Updated March 18, 2019

Types of Life Insurance

Read more about Life Insurance

The best type of insurance for you depends on your budget, what you want to cover, and for how long. Read on to learn the differences.

Let's get it right out in front—no one likes to talk about life insurance. Thinking about your own death is scary. But if you want to protect your family, it's smart to think about it.

Buying life insurance to benefit your survivors is an act of love. Some benefits include:

  • Your spouse will have a sense of security
  • Your family can keep their home
  • Your children will be able to go to college

Many families delay looking at life insurance because they think they can't afford it. In fact, in most cases, life insurance is very inexpensive. For half a million dollars of coverage, the monthly cost is often less than the cost of a restaurant meal for a family of 4.

There are many types of life insurance. It can be very confusing to understand the differences. This guide will break down the different types.

Read on to see which type is best for you.

Did you know:
1 out of every 3 families would be financially devastated in one month if one of the adults died. Is your family one of them?

  • 41% of people do not have any life insurance
  • 20% of people who have some life insurance say they don't have enough to provide for their family

Two Basic Categories of Life Insurance

There are two major basic categories designed to satisfy different needs:

  • Temporary Life Insurance (term insurance):
    This is the simplest and cheapest type. It lasts for a period of time (a term). If you're still alive at the end of it, then the policy expires. It's a lot like auto insurance—you hope you'll never need it but you're glad you have it.

    You can use term insurance to cover temporary needs. For example, you can get enough insurance to last until the children graduate from college or until the mortgage is paid off. This way, your family is protected if you die too soon.

  • Permanent Life Insurance:
    Permanent life insurance doesn't expire. The insurance will stay in force as long as you keep on paying the premium—ideally for your entire life. This type of insurance has higher premiums.

    Permanent life insurance also has a cash value element. This is like an investment savings account. Whole life insurance is a good way to provide cash to pay estate taxes, final expenses, and other money needed at the time of death.

Important definitions:

  • The policy holder: This is the owner of the policy. This person owns all rights to the policy and is responsible for the payments. Only the policy holder can make changes to the policy. You can transfer ownership to another person.

  • The insured: This is the person whose life is insured. You can be the policy owner and the insured (insuring your own life). Or you can name another person as the insured. For example, you can purchase life insurance for your wife.

  • The beneficiary: This is the person who will receive the death benefit. If you purchased life insurance for yourself, you will name another person as your beneficiary. Or you can be the policy owner and the beneficiary (with your spouse being the insured).

  • The death benefit: This is the amount the insurance company will pay out to the beneficiary when the insured dies.

What Is the Best Type of Life Insurance

In most areas of life, good decisions are easier when you know your "why." Begin with why you are buying the insurance. Decide which type of policy will meet your needs.

Term insurance is a great solution if you want to provide financial security while your family grows. It's not a good solution when you have to pay estate taxes.

Whole life insurance is a good way to provide the money to fund a business succession play. It's not a good choice to provide a large amount of insurance for a young family.

The wrong decision is an expensive mistake. Spend time learning about the options so you can make the right decision the first time.

Types of Term Life Insurance

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With term life, the premium only pays for insurance. There are no extras or cash value included. If you die within the term, the insurance company will pay out to your beneficiary. If you don't, then the policy expires.

You can customize the policy to fit specific needs. We'll go over some different types of term insurance below.

How much does it cost? A 40-year-old in good health can buy $500,000 of term insurance for less than $500 per year, which is about $42 per month. If you are younger, in your early '30s, the cost would be less than $400 per year.

  • Level Term:
    This is the most basic type. You choose a length of time you want to have the insurance (the term). During this time, your premium remains the same. Terms can last 1-30 years.

    The premium is higher for policies with longer terms. If your budget is tight, a 1-year renewable term policy may be the best solution.

  • Convertible Term
    A convertible term policy can be converted to permanent insurance without re-evaluating your health. This is good if you need permanent insurance but can't afford the premiums. This allows you to buy the amount of insurance you need at lower term rates and guarantees you will be able to buy permanent insurance when you can afford it.

    If you are buying term insurance, buy from a company you would like to do business with for a long time. Make sure the term insurance you purchase is convertible. It's a very inexpensive way to leave more options open.

  • Return of Premium
    Are you afraid insurance may be a waste of money? Consider a return of premium provision. The premiums are higher, but they are refunded if you're alive at the end of the term.

  • Decreasing Term
    A decreasing term policy has a level premium but the death benefit declines over the length of the term. It's often cheaper than level term. This can be a good choice if you want insurance to pay off a mortgage or student loans. The death benefit declines as your loan balance declines. This way, you aren't paying for more insurance than you need.

