An unfortunate reality about life is the fact that it always ends in death. An unfortunate reality about death is that it can mean leaving the people you care for the most high and dry without the resources necessary to pay bills, provide for themselves and generally enjoy the same standard of living to which they had become accustomed. Knowing that so much could go wrong for your dependents after your passing, it’s important to consider the different types of life insurance at your disposal that can help you make sure that those you care for most are taken care of long after you’re gone.
There are a number of life insurance types, including whole, term and universal insurance. Knowing the differences between these can help you determine which life insurance structure best fits your plans for your beneficiaries. For some people, whole life is the best option. For others who want to be ensured for a certain amount of time, term life insurance might make the most sense. Still for others, the flexibility of premiums and interest paid on the cash value of a policy makes universal life insurance an attractive alternative.
Life insurance plans sometimes combine a little bit of everything to make the plan more cost-effective. This is because term life insurance is usually cheaper than whole life insurance. Regardless of the type of plan, by understanding the different types of life insurance, you can make an informed policy purchase and take the first step toward looking out for your loved ones for years to come.
What is life insurance?
If you have an active life insurance policy and you die, the insurance company should pay your beneficiary or beneficiaries the death benefit on your life insurance policy.
The death benefit is the amount that the beneficiary is owed according to the life insurance contract. For some whole life insurance policies, that death benefit may have any outstanding loans taken against the policy subtracted from the final amount that gets paid out. As long as you were honest during the application process, your named beneficiaries should receive a death benefit upon your passing, assuming the cause of death is not excluded from the policy.
What is whole life insurance?
Whole life insurance is a form of permanent life insurance. The agreed-upon death benefit is paid out to beneficiaries in exchange for a constant, regularly-paid premium that is paid by the policyholder over the course of the life of the policy. Whole life insurance also invests the money of the policyholder while they are still paying premiums. This investment serves as a sort of a savings account from which the policyholder can withdraw or borrow funds for various expenses during their retirement.
The premiums for whole life insurance policies are generally much higher than those on other life insurance policies, but they come with a few benefits. For one, the premium level never changes. The policyholder pays the same amount every time over the course of the life of the policy. Another plus is that the policy never expires. As long as the policyholder continues contributing to the whole life insurance policy, it remains active and will pay out its death benefit to the policyholder’s beneficiaries when the policyholder dies.
There are two primary types of whole life insurance:
- Traditional whole life insurance
- Variable whole life insurance
Traditional whole life insurance
Traditional whole life insurance is when the premium and death benefit stay the same over the course of the policy. Providers achieve this by setting the premium level at an amount that is initially excessive with respect to the benefits that the policyholder needs. As the policyholder ages, the cost per $1,000 of benefits increases and ultimately evens out. All the while, insurance providers invest a policyholder’s premium payments and use the earnings to pay the cost of life insurance for older policyholders.
Variable whole life insurance
A variable whole life insurance policy combines a death benefit with a savings account, giving users the option to invest in various money markets to increase the value of their policy. This is also a significantly riskier option because policyholders are effectively tying the value of their death benefits to the performance of whatever market they put their money in.
What is term insurance?
Term life insurance is a much more affordable kind of life insurance policy because it operates within a set period of time, only pays out the death benefit and does not keep its premiums constant throughout the life of the policy.
Despite the comparatively cheap premiums associated with term life insurance, there are a couple of major drawbacks with such a policy. For one, there is no savings component with term life policies. This element is often what enables policyholders to add value to their policy over the course of their premium payments and be able to have a little extra to cover expenses during their retirement.
Another issue with term life insurance is that it only covers the policyholder’s beneficiaries for a set period of time. If a policyholder buys a 10-year term policy but dies 11 years after buying the policy, his loved ones receive no death benefit. If a policyholder outlives the term of their policy, they have the option of either renewing it for another term, converting the policy to a permanent one, such as whole life insurance or letting the policy end.
The three primary life insurance types types for a term policy are:
- Level term policies
- Yearly renewable term policies
- Return of premium policies
Level term policies
A level term policy covers its policyholder for a set period of time and holds the death benefit and premium at a constant level. Because it gets increasingly expensive to cover a policyholder as they age, level term policies charge premiums higher than necessary initially to cover costs down the road.
Yearly renewable term policies
Yearly renewable term policies have no specified term limit and enable policyholders to extend them year after year. This option makes premiums cheap initially but prohibitively expensive as the policyholder ages.
