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Understanding how term life insurance policies work.
Term life insurance does not have a cash value. It is “pure” insurance: you pay premiums to the insurance company, and if you die during the policy’s term, your beneficiaries get the death benefit. If you don’t die during the the policy term and the policy term expires or if you cancel the policy, there is no refund or surrender value for term life insurance.
Permanent life insurance, also called cash value life insurance, is an entire category of life insurance plans that last as long as you pay the premiums and has a cash value component. These policies are more expensive than term life insurance, and the cash value component offers some additional flexibility. As the cash value grows, you can use it to pay premiums, take out a loan, or even surrender the policy entirely and withdraw the cash value.
Cash value life insurance policies are made up of two components: the cash value component and a term life insurance component.
There are several types, including:
The differences in these cash value policies come from how the cash value grows and how it can be used.
|WHOLE LIFE INSURANCE||VARIABLE LIFE INSURANCE||UNIVERSAL LIFE INSURANCE|
|Guaranteed Death Benefit?||Yes||Yes||Yes|
|Guaranteed Cash Value?||Yes||No||Protected from risk, but can be depleted to pay premiums|
|How Cash Grows (or Shrinks)||Earns interest at pre-determined rate||Sub-accounts - pool of investor funds offered by insurer||Fixed interest rate|
|Premiums||Level||Level||Varies, up to the customer (subject to federal tax laws)|
|Notes||No risk compared to other permanent types, but there may be better investment options||Risk of holding expensive insurance policy with little to no cash value||-|
The value of a cash value policy is in what you can do with it once the cash value reaches a certain amount.
Read more about the types of cash value policies and how the cash value can be used.
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Term life insurance is “pure” insurance. You just pay your premiums for the term of your policy, and if you don’t die, the policy ends when your term ends and you are no longer covered.
Term life insurance is simpler to understand and five to 15 times less expensive than a comparable permanent life insurance policy, which is why term life insurance is often the better choice for the majority of consumers.
But the simplicity and relatively affordable rates of term life insurance mean that there are things you can’t do with it. Because it has no cash value, there is no surrender value to the policy. You also can’t take a loan out from your term policy (though you may be able to use a policy as collateral for a loan through a process called collateral assignment.)
Read more about why term life insurance is the best product for most people.
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