Which life insurance is the right one to pick?

Term and permanent life insurance policies offer different paths to the same goal: Making certain your loved ones can meet their financial needs should you die.

Types of life insurance

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• Term insurance: Covers a defined period, from one to 30 years or longer depending on the policy, and pays benefits only if you die during the defined time.

• Permanent insurance: Builds up cash value over time and provides lifelong protection as long as you pay the premiums. Broadly speaking, three types of permanent insurance are whole, universal and variable life.

• Whole life: Includes level premiums over the life of the policy and a cash value that grows at a fixed rate.

• Universal life: Allows more flexible death benefits and premiums, subject to certain minimum and maximum requirements.

• Variable life: Provides a death benefit and cash values that vary according to how premiums are invested. Investment options include a range of risk among stocks, bonds and accounts that guarantee interest and principal. The cash value of a variable policy is not guaranteed, and the policyholder bears that risk.

Source: American Council of Life Insurers

"We think you ought to buy life insurance if you need the death benefit," said Jeff Sharp, a shareholder in the business consulting and wealth management firm SilverStone Group in Omaha. "You don't buy life insurance primarily as an investment."

How much life insurance do people need?

Jack Dolan, a spokesman for the American Council of Life Insurers, said one rule of thumb is seven to 10 times your annual income. But it varies, depending on the size of your family, if your spouse or children have any special medical needs or if you want to leave any money to charity, Dolan said.

One plus for life insurance: Death benefits are free of federal income tax. If properly structured through an irrevocable life insurance trust, death benefits also can escape the federal estate tax that is levied on people with higher net worth.

Many families have no life insurance protection, or they do not have enough, according to LIMRA International, a research and consulting organization that counts as members more than 800 insurance and financial services companies in 60 countries.

Insured husbands in the United States carry about four times their annual income in life insurance on average, and wives about five times, LIMRA said. Ten percent of families with children under 18, or about 3.6 million households, have no life insurance protection, the organization estimates, based on its consumer studies.

For many families, term insurance is the least expensive option providing the largest death benefit. It is "pure" life insurance coverage for a specific period of time, from one year to 30 years or more depending on the policy.

"Generally, term insurance provides the best bang for your buck," Dolan said.

Permanent life insurance has higher premiums, but it provides coverage for your entire life. You pay more than is needed for current costs of insurance and expenses, and the excess payment is credited to a cash value account.

The cash value allows the company to charge a level premium and to provide a death benefit and cash account that grows tax deferred through the life of the policy.

People can use the cash to pay premiums or purchase additional insurance, or they can cash out a policy if they decide they no longer need it. People can borrow from the insurance company using the cash value as collateral. Borrowing from the account reduces the death benefit and cash surrender value.

People who buy term insurance often expect to have saved enough money in retirement plans and other investments to cover expenses and take care of their family when the policy ends, making life insurance unnecessary in their later years, Sharp said.

One caution, Sharp said: If those savings will not cover expected needs and a lapsed term policy needs to be renewed, insurance companies often charge more for the premiums because they take on greater risk as people age.

Dolan added another caution: People who promise to invest the money they save in lower premiums by getting term insurance sometimes do not follow through.

"Everybody talks about personal savings, but not enough people seem to be doing it," Dolan said. "We provide a disciplined way to save."

Many insurance companies offer term and permanent life insurance products.

Primerica Financial Services, a division of financial services giant Citi, sells only term insurance. It helps its clients invest the money they save from lower premiums.

"For the vast majority of people, term is what will get you the maximum protection" for the minimum price, said Frank Adkisson, an Omaha representative of the Georgia-based company. "If you need to protect your family, let's do it as cost effectively as we can."

One argument against term insurance might be that the insurance company gets all the money and does not pay anything to policyholders when they live past the policy's term. People need to invest the money they save in premiums to get the most out of term insurance, Adkisson said.

Broadly speaking, there are three kinds of permanent life insurance: Whole life, universal life and variable life.

Whole life is the least flexible because it holds its premiums in a general portfolio and guarantees some level of cash value growth that does not vary.

Universal life offers flexible premiums and death benefits as well as cash value, allowing people to increase and decrease their payments and coverage within certain limits. This can be good for people with variable income, such as musicians and free-lance writers, Dolan said.

Variable life insurance offers flexibility similar to universal life, but it includes investment growth potential - and risk. Policyholders choose among a number of accounts offering stocks that generally have higher risks but greater potential for growth, and bonds that bring lower risk but less potential for growth.

"You control your investment earnings in ways you allocate, as opposed to universal, when you take what they declare in interest rates," Sharp said. "Over longer periods of time, it has the potential to outperform."

If the accounts fare poorly, however, premiums could go up as policyholders maintain the death benefit, Sharp said. If premiums are not maintained, the insurance company could end the policy, he said.

Variable life insurance has been criticized as having high fees, but those expenses have gone down as the number of people holding such policies has grown, Sharp said.

How do you choose which life insurance option is right for you?

Sharp suggests that the cost of the needed death benefit be the guiding factor.

"Better the right amount of insurance and get what you can afford," Sharp said. "If that means buy all term, buy all term."

If you can afford permanent life insurance that guarantees some inheritance free of income tax to beneficiaries, that could be an option as well, Sharp said.

The very wealthy often use permanent life insurance as a way to pass on their inheritance free of income taxes, and estate taxes when properly structured, or to give part of their estate to a favorite charity by listing that charity as the beneficiary, Sharp said.