Types of permanent life insurance: Which is best for you?

Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York

Permanent life insurance offers the best of both worlds: coverage for a lifetime and cash value while you're alive. The type of permanent insurance that's best depends on your life insurance strategy.

Permanent policies have the option to keep protecting you until old age. They help with things like estate planning, protecting survivor income or final expenses. While the policy is active, the owner may be able to access the tax-deferred savings component. This is useful to help pay for expenses like a child's college tuition or unexpected medical bills.

There are several types of permanent life insurance. Because they vary from one type to the next, it's important to start with understanding the basics.

What are the types of permanent life insurance?

There are three basic types of permanent life insurance. Each offers various levels of payment flexibility and investment opportunities:

Whole life

For those in search of lifetime benefits, predictable premiums and steady cash accumulation.

Universal life

For those in search of lifetime benefits, flexibility and greater cash value potential.

Variable life

For those in search of lifetime benefits and high risk-reward potential in the cash value.

Let's get into the details of each, so you can differentiate them.

What is whole life insurance?

The most basic form of permanent insurance is whole life insurance. It's also called straight or ordinary life, because of its predictable premiums and benefits.

Most whole life policies have several premium payment choices to consider. One beneficial option is to pay up your policy after reaching a certain age or number of years.

How these policies work, depends on the type of whole life you're considering.

Types of whole life insurance

There are three basic types of whole life policies:

Nonparticipating whole life

Offers lifetime protection with fixed premiums, death benefit and cash value growth. Medical exams are mandatory unless the policy starts from a term conversion. Policy owners can customize the features of the policy with added riders.

Participating whole life

Like a standard whole life policy with a twist – a dividend payment. The insurance company shares its profits through paying non-guaranteed dividends to policy holders. Though the amount can fluctuate, it usually goes to increasing the cash value balance.

Guaranteed issue whole life

These policies are sometimes called burial or final expense policies. They offer lower coverage amounts and slow cash value growth. Premiums are often higher due to bypassing medical underwriting.

What is universal life insurance?

Universal life insurance, or adjustable life insurance, offers greater flexibility than other choices.

These policies combine lifetime coverage with flexible premium and death benefit.

The option to increase or decrease your payments provides adaptability for life changes. But it can also result in change of coverage or cash value.

Types of universal life insurance

There are three basic types of universal life insurance. The main difference among them is how the cash value accrues.

Universal life insurance

Often referred to as UL, or flexible premium life insurance, this is the most basic of the universal options. It offers flexible premium payments, tax deferred cash value growth and lifetime coverage.

Part of the payments go to the life insurance cost while the rest covers cash value and applicable fees. The cash value interest rate is set from the life insurer's general portfolio.

A risk to all universal life policies is that they need to be properly funded to avoid lapse. This means premium payments need to be enough to cover the cost of insurance and policy maintenance.

Cash value growth can offset this. But if it's not high enough or there's no more remaining, then the policy has a risk of lapse. To avoid losing coverage, some insurers offer a no-lapse or secondary guarantee.

Variable universal life insurance

These polices offer the flexibility of universal life but with greater risk-reward potential. This happens because the interest rate is dependent on the investment markets.

These investments, called subaccounts, offer higher growth and greater potential for loss. Keep in mind that premiums for variable universal life can be higher due to the management fees.

Regular reviews are necessary because the death benefit is often tied to the cash value. This performance fluctuation of the subaccounts means you may be leaving less for your beneficiaries than intended.

Indexed universal life insurance

The cash value interest rate for an indexed universal policy is tied to a market index. But there's a limit on how much of that gain or loss your account will take part in.

For example, if the index grows 20% in a given year, there will be a cap on how much your cash value increases. This is called a participation rate.

Indexed universal life is also less expensive than other universal policies. This is because the maintenance cost to track an index is lower than to manage a subaccount.

What is variable life insurance?

Variable life insurance is akin to a combination of whole and universal insurance. With variable life, the death benefit and cash value change based on investment subaccount performance. But unlike a universal life policy, there's a set death benefit.

It's important to note that variable life insurance is more volatile than other types of permanent life insurance. It's best for those who are comfortable with the idea of extra risk.

Comparing the types of permanent insurance

Key takeaway on permanent life insurance

Think of permanent life insurance as coverage first and cash value second.

In other words, though they have investment components, life insurance is first and foremost a way to provide a benefit to your loved ones. It's not to be a substitute for traditional methods of investing or saving.

If you only view these as investments, you may find that find that the money isn't there for you when you need it most.