There are several different types of life insurance policies available. If you understand the basics of each type, you can better select a life insurance policy that suits your needs. Some life insurance policies provide just a death benefit, while others offer a permanent, or cash value. There are pros and cons to all of these types of life insurance, so it’s a good idea to familiarize yourself with them before purchasing your policy.
Term Life Insurance
The easiest type of life insurance to understand, and the least expensive is a “term life” policy. It has no cash value. The purpose of a term life insurance policy is to pay a specific amount to your beneficiary when you die.
If you purchase a $100,000 term life insurance policy, then it will pay $100,000 to your beneficiary. The primary benefit of using a term life insurance policy is that the insurance premiums remain constant throughout the duration of the policy.
If you get a 30-year life insurance policy, then your premiums will be the same for the next 30 years, even if you contract a life-threatening illness, or something else happens to your ability to buy insurability.
The “downside” of a term life policy is that you will not have anything to show for it after your policy ends.
Special life insurance information for military members:
- Veterans’ Group Life Insurance (VGLI)
- Servicemembers Group Life Insurance (SGLI)
- How to Convert an SGLI Policy to VGLI
- How much life insurance do military members need
Specialty life insurance policies:
You may also be in a special category of life insurance if you have certain medical conditions or you participate in high-risk activities. For example, if you are a smoker, be sure to read about smokers life insurance. There may also be different health insurance policies in place for people with a history of cancer, diabetes, and other major medical concerns.
Who Needs Term Life Insurance?
Most people don’t need a life insurance policy for their entire lives.
Life insurance aims to protect your beneficiaries from financial hardship in the event of your death.
Following your financial plan, the term life policy should last long enough to ensure that those who depend on you can maintain their current standard of living if you pass unexpectedly.
It is also worth considering Return of Premium Term Life Insurance. The difference here is if a person outlives the term, they are entitled to the full return of all premiums paid.
Whole Life Insurance
A whole life insurance policy will provide a death benefit for your beneficiaries and also offers as a cash value with tax-deferred earnings. When you purchase the policy, you have a fixed premium amount which cannot increase as long as you make your agreed payments. This is why it is ideal to purchase whole life insurance when you are younger, as the premiums are less expensive than when you get older.
Many life insurance agents sell whole life insurance as an investment. You can use it as an investment, but it is almost always better to keep your investments and life insurance policies separate. Here are some things to know about a whole life insurance policy if you decide to use one as an investment:
With a whole-life policy, you choose to receive dividends from your account or to add them back to your policy to reduce your required payments. You can withdraw cash from your policy if you need to.
You cannot choose to invest in different types of accounts with your cash value from a whole life policy. The insurance company is in control of where the money is invested.
Who Needs Whole Life Insurance?
The decision to purchase a whole life policy depends on your lifestyle and financial circumstances more than anything else.
Whole life insurance is best for people whose heirs will need life insurance premiums regardless of when they pass away. Those with special needs dependents might consider whole life insurance.
Whole life insurance can also be useful for estate planning. If your heirs need assistance managing your estate, it is best to have a policy that makes the transfer as smooth as possible.
Which is better, term life insurance or whole life insurance?
Term and whole life are the two most common forms of life insurance. In most cases, people are better off choosing a term life insurance policy. The reasons for this are outlined in this article comparing term and whole life insurance. However, there are some instances when it may make sense to go with a whole life policy.
Other Types of Life Insurance
As the insurance industry grew and evolved, different types of life insurance began to emerge under the larger umbrellas of term and whole life.
They can often be written as additional coverages within your policy, so it is essential to understand the following types of life insurance to determine if it fits your coverage needs.
Variable Life Insurance
Like a whole life policy, variable life insurance gives permanent protection with account flexibility and a tax-free cash value account. The amount of death benefit will vary depending on how much you earn with the cash-value account, which means there are no guarantees to how much your death benefit would be when you pass away.
You can also borrow money from a variable life insurance policy. Variable life insurance policies are often sold as hybrid investment products and can be complicated to understand. The benefit is that these policies may have special tax advantages.
Universal Life Insurance
Universal life insurance policies often split your premiums into a death benefit and an investment. For example, a person might start out with a $100 monthly premium of which $20 goes to the death insurance and $80 goes toward the investment portion of the account. This gives the policy a cash value and the ability to pay out upon the death of the individual.
