Life Insurance 101

Permanent insurance is also known as cash value insurance, because you build a cash value to the policy as you pay the premiums. Part of your premium pays for the insurance, and part is invested in an account that accumulates interest in your name.

"If you're not going to be a good saver on your own, this will give you a forced savings," says Karen Altfest, a certified financial planner and vice president with L.J. Altfest & Co. in New York City.

The biggest advantage is that when you buy a permanent policy, the insurance sticks with you as long as you pay the premiums. The insurance company can't cancel the policy for medical reasons.

The cash value that accumulates grows tax-deferred, and depending on the type of policy you buy, the cash value is invested in stocks, bonds or other investments. You can actually borrow from this account, or withdraw the cash value completely, though withdrawals will be taxable as regular income.

There are disadvantages to this form of insurance, too. Permanent policies are much more expensive than term insurance -- often thousands of dollars a year, versus a few hundred dollars a year for term insurance -- so most people can't afford as much permanent coverage as they can afford for term coverage. And while the permanent policy has a cash value, you might be able to invest that money better than the insurance company will.

"If you're at all an active investor, it may be better to buy the term," says Altfest. "Insurance companies tend to be very conservative with how they invest your money and you might be able to do better."

Also, the operating expenses of insurance policies are generally quite a bit higher than those of mutual funds. So buying term and investing on the side may be cheaper all around.

There are different types of permanent policies:

• Whole Life: These policies have the same premiums every year, but you don't have the option to decide how your cash value is invested.
• Variable Life: Like whole life, variable life policies have the same premiums every year, but you're given investment choices for your cash value. You can usually choose from among a batch of mutual funds, some more aggressive, some more conservative.
• Universal Life: This is the most flexible type of permanent policy. You can choose the investments for your cash value account and you can also choose what your premiums will be, as long as you pay the minimum. So if you're having a good year or a bad one financially, you can alter what you pay each year.