The difference between permanent and term insurance is that permanent products have an investment or savings component. There are a number of different types of permanent life insurance products, and these products differ according to five investment criteria: mortality risk, investment risk, policy costs, investment choice (i.e., assets), and investment flexibility. For a comparison of various term and permanent life insurance policies, see Table 7 and Table 8.

Mortality risk  refers to the risk that the insured dies within the contract period and is covered by insurance.

Investment risk refers to the risk of who takes responsibility for the investment outcome.

Policy Cost compares the costs of the policy to other life insurance products.

Investment choice refers to the types of vehicles, or assets, the insured chooses to use to build his or her tax-deferred savings.

Policy flexibility refers to the degree of flexibility the insured needs regarding your insurance products—for example, account options, face value (flexibility to change the face amount or death benefit over time), and premiums flexibility (flexibility to change premium payments depending on the insured’s current situation). In the following chart, account flexibility, premium flexibility, and face amount flexibility refer to the flexibility to change the investments, premium payment amounts, and face amount during the life of the contract (see Table 7).

The key is to understand why you want cash-value life insurance. Understand your needs. Understand the individual polices of competing life insurance companies, like the charges and deductions of the insurance company, and fees and expenses of the mutual funds or assets invested in. Finally, select the policy that gives you maximum benefit at the lowest possible cost to you.

 Table 7

Whole life insurance: Whole life insurance gives lifelong coverage; this type of insurance has a fixed premium based on your age at the time of purchase. I tis also called "straight life" or ordinary life."  Although the risk of death increases with age, most insurance companies keep the premium and face amount of an insurance policy constant by charging more in the early years of your policy and less in the later years of your policy than you would be charged for term insurance. Whole life insurance is ideal for those who want and can afford permanent life insurance protection that has a savings element. Mortaligy risk and investment risk are both eliminated with this product.  This type of insurance provides a transition from income replacement goals to goals regarding retirement and estate planning. This type of insurance may also be attractive for those who have low self-discipline or low tolerance for risk in saving and investing.

Table 8

Other advantages of whole life insurance include a fixed death benefit, a growing cash-value, and potential growth from tax-deferred dividends. The disadvantages of whole life insurance include the fact that it provides much less death protection than term life insurance does for the same premium. Moreover, the yield on the cash-value portion of whole life insurance may not be competitive with yields on alternative investments because whole-life policies are generally invested in an insurance company’s long-term bonds and mortgages.

Universal life insurance: Universal life insurance is a type of permanent life insurance that is a mix between term insurance and savings. Mortaligy risk is eliminated.  This type of insurance earns interest at current money market or bond rates, so when interest rates are high, this type of policy will typically earn a better return.  Thus, investment risk, while not eliminated, is low.  This insurance also has a guaranteed minimum interest rate that is set for the life of the insured. The policy deducts a monthly fee for insurance coverage: the fee includes the mortality cost and the cost of managing the policy. Contributed funds (that do not go towards paying for mortality insurance and costs) earn tax-deferred interest.

In a universal life policy, the premium and face amounts are flexible. You can pay premiums in excess of costs in order to build cash value that is within and subject to federal tax limits. You can change the face amount of the policy and the amount and frequency of premium payments. Universal life insurance is ideal for those who want a flexible policy that combines term protection and tax-deferred savings; this type of insurance is also appropriate for those who have sufficient knowledge of financial matters and who are somewhat flexible and self-directed.

An advantage of universal life insurance is that it provides permanent protection that is similar to whole life insurance, and universal life insurance also has flexible premiums and death benefits. The cash-value earns tax-deferred interest and can be borrowed against if the need should arise. Disadvantages, however, include that universal life insurance typically requires a much higher premium than term life insurance requires for the same amount of coverage. Also, the cash-value of the policy fluctuates depending on the amount paid into the policy and the current market interest rates. The cash value can be quickly depleted by insurance charges if sufficient premiums are not paid. The newest form of universal life insurance is similar to whole life insurance in that it guarantees payment for the full face amount of the policy in exchange for a fixed premium.

Variable life insurance: Variable life insurance allows you to funnel the investment portion of your premium into one or more separate investment accounts (these accounts may be stocks, bonds, or money market accounts). For this reason, investment risk is substantial for this type of product.  Depending on company policy, you can change where the investment portion of your premium will go two to five times per year. Unlike universal or whole life insurance, variable life insurance allows you to control the investment of your cash value. While this type of policy gives added flexibility of investment, it is also risky because you decide where your money is invested instead of the insurance company; therefore, you assume the risk of the cash-value component. Variable life insurance often costs more in the long run than other types of permanent life insurance because of the added expenses and risks. This type of insurance is appropriate for those who want to take risks, manage their own investments, and have an opportunity (but no guarantee) for tax-deferred growth. If you need a tax shelter and are an experienced, risk-tolerant investor, variable life insurance may be a viable option.

Variable life insurance has the advantages of permanent protection and potential for building cash value. Returns are earned on a tax-deferred basis, and variable life insurance allows for either a fixed (straight variable) or flexible (variable universal) premium. Because you determine where the cash value will be invested, there is a potential for higher returns; these returns reflect the performance of the separate investment accounts. However, variable life insurance has the disadvantage of generally having higher costs. Premiums for variable life insurance are much higher than premiums for term life insurance and other permanent products with the same amount of coverage. This type of investment is also riskier than others because your investment can lose money, and, as in all permanent products, policies may lapse if you don’t make payments.

Variable universal life insurance: Variable universal life insurance combines the flexible features of universal life insurance with the investment options (and risks) of variable life insurance. You choose where to invest your premium dollars and you assume all the investment risks associated with your choice, just as you do with variable life insurance. Investment risk with this type of permanent insurance is also substantial. You can also raise or lower your premiums in a single policy (as with universal life insurance), and you have the right to choose how your cash-value will be invested. The insurance company makes no guarantee on your cash-value.

When you change investment vehicles, no capital gains are acquired, and any investment gains are tax-deferred. You have great flexibility regarding the frequency and amount of premium payments, and you are able to make partial withdrawals in the form of loans. If you furnish proof of insurability, you can increase or reduce the amount of coverage. Variable universal life insurance may be the best life insurance option for you if you need a tax shelter and if you are comfortable with high-risk/high-reward investing.

The advantages of variable universal life insurance include permanent protection, returns that are earned on a tax-deferred basis, the choice of either a fixed premium (straight variable) or flexible (variable universal) premium, and the potential for higher returns on your cash value (based on the mutual fund investment’s performance). This type of insurance also gives you the ability to choose different types of investments and to change investment vehicles free of charge a certain number of times per year. The disadvantages include higher costs—variable universal premiums are higher than premiums for term insurance on the same coverage. This type of insurance is also much riskier because investments can lose money.