Comparing term and cash-value life insurance

Q: My partner and I are exploring our options for life insurance. Can you please help us understand the difference between term insurance and cash-value life insurance?

A: Life insurance is an important and often overlooked part of an overall financial plan. To be sure you and your partner will be financially protected if something were to happen to either of you, it’s smart that you are evaluating your life-insurance options.

Term and cash value are the two main categories of life insurance. The best choice for your circumstances is likely to depend on how much you are willing to pay for premiums and how long you believe you will need the insurance. With both term and cash-value policies, your beneficiaries receive death benefits free of income taxes.

Term insurance

Term insurance, which typically is less costly, provides a death benefit in return for premiums paid. The length of time (or term) that the policy is in effect is specified in the policy. According to the Insurance Information Institute, the most popular type of term insurance is for a 20-year term. In many instances, consumers are not able to buy policies for a term that extends beyond their 80th birthday.

The cost of term insurance frequently rises as the policyholder gets older. Level-term policies, in which the annual premium remains consistent throughout the term, are available, but premiums frequently increase when the policy is set to expire and the policyholder seeks to renew for an additional term. The policy has no cash value or investment component. If a claim is not filed within the specified term and the policy is not renewed, the policy lapses and the policyholder receives no cash benefit.

Term insurance may be an appropriate choice if you want to keep premiums as affordable as possible. Just be aware that if you want to remain insured beyond the term specified in the policy, affordability could become an issue. If term insurance appeals to you, consider a guaranteed renewable policy that you can renew regardless of your health status at the end of the term. Also, term insurance may be worth considering if you expect to need insurance for a limited period of time (for example, before retirement when you anticipate receiving pension benefits) and do not need coverage for your lifetime.

Cash value

Cash-value insurance, in contrast, combines term insurance with a savings component. Cash value is likely to be more expensive than term insurance but typically remains in effect throughout a policyholder’s lifetime at a level premium. A portion of the premium is used to fund a savings or investment component that the policyholder can access by borrowing against it or by cashing in the policy. If a policyholder cashes in the policy, it is no longer in effect but the policyholder receives the cash-surrender value.

Interest and other earnings that are credited to the cash value are not subject to income taxes. When a policyholder borrows against the cash value, interest is charged as it would be with most types of loans. The loan is treated as a debt and is not considered a distribution for income-tax purposes.

Cash-value insurance may be attractive if you anticipate needing insurance throughout your lifetime, if you can afford the higher premiums and if the option of borrowing against the cash value appeals to you.

As always, it’s important to discuss your specific situation with your financial and tax advisors to help determine the appropriate type and amount of life-insurance coverage. And, as with most insurance, it only gets more expensive if you delay — so plan to have this conversation sooner than later.

Jeremy Gussick is a financial advisor with LPL Financial, the nation’s leading independent broker-dealer.* Jeremy specializes in the financial planning needs of the LGBT community. He is active with several LGBT organizations in the Philadelphia region, including the Delaware Valley Legacy Fund, the Greater Philadelphia Professional Network and the Independence Business Alliance. OutMoney appears monthly. If you have a question for Jeremy, contact him at [email protected].

This article was prepared with the assistance of Standard & Poor’s Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor or Jeremy Gussick if you have any questions. LPL Financial, Member FINRA/SIPC. *Based on total revenues, as reported in Financial Planning Magazine, June 1996-2010.