Life insurance policies can be a little confusing to understand, especially
since there are several different types of
life insurance,
and each is slightly different from the next. All fall under two broad
categories – permanent (sometimes called whole life) and temporary (usually
referred to as term insurance). Both types provide a death benefit that is paid
upon the death of the insured, assuming the policy is currently in force at
that time.
Term life insurance is considered “pure protection,” since it has no
benefits other than the stated death benefit. Permanent life insurance has a
cash accumulation component in addition to the stated death benefit. Term
insurance is written to cover the insured for a specific amount of time, or
“term,” which is typically somewhere between five and thirty years. As long as
premium payments are currently up to date on the policy, if death should occur
to the policyholder at any time during the term, the named beneficiaries will
receive an amount equal to the policy’s face value.
Permanent insurance provides permanent protection for the life of the
policyholder, assuming premium payments are kept current. It provides a death
benefit to the named beneficiary upon the death of the insured. In addition,
these policies accumulate a cash value during the life of the policy that may
be used in a variety of ways.
Cash Value
Permanent insurance premiums are set up to remain level throughout the life
of the insured. In the early years of a policy, the premium charges are in
excess of the real cost of providing the protection against premature death.
The insurance company takes this excess and places it into a separate “savings”
account, which accumulates as the years pass. This account is called the policy
cash value.
Guaranteed Cash
Value
The cash value of a whole life policy earns interest, typically on a
tax-deferred basis. If the policy has a guaranteed cash value, that means a
minimum stated interest rate will be paid regardless of what’s happening with
interest rates in the general economy.
Net Cash Value
If you cancel your permanent life insurance policy, the amount returned to
you is called the net or surrender cash value. You’ll find this amount on your
regular policy statement. It will be lower than the cash value for a number of
years because of the initial expense required to underwrite a policy.
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