HE-0657, Reprinted August 1998. Fred Waddell, Extension Family Resource Management Specialist, Associate Professor, Human Development and Family Studies, Auburn University. Originally prepared by Josephine Turner, Extension Program Specialist, Professor, Human Development and Family Studies, Auburn University.

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The Two Kinds Of Life Insurance

Life Insurance can be very confusing. There are many names for life insurance policies. The main thing you should know is the difference between term insurance and permanent insurance.

Term Insurance

Term life insurance gives you financial protection for a set period of time. The period of (or term) set for the policy can be 1 year, 5 years, or more. If you die during that period, the face amount (dollar amount) of the policy is paid to your beneficiary (the person you decide will get the money).

If you live to the end of the term, no money is paid to you, and the insurance ends. Term insurance does not offer savings, investments, or loan features. It pays only if you die during the term of the insurance.

One kind of term insurance lets you renew the policy each year without a medical checkup. But the premium (payment) increases as you grow older. Other kinds of term insurance state that you must have a physical checkup by your doctor to renew the policy.

Term insurance also may be convertible. Convertible means you can switch to permanent insurance without being checked by a doctor.

Decreasing term is another kind of term insurance. With decreasing term, the premiums stay the same, but the benefits (amount paid when you die) decrease over a set period of time. Decreasing term is also called "declining balance term insurance."

Credit life insurance is one kind of decreasing term. It is usually sold as part of a loan you make from a bank or finance company. It pays off the balance of the loan if you die before making the last payment. This kind of insurance protects the lender in case you are not able to pay off the loan because of death. Credit life often costs more than regular term insurance. Shop around when buying insurance to cover a loan. You probably can get regular term life insurance for less money than credit life.

When you start making premium payments, term insurance costs less than other kinds of policies for the same amount of coverage. The cost of term insurance increases as you grow older.

Whole Life

Whole life insurance is a kind of permanent insurance. It gives you life-long coverage for a fixed premium based on your age when you buy the policy. The risk of your death increases with age. Yet insurance companies keep the premium and face amount of the policy the same. They can do this by charging more in the early years of your policy than for term insurance and less in later policy years than for term insurance.

A whole life insurance policy has a cash value. This cash value is the amount of extra premium you have paid, plus interest that the company pays to your account. You can borrow from the cash value of your insurance policy. However, if you die before you repay this loan, the benefits are less. The loan plus interest is subtracted from the face value of the policy.

If you skip paying a premium, the cash value can be used to keep the policy active if you tell the company to do so. Cash value can also be used to buy a paid-up whole life insurance policy in a reduced amount if you want to quit paying premiums. Or you can convert the policy to term insurance. If you cancel the insurance, you can use the cash value to buy an annuity. An annuity will give you a certain monthly income for life or a fixed period. (The monthly payment you receive will depend on the amount of cash value and your age.) You can also give up the policy and get the built up cash value in one payment.

One kind of whole life insurance has a limited payment policy. Instead of paying premiums for the rest of your life, you pay for a set number of years--usually 10 or 20 years--or until you reach a certain age, such as 65. When you pay premiums for a shorter time period, your premiums cost more. Before buying any life insurance, decide which is the best buy for you.

For more information, contact your county Extension office. Look in your telephone directory under your county's name to find the number.