Unlike term life insurance policies, which do not build a cash value and always have a level death benefit, permanent life insurance policies allow the owner to select a level or increasing death benefit (sometimes called option 1 or option 2).  Most universal life policies (UL) allow the owner to switch between the level or increasing death benefit with few restrictions. Whole life policies (WL) can be a little more complex since the policies are designed to increase the death benefit using dividends to purchase additional coverage. However, the owner can elect other dividend options which help reduce the amount of additional coverage being purchased. But over time, the death benefit will increase as the cash value grows. (See also: How Whole Life Insurance Works.)

Level Death Benefit

In a policy with a level death benefit, for instance $500,000, as the premium is paid fees and sales charges are deducted and the remaining amount is credited to the cash value. The cost of insurance is then deducted from the cash value each month. Over time, as premiums are paid, the cash value of the policy increases and the amount of insurance being purchased each month gradually decreases. For example, in year two a $500,000 policy has a cash value of $1,500 so only $498,500 of insurance is being purchased.

Upon the death of the insured, the insurance company pays a death benefit that is partly insurance and partly a return of policy’s cash value. For example, assume the owner paid the premium for 15 years, and the policy had an accumulated a cash value of $65,000. The insurance company would pay $435,000 for insurance and return the $65,000 of cash value for a total benefit of $500,000.

Increasing Death Benefit

On the other hand, if the policy is a UL with an increasing death benefit, upon the death of the insured, the beneficiary would receive $500,000 of insurance – plus any accumulated cash value. In UL policies with an increasing death benefit, the owner is always buying $500,000 of insurance. However, the growth of the cash value depends on the amount of premium paid. If the premium is the same as in the policy with a level death benefit the cash value in the policy with an increasing death benefit would likely be lower, since more insurance is being purchased each month.

WL policies are different because dividends are being used to buy additional insurance. The death benefit increases because small amounts of additional insurance are being purchased each year.

Level versus Increasing

There are a variety of reasons why a policy owner may choose an increasing rather than the level death benefit. Below are examples of when an individual may opt for an increasing death benefit. 

The policy owner temporarily needs a higher amount of insurance. This works especially well when the insured is younger, and the cost of insurance is lower. The policy owner may later switch back to a level death.

The policy owner needs a death benefit that will continue to increase, for example when insurance is being used as part of a business succession plan. Without an increasing death benefit, the coverage may not provide an adequate replacement value for a growing business.(See also: Using Insurance in a Business Succession Plan.)

The policy is being used to supplement retirement savings, and the owner wants to build a lot of cash value by overfunding the policy in the early years. If the premium paid were to exceed the seven pay limit, without an increasing death benefit, the policy could become a modified endowment contract.

The Bottom Line

Once you have determined you need permanent life insurance, you should consider your options in how the coverage is designed. There are many ways to tailor the coverage to meet your need, and an experienced independent insurance broker can be an excellent resource.

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