Types of Life Insurance

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Setting loved ones up as beneficiaries of a life insurance policy can offer great peace of mind by paying off debts, covering funeral costs and providing tax-free funds to pay for college education or a home mortgage.

There are many different types of life insurance policies available, and it’s important to understand all the options to make an informed decision and get the right amount of coverage for the right price.

Different types of life insurance

There are two main types of life insurance available, as well as some additional, more specialized options:

  • Whole life insurance
  • Term life insurance
  • Other types of life insurance

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 paid by the policyholder over the policy’s life. Whole life insurance also invests the money of the policyholder while they are still paying premiums. This investment serves as a savings account from which the policyholder can withdraw or borrow funds for various expenses.

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. Another plus is that the policy never expires. As long as the premiums are paid, it remains active and will pay out the 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

The premium and death benefit never change with traditional whole life insurance. Providers achieve this by setting the premium level at an amount that is initially excessive in relation 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 life insurance costs 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 their policy’s value. It can be a riskier option, because policyholders are effectively tying the value of their death benefits to the performance of whatever market in which their money is invested.

Term life 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 policy’s life.

Despite the comparatively cheap premiums associated with term life insurance, there are a couple of major drawbacks. For one, there is no savings component with term life policies, which enables policyholders to add value to their policy over the course of their premium payments to cover extra expenses before death.

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 renewing it for another term, converting the policy to a permanent one, such as whole life insurance or letting the policy end. The conversion privilege is typically only available in the first five years.

The three primary life insurance 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 initially charge higher premiums 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 policy’s life 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

While term and whole life insurance are the broadest types of life insurance, other types of policies expand on permanent insurance coverage. They include:

  • Universal life insurance
  • Simplified issue life insurance
  • Guaranteed issue life insurance
  • Final expense insurance
  • Life insurance for babies and toddlers
  • Life insurance for seniors

Universal life insurance

Universal or adjustable life insurance adds an element of flexibility by allowing policyholders to increase the death benefit and adjust premium payments on their policy if there’s enough money in the account to cover costs. Though this is useful if a policyholder’s economic circumstances change, the policy could lapse, and their life insurance coverage could end if the money in the account is used up.

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 the premiums tend to be more expensive because there are no medical exams.

Guaranteed issue life insurance

A guaranteed issue life insurance policy allows users to apply without taking a medical exam or answering health questionnaires. This option is particularly advantageous for elderly applicants whose health condition would make it prohibitively expensive to be insured, but it is less attractive to younger, healthier users.

The only requirement for these kinds of policies is that the policyholder proves that they can pay the monthly premiums.

Final expense insurance

A final expense policy covers the cost of anything associated with the policyholder’s death, including funerals, medical costs, cremations and more. Generally, this kind of life insurance is only issued to users of a certain age. It is especially useful for people who may have outlasted their term policies and have no other way to cover the cost of their death.

Life insurance for babies and toddlers

Life insurance is available for infants and children, but unlike traditional whole life and term policies for adults, the death benefit usually isn’t the main focus. Things like a guaranteed insurability option may be important to have if a child is uninsurable in the future because of disease or illness.

Life insurance for seniors

This policy’s low death benefit of less than $20,000 is meant to cover funeral or burial expenses for people 50 to 80 years old. The benefit may be limited in the first two years, but the policyholder may not have to participate in medical exams or answer health questions.

Choosing the right type of life insurance policy

The many types of life insurance available can be overwhelming. When shopping for a policy, the first critical step is determining the ultimate goal. Another important question to ask may be for how long the insurance will be needed. If the policy is needed for a specific time, term life insurance is probably the most affordable. It might be a good idea for those who would like a lifelong financial planning tool to consider whole life insurance or one of the other types of more specialized coverages available.

Frequently asked questions

How much life insurance do you need?

Getting the right amount of life insurance is important to ensure that all financial needs are covered. Bankrate’s life insurance calculator can offer a starting point to figure out the amount of life insurance needed. It is also a good idea to shop around and compare providers and then speak with a licensed insurance expert to make a final decision.

What’s the difference between whole life insurance and term?

There are several differences between term life insurance and whole life insurance. Term life insurance is temporary but can be converted into a permanent life insurance product. Whole life insurance is permanent.

Is there life insurance for babies?

Some insurance carriers sell baby and toddler life insurance, which may be useful if a child has a life-threatening illness or to provide coverage for the child in the future.

Written by
Cynthia Paez Bowman
Personal Finance Contributor
Cynthia Paez Bowman is a finance and business journalist who has been featured in Bankrate, Business Jet Traveler, MSN, CheatSheet.com, Freshome.com and TheSimpleDollar.com. She regularly travels to Africa and the Middle East to consult with women’s NGOs about small business development and works with select startups and women-owned businesses to provide growth and visibility.