    This type of policy is good if you don't plan to move. But if you don't think you'll remain in your home for thirty years, a level term policy is a better option.

    One downfall of decreasing term is that it does not provide any protection against the risk that an illness will make it difficult to get life insurance later.

  • Renewable Term
    A renewable term policy allows you to renew your policy at the end of the term. But you will be older when you renew, so the renewal premium will be higher.

Types of Permanent Life Insurance

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Traditional Whole Life

  • Designed to stay in force until the insured dies, even if the insured lives until old age.

  • Premiums usually remain the same every year.

  • Premium includes a cash value element.

  • If the policy is participating, dividends may increase the value of the policy.

  • The insurance company assumes the investment risk.

The cash value is like an investment/savings account. You can borrow against that money, but there will be interest on the loan. In traditional whole life policies, the premium and cash value are known when the policy is issued. The policy contract includes a cash value table that shows what the cash value will be every year.

At age 100, the cash value is generally the same as the death benefit. Some companies pay the death benefit when the insured reaches age 100 even if the insured is still alive.

The insurance company invests the cash value. The earnings on the investments offset the higher cost of the pure insurance when the insured is older.

Whole life policies are more expensive than term insurance. But if the insurance is needed for a long time, whole life premiums may be lower than term premiums after the policy has been in force for a number of years.

Universal Life Insurance (UL)

  • Cash values vary based on the interest rate declared by the insurance company.

  • Cash values are not guaranteed.

  • The annual premium is flexible. It can be almost as low as term insurance or higher than a traditional whole life policy.

  • You can choose how much of the premium you want to go into the death benefit and how much to go into cash value.

Because the interest rate varies, Universal Life is desirable when interest rates are high. If interest rates are low or the premiums paid aren't enough to build the cash values, premiums on a UL can be too expensive when the insured is older.

Guaranteed Universal Life Insurance (GUL)

  • Guarantees the policy will remain in effect if minimum premiums are paid.
  • Can remain in force until age 90, 95, 100, 110, 120, or 121.
  • Does not accumulate much cash value.
  • Tends to have the lowest cost of the whole life options.

If the insurance is needed for estate tax purposes, a guarantee that the policy will remain in effect for life is important. Policies to age 120 or 121 are guaranteed to remain in force even if you live longer than those advanced ages.

Guaranteed Universal Life to age 121 has a higher cash value than other versions.

Variable Universal Life Insurance (VUL)

  • Earnings on the cash value are based on investments in the stock market.

  • You can select the investments. You assume the market risk.

  • Nothing is guaranteed. The cash value and death benefit fluctuate up and down with the market.

  • When the stock market is trending down, required premiums can rise significantly. You may feel additional pressure on your ability to pay the premiums.

Variable Universal Life is only for sophisticated investors. If the policy you are buying is the only financial security your family will have, it is not the best choice.

Equity Indexed Universal Life Insurance

  • Cross between Variable Universal Life and Universal Life.

  • Guaranteed minimum returns on the cash values and protections for the policy owner during market downturns.

  • Caps on the gains. This can reduce the amount the cash value can increase during times when the stock market is rising.

  • The policy owner and the insurance company both assume some investment risk.

Many Indexed policies have high fees.

Single Premium Permanent Coverage

  • Requires one large premium that covers the cost of the insurance every year until the insured dies.

  • Can be issued without a lot of medical information.

  • Can be issued as Traditional Whole Life or Universal Life.

  • The growth in the cash value is not tax deferred.

Other Types of Life Insurance

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Besides term and whole policies, there are a few special scenario life insurance policies that may fit your needs a bit better.

Accidental Death Insurance

Accidental death insurance only pays a death benefit if death is the result of an accident. It is NOT life insurance. It does NOT include:

  • Deaths resulting from high-risk activities (like driving a race car, sky diving, or deep sea scuba diving).

  • Suicide

  • Deaths from illnesses

Accidental death insurance shouldn't be your only coverage. Your family's financial security is not well protected since it doesn't cover death from any cause. Term insurance is a more comprehensive option.

Coverage may double if death happens while using public transportation, such as a plane, train, or bus.

Joint Life Policies

These policies insure the life of more than one person. There are two types of joint life policies. One pays when the first of the two people dies. The other pays when the second person dies.

A joint life insurance can be more expensive than a single policy. But it is less expensive than purchasing two separate policies, because only one death benefit is paid.

  • First-to-Die Joint Life.
    This is great for couples who both want to provide for the other if something happens. When the first one dies, the death benefit is paid to the beneficiary. Some first-to-die policies have a convertible provision that allows the surviving spouse to purchase a single life policy without going through the underwriting process.

