Life Insurance

Types of Life Insurance

The first thing you do after getting a car is getting insurance. The same goes with a house; you protect your home with homeowner’s insurance. You have a life too, so it is only natural to get life insurance, right?

Life insurance is one of the most critical aspects of your family’s long-term financial plan, but it’s also one of the most challenging things to discuss. Its goal is straightforward: to replace your income for your family if you pass away. What is the best sort of life insurance for you? The best kind of life insurance for you can be determined by a number of factors, including the length of time you want the policy to last, the amount you want to pay, and if you want to utilize the policy as an investment vehicle. However, selecting the perfect coverage for you may be a confusing and frustrating experience with so many options around, and each offers a number of lucrative benefits.

With us by your side, it doesn’t have to be that way. We’ll walk you through the most common life insurance policies and assist you in determining which one is right for you.

There are numerous possibilities for purchasing life insurance, but it is not as hard as it may appear. Putting it straightforwardly, there are two types of life insurance policies: term and whole life insurance. Term life insurance is a category of insurance that lasts for a set period of time (the term) and then expires. On the flip side, whole life insurance is a category of permanent insurance that provides you coverage for the rest of your life. More insurance plans fall into these two groups, each with its own set of advantages and disadvantages.

Basic features of a life insurance policy

Before diving deep into the features of several kinds of life insurance policies, you must understand that, in reality, a life insurance policy is a commitment: to protect your loved ones financially when you’re not there anymore. How a life insurance policy meets this promise is represented by its essential characteristics:

The death benefit

The death benefit is the amount of money that the insurance company pays when the insured person departs. When the insured or annuitant dies, a death benefit is paid to the recipient of a life insurance policy, annuity, or pension. Death payments from life insurance plans are not taxed, and named recipients often get the death benefit as a lump-sum payment.

The beneficiaries

The person or people who get the death benefit are the beneficiaries. It can all go to a single person, for example, a surviving spouse, or it can be divided by percentage among a few people such as a spouse may get 50%, and two adult children might each get 25%. And by the way, a beneficiary doesn’t have to be a blood relative or even a person – if you choose, you can leave all or part of your death benefit to an entity, such as a charitable cause.

The policy length or term

The term of a life insurance policy means that for how long the insurance company is willing to pay the death benefit. A term insurance policy typically has a policy length of a fixed number of years, ranging between 10 to 30 years. Permanent insurance provides coverage to the insured person for the rest of his life. In whole life and universal life insurance, the coverage is provided for as long as the premiums are paid.

The premium

The payment or installment an insured person agrees to pay a firm in order to receive insurance is known as an insurance premium. You engage in a contract with an insurance company that assures reimbursement in the event of harm or loss in exchange for agreeing to pay them a specific, lesser sum of money. You may make a single or a series of regular or monthly payments, depending on the type of insurance.

The cash value

A life insurance policy’s cash value is the investment component that grows over time and can be cashed out or borrowed against. A term policy does not have any cash value; this feature is only available for permanent life insurance policies.

Basic types of life insurance

Although the term and permanent (whole life insurance) life insurance are probably the two types of life insurance you’ve heard the most about, there are various other options available. Most of these options come under the umbrella of a permanent life insurance policy. Let’s go over each type of life insurance policy, one by one.

Term Life Insurance

A term life insurance policy provides coverage over a specific period of time, generally ranging between ten and thirty years. Term life insurance is also referred to as “pure life insurance” because, unlike whole life insurance, it has no monetary value. The primary purpose of term life insurance is to provide a payout to your beneficiaries if you pass away within the specified period.

Most individual term insurance contracts have level premium rates, meaning you pay the same amount every month. When the term ends, you have two choices: go without coverage or get new insurance, which will almost likely be more expensive: the older you are, the more expensive it will be to obtain coverage. Many companies will let you convert a term policy to permanent life insurance for a portion or the entire coverage period. The premiums on term life insurance policies taken through the employers are usually offered “on achieved age,” which means they’ll rise over time.

In case of your death before the policy term is over, a specific amount of money is given to your specified beneficiary, known as the death benefit. Term insurance is the most basic and accessible type of life insurance; however, it is useless unless you die during the period. Consider it similar to car insurance. You send a cheque to your insurance company every six months (or perhaps every month). They take your check and deposit it. They will pay your claim if you experience a car accident. But what if you don’t have a crash? You don’t expect your premiums to be refunded just because you paid them to take on all the risk of that cross-country family road trip.

