The different types of life insurance
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Life insurance is a type of insurance policy wherein the customer pays monthly premiums and, in return, can name beneficiaries who will gain a lump sum from the insurance company in the case of the insured’s death. This type of insurance can help to fill the financial gap if a family’s primary income earner dies, be used to cover funeral expenses, or even pay off debt. Life insurance payouts, known as a death benefit, are generally untaxed and usually without stipulations as to how they can be spent.
There are numerous kinds of life insurance, many of which will be discussed in this article. While each type has its specialization, they all share certain commonalities. All life insurance types are centered around premiums, beneficiaries and death benefits. This means that choosing the right type of life insurance is going to depend on your situation and what you want to get out of it.
Term life insurance
Term life insurance, as the name implies, is a life insurance policy that only covers a set number of years. If the insured person dies during the covered term, then their beneficiaries receive the insurance payout. If the term expires while the insured still lives, they are presented with the option of extending the term or converting their life insurance to another type. Premiums for term life insurance are determined by the size of the death benefit, as well as the insured’s age, health and gender.
Term life insurance is one of the more restrictive types of life insurance. Consequently, it is often one of the most affordable. Within term life insurance, there are two primary categories: level term policies and yearly renewable term policies. Level term policies have a fixed premium and payout for their duration. Yearly renewable term policies must be renewed yearly. They can see an increased premium from year to year as the insured individual ages.
Young parents are one of the demographics that can benefit from term life insurance. It is among the most affordable insurance plans for the young, and it can still pay out enough in the case of a death to keep a young family from financial ruin when a parent and income earner is lost.
Whole life insurance
Whole life insurance covers the entirety of someone’s life, instead of a selected number of years. This type of coverage classifies it as one of the types of ‘permanent’ life insurance. Whole life insurance policies have a savings component called ‘cash value’ that further separates them from term life insurance. This cash value is separate from the death benefit. It can even be partially withdrawn or borrowed against while the insured still lives. However, loans borrowed against the cash value and unpaid at the time of death will be paid off from the death benefit before it reaches the beneficiaries.
For those who have taken their 401ks, IRAs and Roth IRAs as far as they can, whole life insurance can be a useful investment tool. However, for most, it makes more financial sense to purchase a less expensive life insurance plan while investing in a 401k or other retirement plan.
Term vs whole life insurance
The main difference between these two types of policies is that Term life insurance covers the insured for a specified number of years while whole life insurance covers the insured for the duration of their life. Whole life insurance also differentiates itself from term life insurance by including a ‘cash value’ savings component that functions as an investment option. That is one of the reasons that premiums for whole life insurance tend to cost more.
Both types include a death benefit or payout that is issued in the case of the insured passing away while covered by the insurer. With a term life insurance plan, this means that the payout will only occur if the insured dies while the insurance term is still active. Term plans can be renewed and renegotiated after each specified term. With a whole life insurance plan, the insured will remain covered as long as their premiums are paid.
|Features||Term life insurance||Whole life insurance|
|Cash value savings/investment||No||Yes|
|Death benefits payout||Yes||Yes|
|Covered for life||No||Yes|
|Choose coverage duration||Yes||No|
Universal life insurance
Universal life insurance is a type of permanent life insurance, like whole life insurance, that has an incorporated investment option and lower premiums. