The Different Types Of Life Insurance Explained
You can buy different types of life insurance, each of which has its own advantages and disadvantages. Below is a brief description of the most common types of life insurance and their pluses and minuses. It should give you a good overview of the types of policies available. For more detailed information, speak with a life insurance expert such as an agent or broker.
The most common types of life insurance are:
Term Life Insurance
Covers the insured for a specific term or period of time. When that time period elapses, the policy ends and you have to buy new insurance. The risk with term life insurance is when the term is over and you try to get a new policy, you may have health issues that make you uninsurable. To avoid this problem, purchase renewable-term life insurance, which costs a bit more, but is well worth it.
Term insurance is pure insurance. Unlike whole life insurance, it does not build cash value that you can borrow against. As the insured grows older, standard-term insurance premiums annually rise so buy renewable 15 or 20-year level-premium life insurance because the premium doesn’t increase during the policy term. In the early policy years, the premiums will be higher than those for standard-term insurance, but the amount of your premiums stay the same for the duration of the policy.
My insurance agent buddies like to argue with me about whether term insurance or whole life is better. As I mentioned, I prefer 20-year renewable-level term insurance for the simple reason that you can buy much more coverage for the same price. In my practice, I see many young families that have too little insurance because they were sold expensive whole life policies. I think having the proper amount of insurance at the right cost is more important than any other feature offered by a whole life policy.
However, whole life insurance has advantages that include:
- It is permanent and can never be taken away from you regardless of the state of your health.
- It builds cash value over time because a portion of your premium goes into a savings vehicle.
If you buy a renewable 20-year level-term policy and are not insurable at the end of the 20-year term, the policy still will remain in force, but you will be required to pay a substantially higher premium.
Cash Value Life Insurance
The term “cash value” life insurance covers a variety of policies that combine a death benefit with a tax deferred savings vehicle. The policies are considered permanent policies because they are guaranteed to be renewable for life. A portion of the premium goes toward the death benefit, which is similar to term-life insurance policies, while the balance is applied to a savings vehicle and grows over time.
If the insured dies in the early policy years, most of the death benefit comes from the insurance portion. As you age, more of the death benefit comes from the growing cash value. The savings component, coupled with the permanence of the policy, results in an annual premium that is much larger than the cost of equivalent term insurance. So people wind up buying less death benefits, which is the main reason to purchase life insurance in the first place.
Insurance agents receive much higher commissions for selling cash-value life insurance rather than term policies. So keep that in mind when your friendly insurance agent extols the virtues of cash value policies.
Types of Cash Value Life Insurance
The basic form of cash value life insurance is whole life. Your premium pays for the death benefit and the balance is invested in a conservative interest bearing account. Premiums are fixed throughout the life of the policy. The policy can be cashed in at anytime with the insured receiving the cash value balance at time of surrendering the policy. Some whole life policies have a “vanishing premium” feature where after a number of years have past and you have built up enough cash value the premium will be paid from there and your annual outlay either declines or stops all together.
Universal life insurance was created to provide more flexibility than whole life insurance. Like a whole life policy your premium is split up between death benefit and savings. Unlike whole life, the premiums are variable in a universal policy. The premiums are general affected by the performance of the cash value. If the return is low, premiums will rise if return is good the premiums decline. Many holders of universal life policies have ended up disappointed as the rosy returns on the insurance proposal failed to materialize and the premiums have gone way up, not down as promised. I would avoid universal life policies.
Variable life insurance has a set premium for the life of the policy but allows you to invest the cash value in a variety of investments from low risk fixed income to higher risk stock market funds. The returns are not guaranteed so your cash value can decrease, lowering your death benefit. If the cash value grows than your death benefit will increase. I’m a purest when it comes to life insurance, I want the simplest policy, my advice purchase 20 year level term or a whole life policy avoid universal and variable life insurance.