  • Second-to-Die Joint Life (Survivorship)
    A Second-to-Die Joint Life policy pays the death benefit when the second insured dies. Nothing is paid when the first insured dies.

    Second-to-die policies are good to leave an inheritance to your children. Also, they're good if your children need to pay estate taxes. The downside is that since nothing is paid to the surviving spouse, there is nothing to replace income. And it could be a burden for the surviving spouse to keep up with the premiums.

    They are also useful because they can be issued when one of the insureds is not healthy enough to qualify for a policy alone.

Single Premium and Long-Term Care Combination

This hybrid policy combines long-term care with life insurance. This can cover the expenses if you ever need long-term care.

Long-term care in a nursing home, assisted living facility, or in your own home is very expensive. It can wipe out a lifetime of savings quickly.

Traditional long-term care policies are expensive. If the policy is never used, the premiums are an expense that provided no benefit other than piece of mind.

A better option is a single premium life insurance policy with long-term care benefits. The policy will pay either long-term care benefits or the death benefit. When long-term care benefits are used, the death benefit is reduced.

Final Expense Insurance

Final Expense life insurance (also called Burial Insurance) is a small whole life policy purchased to pay for funeral and burial expenses.

Funeral expenses can be very high—as much as $10,000 (or more). So this insurance is a way to pay for a funeral without burdening the family with a large expense. It's mostly targeted towards older people.

You don't need a medical exam to qualify. And most policies are for just $10,000-$20,000, so the premiums are much more affordable.

Ways to Qualify for Insurance

Underwriting is the process of reviewing the application and determining a rate. Underwriters review medical records, medical exams, family medical history, risky activities or travel, and other information that might affect how long someone will live.

If you're healthy, an underwritten policy will save you money because you will qualify for better rates.

Not all policies require underwriting. Here are some other types.

Guaranteed Issue Life Insurance

  • Requires no medical underwriting; can be issued without evaluating the insured's health.

  • Option for those with health conditions who don't qualify for underwritten life insurance.

  • Premiums are higher because of the lack of underwriting. However, if you're unhealthy, guaranteed issue policies may be less expensive than fully underwritten ones.

In most cases, the insurance company will not pay a death benefit for the first 2-3 years of the contract (unless the death is accidental). This is to protect the company from making a large payout for people who sign up for the policy right before dying.

Simplified Issue

  • Do not require a medical exam or blood tests but they are evaluated by an underwriter. The underwriter makes their decision using less information.

  • Recommended if you don't know if you have health issues. If you apply for a fully underwritten policy and learn you have a health issue, it can be too late to buy a simplified issue life insurance policy.

  • Premiums are higher than those for fully underwritten policies when the insured is healthy.

Fully Underwritten

Fully underwritten policies are thoroughly evaluated by an underwriter.

Underwriters follow underwriting guidelines that help them determine how much information to collect and whether to request a medical examination or other tests. Larger policies and people with complex health histories must provide more information.

Accelerated Underwriting

Accelerated underwriting is a form of automated full underwriting that uses Big Data. This insures people much faster.

How Is the Cost Determined?

Two people of the same age can have very different rates. Here are some factors that determine the cost of the policy.

  • Type of Policy
    Term insurance is less expensive than whole life insurance because no cash value accumulates.

  • Smoker
    The rates for smokers are higher than for non-smokers.

  • Underwriting
    Fully underwritten policies will be less expensive if the insured is healthy. Simplified Issue policies are more expensive. Guaranteed issue policies have higher premiums because there is no medical underwriting.

  • Gender
    Life expectancy for men and women is not the same. Premiums reflect the life expectancy based on large numbers of similar people.

  • Age
    Premiums on older adults are higher because they are closer to death. Premiums on very young children are at higher rates than older children.

  • Health
    When a policy is underwritten, the underwriter makes an educated evaluation about the individual's life expectancy. If life expectancy is shorter than normal, the underwriter can either offer a higher premium or decline to issue the policy.

  • Lifestyle
    If your lifestyle involves risky activities (such as a history of DUIs, sky diving, criminal activities, deep sea scuba diving, or travel to risky countries), your policy can be rated for a higher premium.

BOTTOM LINE

There are many different types of life insurance. The best type for you depends on your budget, needs, what you want to cover, and for how long.

Generally, term insurance is best if you only need coverage for a specific length of time (for example, to replace income for your spouse only until retirement benefits kick in). Permanent insurance is usually for those who need lifelong coverage (for example, if you have estate taxes, a business, or special needs child).

Disclaimer: Opinions expressed here are author's alone. Please support CreditDonkey on our mission to help you make savvy decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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