When you make contributions in the form of premiums, you’re funding the death benefit that will be distributed to your dependents after you pass away. A lump sum, a monthly payment, or an annuity can be used to pay out the death benefit. The majority of people choose to receive their death benefit as a lump sum payment.

Term insurance is intended to cover short-term necessities, such as mortgage or tuition payments. Term insurance prices are initially lower than permanent insurance premiums, allowing you to get higher levels of coverage at a younger age. Term insurance does not allow for the accumulation of financial value.

Term life insurance is the most prevalent type of life insurance offered by an employer. When an employee leaves, the coverage ends. Most states require employees to have a conversion privilege, which allows them to change their insurance to a permanent policy when they leave their employer. Term life insurance policies are less expensive than other forms of life insurance policies, with lower premiums on average.

Permanent life insurance

Permanent insurance accumulates cash value over time and provides lasting protection as long as premiums are paid, which can be flexible and paid regularly to match your individual financial circumstances. The cash value and the face value of the policy are not the same. The face amount is the amount of money that will be given to your chosen recipient. The term “cash value” refers to an amount that grows tax-free over time.

You can utilize your policy’s cash value to pay premiums, purchase additional insurance, or loan collateral. Loans must be repaid with interest, or the beneficiary’s death benefit will be decreased. You can also convert the cash value of permanent insurance into an annuity, which will pay you a fixed amount of money for the rest of your life. In addition, the policy can be canceled or surrendered for monetary value. If the cash value exceeds what you paid in premiums, you may owe taxes on some of it.

A permanent life insurance policy can be customized with riders that allow the policyholder to buy more insurance without proving insurability, cover long-term care costs, or collect death payments if he or she becomes incapacitated or terminally sick. Riders and their prices differ depending on the policy.

While term insurance is the most frequent type of workplace benefit, some firms provide permanent life insurance as a self-funded benefit to their employees. Employees who quit their jobs or leave the company can keep their coverage by paying premiums directly to the insurer.

Types of permanent life insurance

There are several types of life insurance policies that come under the radar of permanent life insurance. Let’s discuss them one by one.

Whole life insurance

Whole life insurance does not expire; hence it is considered as a type of permanent life insurance. If term life insurance is simple to comprehend, permanent life insurance products such as whole life insurance are more challenging to understand. That’s partly due to the fact that it’s a financial product attempting to achieve two things at once. It’s trying to give life insurance benefits by paying your dependents in the case of your death while also attempting to function as an investing account.

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When buying a whole life insurance policy, you can lock in the premium amount for the duration of the policy. Isn’t that appealing? And when you pay your monthly premium to the insurance provider, a portion of it goes into a cash value account. The cash value account grows tax-deferred over the policy’s life, so you don’t have to pay taxes on the profits.

In a whole life insurance policy, the death benefit and the premium are supposed to stay the same (level) during the life of a standard whole life policy. As the insured person becomes older, the cost per $1,000 of benefit rises, and it obviously rises dramatically when the insured person lives to be 80 or beyond. The insurance firm may levy an annual fee, but most people would find it difficult to buy life insurance at their senior age. Therefore, the insurance companies normally maintain the premium level by collecting a larger premium than what is required to pay claims in the early years, investing the money, and then utilizing it to supplement the level premium to help pay for life insurance for older individuals.

As a certain percentage of your premium goes into a cash value account, the longer you own the policy, the more cash value it has. Cash value has several substantial advantages that you can make use of while you’re still living. It takes a few years for your money to develop into a useful sum, but once it does, you can borrow against it, use it to help pay your insurance premiums, or even sell it for cash to live on in retirement.

It’s exactly like having a savings account. Some might consider this as a drawback of whole life insurance, considering that your life insurance only has one purpose: to pay out to your beneficiaries in the event of your death. And since the whole life insurance achieves this while also building a cash value, you’re frequently paying more for less coverage.

A whole life insurance policy has three unique characteristics compared to other insurance policies.

  • For the rest of your life, you’ll pay the same level of premium.
  • The death benefit is assured (as long as the premiums are paid).
  • The policy also offers guaranteed cash value with a guaranteed growth rate.

As a result, whole life insurance can be significantly more costly than term life insurance. Worse, whole life insurance doesn’t gain as much cash value as a decent mutual fund would if the extra money you’re paying was placed in one. Is it reasonable to pay more for less coverage and a poor long-term investment? If you need the cash value to fund things like endowments or estate planning, or if you have long-term dependents like disabled children, whole life insurance may be worth it.

