Choosing the Right Life Insurance as a Federal Employee: Term, Whole, Universal, or Variable

This is the second in a series of columns on life insurance to help federal employees understand their need for life insurance coverage. This column presents information about the most popular types of individual life insurance policies, including how each works, the advantages and disadvantages of each, how long the coverage lasts, and which policies are best suited for which individuals.

Term Life Insurance

Term life insurance is a popular choice for many individuals. Among the reasons term life insurance is popular is that it is affordable for most individuals, it only lasts for as long as the individual needs it, and it does not come with many tax rules or restrictions.

Term life insurance is best suited for individuals looking for affordable life insurance lasting 10 to 30 years. Among its advantages is that it is less expensive than other types of life insurance and generally has lower premiums. The disadvantage of a term life insurance policy is its limited length; term life expires at the end of its term. However, an individual can choose a term life insurance policy that aligns with their family’s needs for financial protection, for example, while paying down a mortgage or protecting income while raising a family.

Term life insurance policies work by offering coverage for a set number of years before the policy expires. The policy owner (the insured) makes premium payments toward the insurance policy. If the insured dies during the term, the insurance company pays a set amount of money, known as the death benefit, to the insured’s designated beneficiaries.

Whole Life Insurance

Whole life insurance is a popular type of permanent life insurance. Among the reasons for its popularity are: it provides permanent coverage as long as the policy owner pays the premiums; premiums remain the same for the length of the policy; and, like most permanent life insurance policies, whole life insurance comes with a cash value account. The cash value account acts as a tax-deferred savings account and earns interest at a fixed rate set by the insurance company.

Whole life insurance is best suited for high-net-worth individuals who want to diversify their investment portfolio with a low-risk investment option. It has a guaranteed death benefit and cash value that earns interest over time. A portion of the policy owner’s premium goes toward the cost of the policy’s death benefit, and the rest goes toward the cash value account. Once enough cash has accumulated in the cash account, the policy owner can borrow or withdraw money from it.

The advantages of owning whole life insurance are its cash value and lifetime coverage. The disadvantage is its potential high cost and fees. A whole life insurance policy is usually many times more expensive than a comparable term life policy with the same death benefit, and the cash value component makes whole life insurance more complex because of potential surrender fees, taxes, and interest.

Universal Life Insurance

Universal life insurance is an adjustable permanent life insurance policy that also builds cash value. “Adjustable” means the policy owner can decrease or increase how much they pay toward their monthly or annual premiums over time. If the policy owner decreases how much they pay in premiums, they can choose to cover the required premium difference with the policy’s cash value.

A universal life insurance policy can be well suited for an individual with an above-average budget and a sufficient amount of liquid assets who is looking for flexibility in their life insurance coverage. It is also suitable for high-wage earners trying to build a large retirement nest egg without being pushed into a higher income tax bracket.

The advantage of owning a universal life insurance policy is its flexibility; policy owners can adjust their premiums based on their financial needs. The disadvantage is high investment risk, since interest earned from the cash value can be based on market conditions depending on the type of universal life policy the policy owner owns.

Variable Life Insurance

Variable life insurance is another type of adjustable life insurance that allows the policy owner to invest the money from the policy’s cash value in various funds offered by the insurance company, including open-end (mutual) funds. While a variable life insurance policy comes with a guaranteed minimum death benefit, there is no guarantee on the amount of cash value, since the cash value will depend on market conditions.

A variable life insurance policy owner can potentially earn more interest than they could with a whole life insurance policy. However, they could also lose money if the insurance company’s underlying funds underperform.

Some Guidance for Federal Employees to Decide What Type of Life Insurance Is Best for Them

Federal employees are advised that the best type of insurance for them depends on their budget and financial responsibilities. The following are some guidelines:

1. Term life insurance. Term life insurance policies are best suited for federal employees who need affordable coverage for a specific period of time. If the purpose of buying life insurance is to protect family members from a financial loss, such as loss of income protection or paying off a mortgage balance, then term life insurance is well suited for a federal employee.
2. Permanent life insurance. Permanent life insurance policies — whole life, universal life, and variable life — are best suited for employees who can afford much higher premiums, have permanent life insurance coverage needs, or want to use life insurance to diversify their investment portfolio.
3. Maximizing the Thrift Savings Plan (TSP). Permanent life insurance can be beneficial for federal employees who annually maximize their contributions to the Thrift Savings Plan (TSP) and to their IRAs and want another tax-beneficial investment vehicle.
4. Employees with serious health conditions. For employees who have serious health conditions and may not qualify for life insurance, final expense insurance can be an option. Final expense life insurance is ideal for individuals who do not want to burden their families with burial costs.

The right type of life insurance for an individual depends on their individual situation. Employees who need individual life insurance are advised to speak with a licensed insurance agent in their state to determine the best type of policy for them.