Purchasing a life insurance policy is an important step towards planning for your future.
There are several reasons why should get life insurance. Circumstances may include:
- protecting your spouse and children in the event of your death
- covering any expenses that your estate might leave behind
- building cash value to finance a large expense such as college
Several types of life insurance exist, and which one is right for you will depend on a number of factors. Here, you’ll find the different types of life insurance explained, as well as the pros and cons of each.
Different Types of Life Insurance Explained: Term Life and Whole Life
If you’ve begun researching your life insurance options, you’ve probably heard these terms before. The biggest difference between term life and whole life insurance is the length of coverage provided, which in turn results in each type of policy having its own pros and cons.
Term Life Insurance
The most popular option is term life insurance.
The “term” in term life refers to these policies’ set coverage duration. When you purchase a term life policy, you choose how long you want your coverage to last. Term life policies are generally available in five-year increments, from five years to 30 years.
Your beneficiary will only receive benefits if you pass away during the policy’s term. If you survive beyond the end of your term life policy’s coverage time frame, the policy simply expires and you’ll receive no payout.
You can also choose how much coverage you want. The smallest term life policies offer less than $50,000 in coverage, but term life policies exist with up to millions of dollars in coverage. Of course, keep in mind that your premiums rise with your coverage.
The popularity of term life is driven primarily by its simplicity and its affordability. When you decide to purchase a term life plan, you only have two choices to make:
- how much coverage you need
- how long you’d like the coverage to continue
Premiums for term life insurance are generally the lowest for comparable amounts of coverage compared to other types of life insurance.
Term life insurance does have one big downside. You could easily outlive your policy, and all the premiums you’ve paid will not be returned to you.
What’s more, if you still want life insurance coverage after the end of your term life policy, you’ll have to either extend your current policy or shop for a new one.
Many term life insurance plans will allow you to renew your coverage once your initial term expires (at least until you reach age 95), but you’ll likely face increased premiums or reduced coverage amounts. Otherwise, you’ll face paying more for a new policy due to your age and potential health issues.
Whole Life Insurance
As the name implies, whole life insurance is a type of permanent life insurance, meaning that it will never expire (as long as you continue to pay your premiums). In other words, if you purchase whole life insurance at age 30 and live to be 110, your policy will still pay a death benefit to your beneficiaries.
“Whole life” typically refers to traditional whole life insurance, the most common form of these permanent life insurance policies; however, guaranteed universal life and variable universal life are also popular forms of whole life insurance, with a number of less common variants also available.
Under a traditional whole life insurance policy, you select your coverage level as you would with a term life policy. At the point of purchase, your premium payments and death benefits are set, and both will remain the same throughout the entire life of the policy.
For example, if you opt for $250,000 in coverage with a monthly premium of $300 at age 30, your premiums will stay $300 a month for life and your death benefit will never decrease.
Unlike term life insurance, the premiums you pay accumulate cash value which provides you with the flexibility to borrow against the amount to finance large life expenses.
The disadvantage of traditional whole life insurance is that it is expensive. In general, it costs a life insurer significantly more to provide coverage to an 80-year-old in poor health than it does to a healthy 30-year-old.
Since premiums and death benefits stay at the same level for the entire life of the policy, the insurer has to set premiums at a higher level than would be needed to cover claims from the start. The premiums you pay at the beginning of your policy will be invested and used to supplement your coverage later in life.
For this reason, traditional whole life premiums for a person who is young and healthy can easily be up to 10 times that of comparable term life insurance coverage.
Guaranteed Universal Life Insurance
Another form of whole life insurance, guaranteed universal life insurance, is similar to traditional whole life in that the death benefit and premium payments don’t change over the course of the policy.
However, guaranteed universal life policies typically don’t accumulate cash value like traditional whole life does, or the plan may grow its cash value at a significantly reduced rate. While this removes one of the main benefits of traditional whole life coverage, the upside is that premiums are quite a bit lower than with other forms of whole life insurance.
Variable Universal Life Insurance
The last major form of permanent life insurance, variable universal life insurance, ties the cash value accumulated in the policy to market investments such as money market accounts or bonds.
If you’re a savvy investor, the pros of such policies can be significant. You can realize large gains in the cash value of your life insurance policy if you make good investment choices, and variable universal life policies allow you to partially withdraw this cash value or take out a loan against it.
Of course, poor investments can hurt the value of your life insurance policy, and variable universal life plans do require a lot of day-to-day policy management.
Other Types of Permanent Whole Life Insurance
There are other types of less common permanent whole life insurance.
Indexed universal life insurance ties your policy’s cash value to a particular stock market index and allows for more flexible death benefit amounts and premiums.
Accidental death insurance is another option that pays out a death benefit only if you die due to an accidental death such as a trip and fall or car accident.
The Role Underwriting Plays in Different Types of Life Insurance
In addition, the type of underwriting your insurance policy provider uses can change both your premiums and your coverage amount for both term and whole life policies.
A healthy person can obtain lower premiums and higher coverage by pursuing fully underwritten life insurance, which usually requires a full medical exam and health questionnaire. Whichever policy you choose is then priced according to your health risks and life expectancy.
On the other end of the spectrum, guaranteed issue life insurance requires no medical exams and no health questionnaires. All applicants are accepted. However, premiums are highest under guaranteed issue plans, and typically only low coverage is available.
Choosing Among Different Types of Life Insurance
Ultimately, no one type of life insurance is right for everyone. Examining your coverage needs and the maximum amount of monthly premium you can afford is crucial, as is understanding how your life insurance policy fits into your overall financial plan.
Protect your family, your assets and your future.