Cash-Value Varieties

INTRIGUED BY cash-value life insurance? There are three types to choose from:

Whole life. This is the most conservative type of cash-value life insurance, with the insurer guaranteeing that your premiums will remain the same and that the policy’s cash value will earn a minimum rate of interest. A whole-life policy can also earn additional dividends that help your cash value grow faster, though these additional dividends aren’t guaranteed.

Whole life has received a big push from advisors who advocate BYOB, or “be your own banker,” which involves building up a whole-life policy and then using it as a source of borrowed money. But the benefits claimed are inflated, and some of the advice offered, such as reducing your 401(k) contributions so you can put more into a whole-life policy, is dubious at best.

Universal life. While a whole-life policy has a fixed interest rate, the interest paid by a universal life policy varies over time. With indexed universal life, the interest you receive can be linked to the returns of a stock market index, often the S&P 500. Policyholders receive the S&P 500’s return, excluding dividends. The annual gain is capped, but you are also protected against losses. Universal life policies give holders some flexibility to vary premium payments and raise or reduce the death benefit.

Variable life. Instead of earning interest, a variable life policy allows you to invest the policy’s cash value in a series of subaccounts, which are similar to stock and bond mutual funds. Many variable life policies are actually variable universal life, meaning they offer the flexibility to vary payments, like universal life. During periods of strong stock market returns, sales of variable universal life tend to pick up.

If you aren’t careful, cash-value life insurance’s promise of lifetime coverage can break down. Suppose you take out a policy loan, cut back the premiums too much on a universal policy, make poor investment choices from among a variable policy’s series of subaccounts or the interest rate drops sharply on a universal policy. In all of these situations, you may need to make big payments to keep the policy going—and without those big payments the policy could lapse or its death benefit could be sharply reduced.

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