Types of Life Insurance
Making loved ones the beneficiaries of a life insurance policy can provide great peace of mind by paying off debts, covering funeral expenses, and providing tax-free funds to pay for college or a home mortgage.
There are numerous types of life insurance policies available, and it is critical to understand all of your options in order to make an informed decision and obtain the right amount of coverage at the right price.
Different types of life insurance
There are two primary types of life insurance, 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 to beneficiaries in exchange for a consistent, recurring premium paid by the policyholder over the life of the policy. Whole life insurance invests the policyholder's money while they are still paying premiums. This investment functions as a savings account from which the policyholder can withdraw or borrow funds to cover a variety of expenses.
Whole life insurance premiums are generally much higher than those for other types of life insurance policies, but they do come with a few advantages. For one thing, the premium level is constant. Another advantage is that the policy is never going to expire. It remains active as long as the premiums are paid and will pay out the death benefit to the policyholder's beneficiaries when the policyholder dies.
Whole life insurance is classified into two types:
- Traditional whole life insurance
- Variable whole life insurance
Traditional whole life insurance
Traditional whole life insurance has a fixed premium and death benefit. Providers accomplish this by setting the premium level at a level that is initially excessive in relation to the benefits required by the policyholder. As the policyholder ages, the cost per $1,000 of benefits rises and eventually equalizes. Meanwhile, insurance companies invest a policyholder's premium payments and use the earnings to cover the costs of life insurance for older policyholders.
Variable whole life insurance
A variable whole life insurance policy combines a death benefit with a savings account, allowing users to invest in various money markets to increase the value of their policy. It is a riskier option because policyholders effectively tether the value of their death benefits to the performance of the market in which their money is invested.
Term life insurance
Term life insurance is a much more affordable type of life insurance policy because it operates for a set period of time, only pays out the death benefit, and does not maintain consistent premiums throughout the policy's life.
Despite the low premiums associated with term life insurance, there are a couple of significant drawbacks. For one thing, term life policies lack a savings component, which allows policyholders to add value to their policy over the course of their premium payments to cover unexpected expenses before death.
Another disadvantage of term life insurance is that it only covers the policyholder's beneficiaries for a limited time. If a policyholder purchases a 10-year term policy but dies 11 years later, his loved ones receive no death benefit. If a policyholder outlives the term of their policy, they can renew it for another term, convert the policy to a permanent one, such as whole life insurance, or let the policy expire. Typically, the conversion privilege is only available for the first five years.
The three primary types of life insurance for a term policy are:
- Level term policies
- Yearly renewable term policies
- Return of premium policies
Level term policies
A level term policy protects the policyholder for a set period of time while keeping the death benefit and premium constant. Because it becomes more expensive to cover a policyholder as they age, level term policies charge higher premiums at first to cover future costs.
Yearly renewable term policies
Yearly renewable term policies have no specified term limit and can be renewed year after year. This option causes premiums to be low at first but become 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 on the same terms as other term policies. Because many policyholders consider the vanishing death benefit component of traditional level term policies to be unfair, insurance companies have begun to offer a return of premium option, which refunds users' premium payments at the end of the policy. This option significantly increases premium payments over the life of the policy.
Other types of life insurance
While term and whole life insurance are the most comprehensive types of life insurance, other policies extend permanent insurance coverage. They are as follows:
- 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 flexibility by allowing policyholders to increase the death benefit and adjust premium payments on their policy if there is sufficient money in the account to cover costs. Though this is useful if a policyholder's financial circumstances change, the policy may lapse and their life insurance coverage may end if the money in the account is depleted.
Simplified issue life insurance
While many life insurance providers require policy applicants to undergo a medical exam in order for the insurer to properly assess their risk of death, a simplified issue policy allows applicants to avoid the exam. Instead, policyholders complete a health questionnaire and report any habits that may increase their risk of death. The disadvantage of this option is that the premiums are usually higher because there are no medical exams.
Guaranteed issue life insurance
A guaranteed issue life insurance policy allows users to apply for coverage without having to take a medical exam or fill out health questionnaires. This option is especially beneficial for elderly applicants whose health condition would make insurance prohibitively expensive, but it is less appealing to younger, healthier users.
The only requirement for these policies is that the policyholder demonstrate their ability to pay the monthly premiums.
Final expense insurance
Funerals, medical expenses, cremations, and other costs associated with the policyholder's death are all covered by a final expense policy. In most cases, this type of life insurance is only available to people of a certain age. It is especially beneficial for people who have outlived their term policies and have no other means of covering the cost of their death.
Life insurance for babies and toddlers
Infant and child life insurance is available, but unlike traditional whole life and term policies for adults, the death benefit is usually not the primary focus. A guaranteed insurability option, for example, may be useful if a child becomes uninsurable in the future due to disease or illness.
Life insurance for seniors
The low death benefit of less than $20,000 on this policy is intended to cover funeral or burial expenses for people aged 50 to 80. Although the benefit may be limited in the first two years, the policyholder may not be required to participate in medical exams or answer health questions.
Choosing the right type of life insurance policy
The various types of life insurance available can be confusing. The first critical step in shopping for a policy is determining the ultimate goal. Another important question to consider is how long the insurance will be required. If the policy is only needed for a short period of time, term life insurance is most likely the most cost-effective option. Consider whole life insurance or one of the other types of more specialized coverages available to those looking for a long-term financial planning tool.
Frequently asked questions
How much life insurance do you need?
It is critical to obtain the appropriate amount of life insurance to ensure that all financial needs are met. StrongInsurance life insurance calculator can help you figure out how much life insurance you need. It is also a good idea to shop around and compare providers before making a final decision with a licensed insurance expert.
What’s the difference between whole life insurance and term?
There are several differences between term and whole life insurance. Term life insurance is only temporary, but it can be converted into permanent life insurance. Whole life insurance is indefinite.
Is there life insurance for babies?
Some insurance companies sell baby and toddler life insurance, which can be beneficial if a child has a life-threatening illness or to provide future coverage for the child.