What Are The Different Types of Life Insurance?

As you get older, you may begin to worry about how your family would carry on financially if something were to happen to you. They will have to pay for everyday expenses without your income and all of the costs associated with your passing, which can be expensive. According to the National Funeral Directors Association, the average cost of a funeral in 2012 was $7,045.

Furthermore, the Federal Trade Commission (FTC) says family members may be responsible for your debt under certain circumstance, such as if they co-signed for an obligation or if you live in a community property state such as California. Other situations include when state laws require a spouse to pay certain kinds of debts such as health care, and if a person is responsible for resolving your estate and doesn’t comply with the state probate laws.

This is where life insurance comes in, as it can protect your loved ones if something does happen to you. However, there are as many types of life insurance nowadays as there are brands of bread at the grocery store. It’s easy to get confused with all of the different offerings, so here is a quick guide to the main types you should know.

Term life insurance

Term life insurance is a policy that lasts for a specific period. Generally, the terms range from five to 30 years, in increments of five. With this type of insurance, you pay premiums for each year of the term. If you die at any time during the term, your beneficiary will receive the death benefit. When the term ends, the coverage also ends. Insurance provider MetLife says this is usually the most affordable life insurance option.

Pros

  • Good value for the cost
  • Simple structure makes it easy to understand
  • Only buy as much as you need (for example, if you only want coverage while paying off your mortgage)

Cons

  • No savings component
  • No interest earned
  • You could live past your policy end date
  • Extending coverage can be problematic (i.e. expensive, difficulty in proving insurability)

There are a few types of term insurance from which you can choose.

Level premium insurance

This is a sub-type of term insurance in which the death benefits and premiums remain the same throughout the entire term. This is good for people who want a predictable payment.

Annual renewable term insurance

With this type of term insurance, the death benefits remain the same, but the contract renews each year, which results in a change to the premium payment amount. The policy typically starts with a premium that is lower than the level premium insurance but becomes more expensive over the length of the term.

Decreasing term insurance

With this option, your premium remains the same, but the death benefit decreases each year of the term. By the end, it will reach zero.

Convertible term insurance

This variation helps to resolve the difficulties with extending coverage when a term life insurance policy ends. It does so by allowing plan participants to convert a term insurance plan into another type, such as universal life insurance, without needing to re-qualify medically.

Whole life insurance

Whole life insurance is considered a permanent type of policy. This plan will provide you with coverage for the rest of your life as long as you pay the premiums. As for the premium payments, they will remain fixed each year.

It also has a “cash value” investment component. This means that part of your yearly premium goes toward a growing amount of money called your “cash value.” You earn interest on the amount of cash value that accumulates and are guaranteed a set amount of growth each year.

You can also borrow against your cash value at any time, for any purpose. However, any outstanding loan amount at the time of your death will be subtracted from the death benefit your beneficiary receives. When your plan ends because of death or cancellation, the insurance company retains the accumulated cash value.

Pros

  • Offers coverage for life
  • You earn dividends on your cash value
  • Guaranteed premium payment, death benefit and dividend amounts
  • You can borrow against your cash value without a credit check

Cons

  • Expensive compared to term life insurance
  • Complicated so can be difficult to understand
  • Cash value grows slowly initially because payments go toward agent commissions and the costs of insurance

Universal life insurance

Universal life insurance is another permanent insurance type that is very similar to whole life insurance but with a few more options. Again, you have a plan that can cover you for the rest of your life and you will also have the “cash value” investment component. The difference is that you can adjust your premium, cash value investment or death benefit if you want. However, requesting these changes will have stipulations in many cases, such as passing medical underwriting or paying surrender fees. Insurance provider USAA recommends this policy for people who want permanent insurance that fits into a complex financial plan.

Pros

  • Offers coverage for life
  • You can borrow against your cash value without a credit check
  • Allows you to make adjustments to your premium, cash value investment and death benefits

Cons

  • Your insurance company invests funds and pays dividends; rates earned may not be the best possible rates
  • Premiums can be more expensive than term and whole life insurance
  • This type of plan is complex and can be difficult to understand
  • Administrative fees and management fees are expensive and come out of premiums

There are a few common variations on universal life insurance.

Guaranteed universal life insurance

This is a type of universal life insurance that offers fixed premium payments that can be paid to keep coverage for the rest of your life or for a shorter period. It also offers a guaranteed death benefit. Unlike regular universal life insurance policies, it does not have a cash value investment component. This results in a less expensive premium cost. It can be a good option for people who want permanent coverage that is affordable and who don’t want the investment component.

Indexed universal life insurance (IUL)

Another form of universal life insurance is the IUL. With this policy, the same rules apply as the regular universal life insurance, except the cash value component is linked to a stock market index. Policies will typically outline a participation rate that determines how large of a return you get, as well as a cap that is the maximum you can earn regardless of market fluctuations. An upside is that when the market goes down, you won’t lose money, as the lowest you can get is a 0% return.

Variable universal life insurance

With this sub-type of universal life insurance, you can decide where to invest your cash value. It also maintains the options offered with regular universal life insurance, so you can adjust premiums and other aspects of your policy. This plan is recommended for individuals with advanced knowledge of insurance and investments.

Variable life insurance

The last main type of insurance is variable life insurance, which offers both a death benefit and cash value investment component. You also get a guaranteed death benefit and fixed premium payments. Where this policy varies is that you get more investment options and the death benefit can fluctuate based on your returns from the cash value. There will be sub-accounts you can choose to invest in, including mutual funds and stocks.

Pros

  • Potential to earn higher returns on your cash value
  • You can get coverage for life
  • Premium payments are fixed
  • You can borrow against the cash value
  • Your death benefit can’t go below the guaranteed minimum but can increase

Cons

  • More expensive than term life insurance
  • Complicated and requires policyholder to play an active role

Find the right policy for your needs

As you can see,  the options for life insurance vary greatly. If you are looking for a policy that is affordable and simply offers a death benefit for your beneficiary, term and guaranteed universal life insurance are the best options. However, if you are interested in the cash value investment component, there are many types, from whole life insurance policies (best for beginners) to universal and variable life insurance policies (for the more advanced investors).

Ready to shop around and compare insurance plans? Head over to our life insurance reviews page. We list a wide range of insurance companies, including industry leaders such as USAA, MetLife and Aflac, making it easy to find the right policy for your needs in just a few clicks.

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