Universal Life Insurance

Like other permanent types of life insurance, Universal life insurance has a death benefit and a cash value. Unlike whole life insurance policies, universal life insurance policies have flexible premiums, which means you can use some of the cash value to adjust your yearly payment. In any case, you’re still responsible for paying the minimum premium to keep the insurance active, but depending upon how much potential cash value you have, you might be able to eliminate a premium payment. Alternatively, you might choose to leave things alone and accumulate some cash value over time.

This brings us to the long-term investment strategy associated with universal life insurance. A portion of the monthly premium goes toward the death benefit in a universal life policy, while the rest is invested as savings. The idea is that the investment will grow over time, possibly enough to cover the premiums entirely. Universal life insurance is considered a poor investment approach because of its hefty management charges and annual renewal terms.

Guaranteed universal life insurance

In guaranteed universal life insurance, your premiums do not change, and your death benefit is guaranteed. The policy usually has little or no cash value, and insurers expect timely payments. You can specify an age at which the death benefit will be assured. If you don’t make a payment on time, you risk losing your guaranteed universal life insurance policy. You would walk away with nothing because the policy has no cash value. On the other hand, a guaranteed universal life insurance policy is less expensive than whole life and other forms of universal life insurance because of its low cash value.

Indexed universal life insurance

An index is a collection of investments, such as stocks or bonds, for example, the S&P 500 and the NASDAQ-100. The insurer does not invest directly in the market but instead bases your policy’s interest rate on a particular index’s interest rate and performance.

Indexed universal life insurance products feature a guaranteed minimum interest rate (so you won’t lose money), but the interest rates aren’t set or variable, unlike other permanent insurance policies. Most indexed universal life insurance policies have an earnings cap, which means that if the index outperforms the maximum set limit, you may lose out on the gains.

Indexed universal life insurance policies give the same benefits as universal life insurance policies, but the cash value account grows and diminishes in a different method. The cash value of universal life is based on a variable interest rate established by the life insurance company. In contrast, the cash value of indexed universal life is based on an index determined by the insurer.

Variable life insurance

Attempting to cover too much at once, variable universal life insurance policies are similar to whole life and universal life policies. They’re only going to get more complex! Variable universal life policies attempt to combine the functions of a life insurance policy, a savings account, and a mutual fund. And that’s not cheap at all.

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In variable life insurance, you can choose how your cash value is invested. There are hundreds of risk levels of equities and bonds to pick from, just as in a conventional mutual fund. You’re given various investment alternatives for your cash value, and you get to choose how risky you want to go with each one. That’s where the “variable” part comes in. It’s important to remember, though, that insurance is about risk and who bears the risk.

You have control over the risk of your investments since you have authority over where your money is invested. However, there are no promises about how big the cash value of variable universal life plans will be.

Variable universal life insurance

Variable universal life insurance sometimes feels like a hybrid of universal and variable life insurance policies because it shares various characteristics with both of the life insurance policies.

In variable universal life insurance, you have the luxury to alter the premium and death benefit amount while also investing in the policy’s cash value. However, it also shares many of the similar risks as other types of life insurance. Most people don’t require the complexities of a universal life insurance policy, so it’s a good idea to look into additional investment and insurance possibilities. You can always opt for a cheaper term life insurance policy along with traditional investments such as mutual funds. This combination will provide you the same insurance coverage as a variable universal life insurance policy, but at a cheaper cost and with less hassle.

Final Expense Insurance

Final expense insurance only covers expenses related to the end of life, such as funeral and burial fees. The insurance coverage is permanent in the sense that it will continue to exist until you continue to pay your premiums, but there is no cash value or investment component to these policies. Older adults frequently purchase final expense coverage to safeguard loved ones who otherwise have to shoulder these costs out of pocket.

While the premiums for these plans are often low, the death benefit is generally small as it isn’t intended to provide your beneficiaries with years of financial support. Whole life, universal life, and term life policies are likely to be more valuable to younger, healthier people who wish to develop cash value or provide a high death benefit for their relatives.

Other types of life insurance

Other than term life and permanent life insurance policies (whole life, universal life, and final expense), there are several different types of life insurance. Let’s see what these are and how they provide coverage to you.

No medical exam insurance

Applying for a term or whole life policy used to be like trying out for a sports team—you had to go through a thorough medical examination just to get started!  We’re talking about a blood test, a bodyweight additional investment drug test!

