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Life insurance: Term vs. cash value

When shopping for a life insurance policy, it's vital to know the distinction between term life insurance and cash value life insurance.

Term life insurance lasts for your choice of a specified time (10, 15, 25 or 30 years) rather than up until death. Should you, the policyholder, die while coverage is in effect, the benefit goes to your designated beneficiaries, tax free. Should the policy end before death, you can renew it or let it expire. If you renew, the new premiums will be higher as your age and health are assessed anew. If it expires, there's no value or payout. You can cancel term life at any time, without penalty.

Cash value life insurance, also called permanent insurance, however, lasts throughout your life and also accumulates value during that time. A portion of the premium payments go toward an account that grows tax-deferred over time. As the policyholder, you may borrow or pay premiums from it, but doing so will decrease the death benefit.

Because of the cash value component, premiums are considerably higher than for term life policies. Cancelling a plan also often carries severe penalties.

When you die, the stated benefit goes to your beneficiaries, tax free. Sometimes the cash value does, too, depending upon the terms of the individual policy.

Term vs. cash value: Pros and cons

The pros of term life insurance are:

  • It's affordable
  • It's easy to buy
  • It's easy to cancel

The pros of cash value life insurance are:

  • You will always be covered
  • It can help coax you into saving
  • It may enable tax benefits

The cons of term life are:

  • If you outlive or cancel your policy, you don't get anything
  • Renewals often costs more than the original policy

The downsides to cash value life are:

  • It's expensive
  • Buying it is complicated because of the various options
  • A policy's cash value may not equal the premiums paid for about 12 years or longer

The decision ultimately comes down to your financial goals. If you want life insurance for a determined period of time, say, until your children graduate college, term life will meet that need. If you're looking to create wealth or ensure your heirs receive a benefit regardless of when you pass, cash value life may be a better fit.

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