If you are interested in life insurance, any insurance salesperson will be delighted to explain the bewildering array of policies available to you. But unless you educate yourself first, it's all too easy to get mesmerized by insurance policy lingo and end up paying too much for a policy that may not even meet your needs. Start by learning about the main types of life insurance, explained below.

Term Insurance

Term insurance provides a preset amount of cash if you die while the policy is in force. For example, a five-year $130,000 term policy pays off if you die within five years -- and that's it. If you live beyond the end of the term, you get nothing (except, of course, the continued joys and sorrows of life itself). With term insurance, you pay only for life insurance coverage. The policy does not develop reserves.

Term insurance is the cheapest form of coverage over a limited number of years. As a candid life insurance salesperson once said, "It provides the most bang for the buck, no question -- over the short term." There are many types of term insurance, such as policies that have an automatic right to renew for an additional term, but these options don't change the basic fact that term insurance pays off if you die during the policy time period and doesn't pay anything if you live beyond that period.

Term life insurance is particularly suitable for younger people with families, who want substantial insurance coverage at low cost. Since the risk of dying in your 20s, 30s or 40s is quite low, the cost of term insurance during these years is as reasonable as life insurance prices get. Also, if you need insurance for only a short time, say to qualify for a business loan, term is your best bet. However, the older you are, the more expensive term insurance premiums become compared to the payoff value of the policy. This, of course, is understandable, as the older you are, the greater the chance you will die during the policy term.

Term policies offered by different companies have all sorts of differences, some fairly significant. For example, some policies are automatically renewable at the end of the term without a medical examination, often for higher premiums, and some are not. Some have premiums set for a period of years, but others guarantee a premium rate for only the first year. After that, the rate can go up. Some can also be converted from a term to whole life or "universal" policy during the term, again without needing to requalify.

But remember, with term insurance you never lock in the right to maintain the policy no matter how old you become. If you want to ensure that insurance will continue in force your entire life, term isn't for you.

Permanent Insurance

Permanent insurance can never be cancelled as long as you pay the premiums. You can renew a permanent insurance policy automatically, without undergoing an additional physical examination. With a permanent policy, your premium payments for the first few (or more than a few) years cover more than the insurance company's cost of your risk of death (because you are less likely to die when you are young). The excess money goes into a reserve account, which is invested by the insurance company. Unless the company is disastrously managed, these investments yield returns -- interest or dividends. A proportion of these are passed along to you. You can add these returns to your policy reserves or borrow against them, after a set time. And if you decide to end the policy, you can cash it in for the "surrender value." However, although permanent insurance policies do function as one type of investment, maximizing your investment return is not the purpose of insurance. If that's what you want, look elsewhere.

Returns that accumulate are not taxable, unless the money is actually distributed to you. Certain partial withdrawals can even be made without paying tax. By contrast, the interest on bank accounts is subject to tax in the year it is paid, even if left untouched in the account. Here are more details on several types of permanent life insurance.

Whole Life Insurance

Whole life (sometimes called "straight life") insurance provides a set dollar amount of coverage which can never be canceled, in exchange for fixed, uniform payments. Because the payments are the same throughout your life, in the early years of the policy, the premiums are high compared to your statistical risk of death. This is why reserves are built up. Assuming you live a long while after the policy was issued, your payments become low, compared to your risk of death. In other words, during the first few years of a whole life policy, insurance companies take in substantially more money than they pay out. The insurance company invests the surplus. Some of the surplus becomes your cash reserve, which grows over time. The cash reserve earns dividends, paid by the insurance company. After a set time, usually several years, you have the right to borrow against the cash reserve. You can also, of course, cancel the policy and receive its cash surrender value.

Whole life often is not desirable for younger people with small children who can't afford the high premiums during the early years of the policy.

Universal Life Insurance

Universal life combines some of the desirable features of both term and whole life insurance, and offers other advantages. Over time, the net cost usually is lower than whole life insurance. With universal life, you build up a cash reserve, as with whole life. But you can also vary premium payments, amount of coverage, or both, from year to year. In contrast, whole life requires one set payment amount, which cannot be varied, for the life of the policy. Also, universal life policies normally provide you with more consumer information. For example, you are told how much of your premiums goes towards company overhead expenses, reserves and policy proceed payments, and how much is retained for your savings. This information isn't usually provided with whole life policies. There can be other significant advantages to universal life; an insurance agent will be glad to explain them to you.