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However, this year, no medical exam policies and touchless exams have become the standard due to the pandemic. This strategy is currently available at the same price as those that need a medical exam from top-tier companies.

There are two categories of life insurance that don’t require a medical exam:

Simplified Issue Life Insurance

You don’t have to appear in a medical exam to get a simplified issue insurance policy. You may, however, be asked a few health-related questions and may be turned down based on your responses. To speed up the application process, instant-approval life insurance policies use short, online health surveys, as well as algorithms and big data.

Guaranteed Issue Life Insurance

The guaranteed issue comes with even fewer restrictions than the simplified policy; you don’t even have to answer any health-related questions. The only criteria is that you are between the ages of 40 and 85 years old. One disadvantage is that a graded death benefit will cover your policy.

In other words, if you die within the first few years of purchasing the insurance, your beneficiaries will only receive a fraction of the full death benefit. This sort of policy permits those who have been turned down for other types of health difficulties to acquire adequate life insurance to cover their final needs.

Decreasing term life: mortgage life and credit life insurance

Decreasing term life insurance was created to provide a death benefit that lowers in direct proportion to your liabilities. Mortgage life and credit life insurance are two examples of this form of insurance. The death benefit in these cases is set up to follow the repayment schedule of a mortgage or other personal loan.

The insurance policies are promoted to pay off your debts or pay off your mortgage if you pass away. So it’s basically just paying off your debts—and your beneficiaries aren’t getting the full benefits of life insurance. In other words, they may inherit nothing more than a debt that has been paid off or reduced but no cash. There is no monetary value, just like term life insurance. As a result, after the term, the ultimate value is ZERO.

However, if life insurance is about preserving your family’s long-term financial plan, how can you plan for something you don’t know how much it’s worth? This is the issue with decreasing term life insurance coverage. You never know how much they’ll be worth when you die, so they don’t give much financial stability to your family.

Accidental death and dismemberment insurance

An AD&D policy, also known as an accidental death and dismemberment policy, is one of those policies that almost everyone has come across at some point. The insurance salesman tries to offer you low-cost coverage that pays out in the case of your accidental death or dismemberment. It pays a portion of the compensation if you lose an arm and are unable to work. It delivers the entire death benefit if you die in an accident.

These plans are inexpensive—typically a few dollars every pay period—but you get what you pay for. If a medical procedure causes your death, a health-related issue, or a drug overdose, most AD&D policies do not pay a death benefit. As a result, your odds of dying in an accident decrease as you become older. That’s why an AD&D policy isn’t a replacement for a term life policy.

Group life insurance

Now we have group life insurance. This sort of life insurance is purchased by a company or organization, which explains the name “group,” and then offered to its employees as a perk. The majority of group life insurance is a term, although some employers also provide permanent coverage as an optional (employee-paid) benefit.

Until recently, the most common way to receive life insurance was through individual policies purchased through agents or directly from insurance companies. A growing number of Americans are now insured by group insurance policies through their place of employment. These plans have inexpensive rates since the business or group is essentially “buying in bulk.”  Some firms even provide employees with free term insurance equal to 1x their annual income. Group insurance may also be streamlined, at least for lesser coverage amounts, to make it easier for employees with health problems to get coverage. Coverage amounts, on the other hand, maybe limited.

If you’ve opted in for group life insurance at work, the most fantastic news is that it’s usually free. It’s also an alternative to taking a medical exam to obtain life insurance. But that’s where the benefits stop. Unfortunately, a basic group life insurance policy’s death payout is insignificant. This is because most of these plans only cover a few times your annual pay. Remember that a life insurance policy with a benefit less to 10–12 times your yearly salary is not a good idea.

Although group life insurance may not give the total coverage you desire, it can be a cost-effective and straightforward option to begin or supplement your life insurance coverage. Check to see if the policy is transferable, which means you may take your coverage with you if you leave your employment.

Joint life (first-to-die) insurance

Joint life insurance, often known as first-to-die insurance, is a cash-value policy sold to married couples who desire to share a policy. Consider joint life insurance plans to be the life insurance equivalent of a joint checking account. For a single cost, the policy covers two people. When the first spouse dies, the policy pays out a death benefit.

And there’s the rub: if your finances are typical of most families, one spouse earns far more than the other. Keep in mind that life insurance’s purpose is to replace a person’s income in the case of their death. Joint life insurance is a one-size-fits-all policy that provides the same benefit to both spouses. That means you can end up paying a lot more to protect your spouse’s part-time income from any source than if you just bought two separate term life policies. When you consider the costs, a shared life insurance policy doesn’t make that much sense.