When you die, your beneficiaries receive a death benefit, and you’ll have a tax-deferred cash value account that you can borrow from if you need to. You earn the market rate of interest on your cash accumulation, but you can’t invest your money in separate types of accounts. Universal life insurance policies offer flexibility with premiums and the face amount.
Universal Variable Life Insurance
If you’re looking for a life insurance policy that gives you control over the cash accumulation, a Universal Variable Life policy provides more features than other types of insurance. These types of insurance policies provide death benefits to your beneficiaries and allow you to invest cash value into your choice of money markets, bonds, and stocks. This means the success of the earnings depends on your ability to manage the account and move money to strong investments.
Universal Variable Life also offers premium flexibility and allows policyholders to borrow money from the account or make a withdrawal. If you terminate the policy early, you receive less cash value than you would if you met the full term of the contract.
Mortgage Life Insurance
Mortgage life insurance isn’t your traditional life insurance policy – the sole purpose of this policy is to protect the lender. You take out a policy when you buy your home, and the policy will pay off your home in the event of your death. The downside is that your premiums often stay the same, even though the payoff benefit decreases as your mortgage principal decreases.
In most cases, it is better to take out a term life policy for the amount of your mortgage, since your payoff benefit doesn’t decrease.
Decreasing and Increasing Term Life
Decreasing and increasing terms refer to changes to the death benefit over the course of the policy.
In a decreasing term policy, the death benefit decreases over time while the premium generally stays the same. Those who wish for the remaining amount of their mortgage to be paid may consider a decreasing term policy.
The death benefit and mortgage amount will decrease over time until, eventually, both are gone entirely. Alternatively, increasing term coverage offers an increasing death benefit with a relatively stable premium.
Increasing term life insurance would be best for someone whose financial needs will increase with the death benefit, such as a young parent or newlyweds.
No-Exam Life Insurance
A no-exam life insurance policy does not require an insured to complete a medical exam to obtain coverage. They can be written as either term or whole life policies.
The best candidate for a no exam policy would be someone that is considered by the insurance company to be “high risk”.
Because there is no examination to determine eligibility, the premiums will be much higher than if a medical exam were performed.
Survivorship Life Insurance
Survivorship policies insure two lives instead of one. Unlike other life insurance policies, the benefits are only triggered after the second insured passes.
Because two lives are being insured instead of one, the underwriting guidelines for these policies tend to be much more lenient. The policy will likely be approved, even if one of the insureds would not be eligible for a single life insurance policy.
Spouses will often purchase a survivorship policy to assist their children with paying estate taxes after they have gone. It can also assist in the transition of assets.
What Should I Consider When Purchasing Life Insurance?
There are two common situations in which a life insurance policy is not necessary: when no one depends on your income or if your assets are large enough to care for dependents if you pass.
If neither of these scenarios applies to you, you will likely need life insurance. The best way to determine the best life insurance policy for you is to consider what expenses will be left to your dependents if you pass.
If they are left with a mortgage, college expenses, and other living expenses, you should account for this in the death benefit. It is also wise to account for whatever your salary is that they would be without.
Be sure to consider if you have circumstances that demand whole life insurance. There are simply times in your life when you need certainty about the future well-being of your family.
If you are unsure if you need whole life insurance, read our post about the reasons to buy whole life insurance. Quotes vary from company to company, and some life insurance companies are better rated than others. So make sure you shop around when you are in the market for insurance.
Also, be sure to discuss your decision to purchase life insurance with an insurance professional. Life insurance is meant to protect those you love, so do not make the decision alone.
Which Type of Life Insurance is Best?
As with all major financial decisions, it depends on your unique situation. The most important thing to consider is whether or not you have enough life insurance to protect your loved ones when you die. That is the primary purpose of life insurance – everything else is secondary.
The next thing to consider is whether or not you can understand the ins and outs of the policy, and whether you have a special situation where the special tax advantages of some of these accounts come into play.
For most people with an uncomplicated situation, a term life insurance policy will be the best type of life insurance policy to buy. Term life insurance is straightforward – you pay X amount per month and receive X amount of coverage. At the end of your policy, you can choose to open another policy or do without.
The other life insurance policies described in this article take more work to understand and may not offer the right type of coverage for some people.
If you choose to go with one of these policies, be sure you understand how the insurance policy is written, the ins and outs of any investments that are run through the policy, and any fees you will pay either directly or indirectly through the policy (many investments held in insurance policies are notorious for having high fees). If your concern is also having an investment, then you should be able to do that through a separate investment rather than with a life insurance policy.