Deciphering Life Insurance Lingo

Lewis Schiff

Question of the week
With two young children, we know we need life insurance, but are a bit intimidated by all the choices. What's your opinion about the best type? --J. and P., San Diego.

Dear J and P.,

I find that there's a lot of confusion around all the options in life insurance, but that once you know the basics it will soon become clear which one is right for you. As you can see from these recent comments from members of the Armchair Millionaire community, these folks hold clear, strong opinions:

"I have term life insurance. I think whole life insurance is a waste of money because you don't have control over where that money is being invested. Buy cheap term life insurance and invest your money elsewhere." --Tiffany

"Our polices have investment components. Otherwise, it is pretty much just a waste of cash if you live to be a ripe old age!" --1

So what exactly are these people talking about? And how can they have such contrary opinions? To start, it's helpful to understand that there are two broad categories of life insurance: temporary (commonly called term), which lasts for only a set amount of time, and permanent (also called cash value), which lasts for your entire life.

Another key difference is that term insurance simply pays a benefit if the insured person dies while the policy is in effect, while permanent insurance includes an investment component so that a portion of your premium is invested. This is where the major differences of opinion arise. The people who argue for term insurance (this includes me) generally believe that they can get a better return on their money by investing on their own, while fans of permanent life insurance believe the insurance/investment mix can be a valuable combination.

Unfortunately, beyond these basic distinctions, it gets a little more complicated, and this is where some people get lost. To help you make an informed decision, my guide will help you decipher the lingo.

The Armchair Millionaire Guide to Life Insurance Choices

• Term insurance. This is the cheapest, simplest kind of life insurance. Buy a policy for a set term (typically 10 or 20 years) and if you die during that time, your beneficiary will receive the benefit.
• Whole life. This is the simplest type of permanent life insurance. Your premiums remain the same throughout the life of the policy, and a portion of each premium is invested by the company, allowing you to accumulate this money (the cash value) on a tax-deferred basis.
• Universal life. This has the same basic features as whole life, but is a bit more flexible. If you choose, you can pay in amounts above your regular premium, and adjust the death benefit relative to the cash value amount.
• Variable life. With a variable policy, you get a choice of different funds where the company will invest your money for you. Generally, if the investments do well you'll have a higher death benefit and greater cash value. It they don't do well, you'll have a lower death benefit and cash value, though some policies guarantee a minimum death benefit.
• Variable universal life combines the flexibility of adjusting the amount of the death benefit and premium (as in universal life) with the ability to take a little more risk in investment choices in the hope of getting a bigger return (as in variable life).

THE BOTTOM LINE: While complex at first glance, life insurance need not be overly confounding. If you understand your choices and are clear about why you're buying life insurance in the first place, the right option for you will be obvious.

From "Ask the Armchair Millionaire" featured each week on CNNMoney

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