Survivorship (second-to-die) life insurance

Survivorship insurances are generally designed for rich individuals who seek to avoid paying significant inheritance taxes on their assets. They aren’t intended to protect your spouse in any way. Furthermore, your spouse is not insured in the event of your death. The broken-record message, as with all cash value policies, is that you and your spouse are better off purchasing a term life policy and then investing in a decent mutual fund.

If joint life insurance policies aren’t for you, survivorship or second-to-die life insurance policies are a complete waste of money (and doubly hard to talk about).  Because a survivorship life policy, which is also a sort of cash value policy, provides no benefits to anyone until both spouses die, we recommend that you avoid them entirely.

Term vs. whole life insurance

The following are some essential variations between term and whole life insurance:

  • Premiums: Level premiums are seen in the most prevalent kinds of both term and whole life insurance. That means your premium payments will remain constant throughout time, and you’ll always know how much you owe.
  • Cash value: Term life insurance policies do not accumulate any cash value. A cash value account is included in whole life policies, and it gets cover time at a fixed interest rate.
  • Death benefit: The payouts on whole life and term life plans, known as death benefits, are guaranteed and do not fluctuate. Beneficiaries receive a death benefit that is normally tax-free. The primary distinction is that there is no payout if you outlive a term life policy. You can normally renew a term life policy at a greater cost when level premiums expire. If you don’t renew, your policy will expire, and your coverage will end. On the other hand, if you continue to pay your premiums, whole life insurance pays out regardless of when you die.
  • Price: Whole life insurance is more expensive compared to term life insurance because it provides everlasting coverage and cash value.

What type of life insurance should I get?

To understand what type of life insurance suits you the best, save your money, and will provide your loved ones a long-term peace, the first and foremost thing to know is how much life insurance you truly need?

How much life insurance do you need?

One of the first steps in purchasing life insurance is determining how much coverage you will require. A life insurance purchase should be made as part of a more comprehensive financial strategy. A financial advisor can help you recognize gaps and strengths in your current status and where you want to go.

Life insurance calculator

To calculate how much life insurance you need, several online platforms provide the facility of life insurance calculators. In most cases, a life insurance calculator will utilize your current assets and debts to determine how much life insurance coverage you require.

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How to manually calculate how much life insurance you need

You can also manually calculate how much life insurance you need. It is a straightforward procedure with the help of the following formula:

  • Expenses you want to cover – existing assets = The amount of life insurance you need
    • Expenses you want to cover may include a mortgage, income replacement, large debts, or your child’s college tuition fee.
    • Existing assets may consist of existing life insurance, savings, college 529 savings,

The amount you will get after doing the above calculation will be the life insurance you need.

Conclusion

Whatever type of coverage you get, be sure it is from a reputable and financially stable insurer. After all, one of the primary advantages of obtaining life insurance is that it helps to give a sense of security in an otherwise uncertain world. Financial strength ratings are an unbiased approach to determine whether a company will be there for your family in the future. Look for a firm that has received a “Superior” (A+) rating from a reputable insurance rating agency.

After understanding all the basics about life insurance policies, it’s time to consult with someone who can assist you in determining which sort of life insurance is best for you. As you might assume, your age, financial situation, family status, and various other factors will all play a role. A broker or financial advisor may assist you in determining which form of policy is appropriate for you, how it can be personalized to your needs, and what alternatives are available if the term, whole life, or universal life insurance does not meet your needs.

If you don’t have somebody to talk to about insurance, there are a number of internet resources that can assist you in learning more about getting life insurance or even locate a local financial professional who can listen to your concerns and guide you to the best answer.

Charles Bains

Charles Bains started his insurance career as a marketing intern before pounding the pavement as a commercial lines agent in Orlando, FL. As an industry journalist, his articles have appeared in a variety of trade publications. His insurance television career, short-lived but glorious, once saw him serve as the expert adviser on an insurance-themed infomercial (yes, you read that correctly). Having recently worked for various organizations, coupled with his broader insurance knowledge, Charles is able to understand our client’s needs and guide them accordingly. He is a gem for Insurance Noon as his wide area of expertise and experience have been beneficial in conducting further researches to come up with solutions and writing them in a manner which is easy for everyone including beginners to comprehend.

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Charles Bains

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