Return of premium policies
Finally, return of premium policies charge the policyholder a fixed premium for the life of the policy and operate under a specific term period in the same way that other term policies do. Because many policyholders have found the vanishing death benefit component of traditional level term policies to be unfair, insurance providers have begun offering a return of premium option that refunds users their premium payments at the end of the policy. This option makes premium payments during the life of the policy considerably more expensive.
Other types of life insurance
Universal life insurance
Universal or adjustable life insurance adds an element of flexibility by allowing policyholders to increase the death benefit and adjust their premium payments on their policy if there’s enough money in the account to cover costs. Though this ability is useful if a policyholder’s economic circumstances change, if the money in the account is used up, the policy could lapse and their life insurance coverage could end.
Simplified issue life insurance
While many life insurance providers require that policy applicants undergo a medical exam so that the insurer can adequately assess their risk of death, a simplified issue policy allows applicants to skip the exam. Instead, policyholders fill out a health questionnaire and report any habits they have that might increase their likelihood of dying. The drawback to this option is that because there are no medical exams, the premiums tend to be more expensive.
Guaranteed issue life insurance
A guaranteed issue life insurance policy allows users to apply without having to take a medical exam or answer any health questionnaires. This option is particularly advantageous for elderly applicants whose health condition would make it prohibitively expensive to be insured, but it is much less-attractive to younger, healthier users.
The only requirement for these kinds of policies is that the policyholder can prove that they can pay the premiums decided on by the life insurance provider each month.
Final expense insurance
A final expense policy exists to cover the cost of anything associated with your death. This includes funerals, medical costs, cremations or anything else of a similarly morbid nature. Generally, this kind of life insurance is only issued to users of a certain age but is especially useful for people who may have outlasted their term policies and have no other way to cover the cost of their death.
Term insurance can be the best of both worlds
Many term life insurance policies have what is called a conversion privilege. This may allow a customer to convert their term insurance policy into a whole life policy.
Feldman says few clients understand or know about this feature. Feldman says he is currently helping a customer who bought a 10-year term policy nine years ago. He has developed some significant heart issues and is currently uninsurable. So, Feldman is helping this customer convert because there is no medical test necessary for the conversion in this instance. Because his original policy was issued as an elite non-smoker, his whole life policy will also be at an elite non-smoker rate, even though he is uninsurable.
“So, it locks in the underwriting classification when you go through that conversion,” Feldman says. “Chances are very, very few people out there truly understand the flexibility that they have in the term.”
That’s where an insurance expert comes into play, whether that is a life insurance agent, an advisor or a company.
Feldman says if you’re buying a 5-year term policy, you may have five years to convert, and if you have a 10-year term, you may have 10 years to convert. But some of the 20-year term policies only allow you to convert through the first 10 years.
Some companies may only allow a conversion during the first five years, if they allow a conversion, no matter how long the contract is for. Always check with your individual life insurance company to see what its conversion policy is.
An easy way to think of whole life and term
Think of whole life as buying a home and term as renting. When you buy a home, you are building equity. When you sell that home, you may profit if it went up in value. If you walk away from a whole life insurance policy or surrender it, you may get some cash back if a certain amount of time has passed.
Term is like paying your landlord for 10 years. If you pay your landlord rent for 10 years and tell that person that you’re moving, you don’t get any equity back (a security deposit isn’t equity.) The same thing happens if you terminate a term policy — you paid money into the policy but don’t get any money back.
Life insurance for babies and toddlers
Life insurance is available for infants and children. Unlike traditional whole life and term policies for adults, the death benefit usually isn’t the main focus. Items such as a guaranteed insurability option may be important to have if a child is uninsurable in the future because of disease or illness.
Feldman says he remembers one client who had a child who developed severe epilepsy and had a life insurance policy as a child. The child died from an epileptic seizure while in his apartment while away at college.
“Everybody thought, ‘(Oh) you don’t need that,’” Feldman says.
In this case, the policy paid for funeral costs and helped set up a nonprofit foundation to help people get treatment for epilepsy.
Feldman says he got policies on his children and grandchildren as soon as they were born. He also used the cash value from a policy that his father gave him to purchase his first home.
Life insurance for seniors
These policies are usually called funeral expense or final expense policies. They usually have a death benefit under $20,000 and typically are for people 50 to 80 years old. The different types of life insurance for whole life policies may not have medical exams, and they might not ask health questions.
The low death benefit is meant to cover expenses that a family would incur for a burial or funeral. These policies may have a limited death benefit during the first two years.
How much life insurance do you need?
Getting the right amount of life insurance is important so that if something happens to you, your family is adequately covered. Bankrate’s life insurance calculator can help you figure out the amount of life insurance you should get.