by Archie M. Richards, Jr., CFP^®
May 29, 2006

Avoid permanent life insurance. But if you want such a policy anyway, use variable universal life. Here are explanations of those three little words: variable, universal, and life, taking life first.

Life insurance pays money after you die to the beneficiaries named in the policy. Every year you age, the chances of dying increase. Barring special physical problems, "term" life insurance when you 35 is remarkably inexpensive, because the chances of dying are low. But when you're 95, term insurance is much too costly, because you can kick off any time.

Permanent or "cash value" insurance is intended to continue for your entire life, with the premium remaining roughly level throughout. When you're young, the premiums are higher than they would be for term insurance. But within the policy, a big chunk of each premium is invested. When death occurs at an advanced age, most of the death benefit is paid from the accumulated cash value.

If the cash value is invested in mutual funds and bonds selected by the policyholder, the insurance is said to be a variable policy. If you believe, as I do, that stocks should be an important part of an investment program, use variable life, not "whole life," which invests only in bonds chosen by the insurance company.

Universal means that you may vary the premium payments, depending on whether you're flush or strapped for cash. Each year, the insurance company advises you of the limits. If you pay less than the minimum, the company can't guarantee the death benefit. If you pay more than the maximum, the IRS doesn't consider the policy to be genuine life insurance and taxes part of the earnings.

Here's how you're taxed on a variable universal life policy:

• Investment earnings that remain in the policy (and you pay no more than the maximum premiums) are not currently taxed.
• After death, the death benefits to the beneficiaries are tax free.
• During life, withdrawals of cash value up to the sum of the premiums paid are tax free.
• Withdrawals in excess of the sum of the premiums paid are taxed as ordinary income. This applies even if the stock investments produce long-term capital gains. On withdrawals of cash value before death, a variable life policy unfortunately converts low-taxed capital gains into high-taxed ordinary income.

Most life insurance policies are not bought; they're sold by skilled salespersons who persuade people to buy the kinds of policies they probably wouldn't buy on their own. A key reason they wouldn't buy on their own? The premiums include substantial sales costs.

Think of it this way: When you buy corn flakes, you're not paying for just the flakes. You're also paying for the advertisements and packaging that persuaded you to buy the product.

With most permanent life insurance, you're not paying for just the death benefit. You're also paying the person who induced you to buy the policy. Skilled insurance salespersons are paid well.

Don't allow yourself to be sold life insurance. If you're intent on having a permanent policy, buy one that doesn't include sales costs.

Ameritas Direct, a division of Ameritas Life Insurance Corp., offers a variable universal life policy with no sales costs. It offers a wide range of investments, including Vanguard mutual funds. (Sorry, the policy isn't available in New York; New York insurance agents apply pressure on state legislators to restrict low-cost competition.)

With Ameritas, no salesman will call on you. You must take the initiative to contact the company (www.ameritasdirect.com, 800-552-3553), read the materials, raise questions over the phone, and send in your check, with no friendly salesman looking over your shoulder, egging you on.

Avoiding sales costs provides more bang for the buck. If you insist on having a permanent life insurance policy, save money with a policy that offers stock investments and flexible premium payments. Variable universal life is the right product, and Ameritas is the right source.