Term life insurance: your premium payments are applied 100% to the cost of the insurance. As retirement approaches, your need for life insurance is likely to decline, as children
become able to support themselves and your retirement savings have reached to a sizable amount. At this point, you can simply drop the term insurance without any penalty.
Cash value insurance: this is a big category, it includes whole life, universal life, variable life, and indexed universal life. These products combine term life insurance with a long-term, tax-sheltered savings plan. Only portions of your premium payment go to the cost of insurance, the rest goes to your savings account.
The most important thing to understand about cash value policies is that they are designed to be held for life, usually as an estate planning tool used by wealthy families.
It can be tough to spend your cash value savings if you want to use them for something other than insurance payments. Many policies allow you to borrow against your savings at low interest rates, but you are still paying for the use of your own money and the rules can be complicated, especially if you have no interest in paying back the loans (returning money to the plan).
You purchase a $500K cash value policy and expect your cash value to reach $300K in 20 years with your regular contribution.
Now 5 years later you find your income has increased and you decide to increase your contribution, and in 15 years your additional contribution has cash value of $100K. So your total cash value is about $400K now.
If you decide to take the $100K out to use with no intention to return, if you die in an accident, how much will your beneficiary receive? Only $400K! Because your policy has a loan of $100K outstanding, even though you thought this is your additional saving and you were just trying to take advantage the tax-deferred life insurance vehicle.
Insurance companies profit handsomely from folks who unwittingly buy into cash value plans and then drop them early. It's called surrender charge, because there are usually significant up-front charges associated with setting up the savings plan, investing the money, and paying the agent's commission. There is no surrender charge for Term life, you just stop sending the premium check to the insurance company.
A Common Misleading Sales Tactic
One common sales tactic when agents sell cash value policies is to stress that cash value policies are "permanent" and that a payoff is "guaranteed," as opposed to those "temporary" policies in which your money simply "disappears."
There can be benefits to a cash value plan, but these are not among them, because a Term life can be as "permanent" if you choose to make it, via guaranteed renewable policies, of course you have to pay more, just like in the case of Cash Value policies.
If someone tries to sell you cash value life policy, ask him or her to separate the two basic pieces -- insurance payments versus savings plan. You will find it can be like getting a politician to talk about the real issues.