life insurance:

• It is a combination of term insurance plus a savings component.
• There is a guaranteed minimum interest rate and a maximum guaranteed mortality rate.
• It has flexible premium payments (scheduled contributions); the size and frequency of the premium are adjustable.
• The death benefit is flexible; the size of the death benefit can be increased or decreased.
• Loans are available from the policy.
• Risks include being subject to higher premiums and out-of-pocket costs because the policy is not generating enough income to cover the costs of the policy due to fluctuations in the overall economy and interest rates.
• Universal life policies typically cost more than other types of insurance policies because a portion of the premiums goes toward the savings and investment component.
• Premiums for universal life policies may increase if the premiums are too low to cover the costs and fees or if the cash value of the policy declines.

Variable Life

Variable life insurance is similar to whole life insurance in that it has fixed premiums and a minimum guaranteed death benefit. The difference is that you can direct the investments in the policy from a group of investment accounts made available by the insurance company. So, the investment risk is shifted from the insurance company to you, as the policy owner. Variable life policies are most appropriate for individuals who want greater control over how their premium dollars are invested and who are willing to assume greater risk.

Key features of variable life insurance:

• It is permanent.
• It has a fixed premium.
• Performance risk is transferred from the insurance company to the insured; the policyholder determines how the cash-value element is invested.
• There is no guaranteed minimum cash value; the performance of the cash value depends on the individual sub-accounts selected.
• The death benefit varies with investment performance, but cannot be less than the original face amount.
• Loans may be available from the policy.

Variable Universal Life

Variable universal life is a combination of universal life and variable life insurance. It is the most common form of variable life insurance sold. It lets you adjust the insurance premiums and the death benefit. You choose the underlying investments that support your policy. You control all three basic features of your life insurance. This type of insurance is most appropriate for individuals with changing financial needs, long-term needs, and for those willing to give up guarantees in exchange for policy and investment flexibility.

Key features of variable universal life insurance:

• Contains the features of universal life, but the policyholder determines how the savings portion is invested.
• Your cash value is not guaranteed and the fees and administrative expenses are high. So you need a high annual return to make your investment worthwhile.
• If your funds perform well over time, your cash value and death benefit will increase significantly.