Variable Life Insurance

Variable life insurance refers to policies in which cash reserves are invested in securities, stocks and bonds. In a sense, these policies combine an insurance feature with a mutual fund. Since over the past decade, overall prices on the stock market have risen dramatically, variable life policies have usually produced the best returns. But, of course, there's a potential downside to this. These policies are almost sure to bring unpleasant surprises when financial markets decline.

Variable Universal Life Insurance

Variable Universal Life Insurance is a type of whole life insurance that combines the premium payment and coverage flexibility of universal life insurance with the investment opportunity (and risk) of variable life insurance.

Single-Premium Life Insurance

With single-premium life, you pay, up-front, all premiums due for the full duration of the policy. Normally, any policy with a savings feature can be purchased with a single premium. Obviously, this requires the expenditure of a large amount of cash -- $5,000, $10,000 or often much more, depending on your age and the dollar amount of the policy. One reason to commit so much cash to buying an insurance policy is that it enables you to give the fully-paid-for policy to new owners, which can result in major estate tax savings. Because there are no more payments to make, a gift of a single-premium policy doesn't involve risks that the new owners will fail to make payments and cause the policy to be canceled.

Survivorship Life Insurance

Survivorship life insurance (also called "second to die" or "joint" insurance) is a relatively new type of insurance. It provides a single policy that insures two lives, usually spouses. When the first spouse dies, no proceeds are paid. Instead, the policy remains in force and the surviving spouse must continue to pay premiums. The policy pays off only upon the death of the second spouse.

Why would any couple want such a policy? Mainly for use as part of an estate plan for wealthier couples who expect that substantial estate taxes will be assessed on the death of the second spouse. None of this is of interest to people with small or moderate-sized estates.

This type of insurance may also be desirable when a major family asset is a valuable family business, or real estate interests -- assets that aren't liquid, and which the survivors may not want to sell. Or suppose two children inherit a family business, but one doesn't want to keep it going. The other could use her share of the insurance proceeds as an initial buy-out payment, so she could retain ownership of the business.

Finally, this kind of insurance may be desirable if one member of a couple is in less than good health, making other types of insurance extremely expensive. Because two lives are insured, premiums for survivorship life policies are comparatively low compared to policies on one person's life. Therefore, if the other spouse is in reasonably good health, the couple can usually obtain survivorship life insurance.

"First to Die" Life Insurance

"First to die" life insurance is, as the name indicates, the reverse of survivorship insurance. With a first to die policy, two (or occasionally more) people, usually business partners or co-owners, are insured under one policy. Because these policies are usually maintained as part of a business buy-out agreement, typically the company or partnership itself buys and maintains the policy. When the first insured dies, the policy funds typically go to the company or partnership. A first to die policy is significantly cheaper than individual policies for two or more business owners. Obviously, insuring against only one death exposes an insurance company to lower risks, and lesser proceed payments, than if several people are separately insured for the same amount. When one business owner dies, the proceeds of a first to die policy can be used to pay off the worth of the deceased owner's interest, under a buy-out clause. Or, if the deceased owner's beneficiaries wish to, and are allowed to, participate in the business, the funds can be used for the costs of whatever adjustments and problems the business faces because of an owner's death.

Annuities

An annuity is a policy in which an insurance company pays the policy beneficiary a certain cash amount each year, or month, instead of one lump sum upon death. There are all sorts of annuity policies and combinations of annuity payment plans with cash-value life insurance policies. Some people who don't trust their own ability to hold onto money will purchase an annuity policy when times are good, naming themselves as beneficiary. They thus provide themselves with a set income for life, beginning at a specified age.

An estate planning advantage of an annuity is that you can buy one that will provide periodic payments to someone you believe is unable (too young, or too much of a wastrel) to handle one large lump sum insurance payment. In this sense, annuities work somewhat like a trust.

However, even if you want to arrange for periodic payments to a beneficiary, you should consider other alternatives, including establishing a trust. Annuity policies tend to be a relatively expensive way to meet your objective. Also, they are not flexible. For example, if special needs of the beneficiary arise, such as an extended illness, the payments often cannot be increased, as they often can be with a well-designed trust. In short, it's usually wiser to buy a more commonplace type of insurance and have the benefits put in trust should you die, to be administered by a trusted friend or family member who can vary pay-outs to meet the needs of the trust beneficiary.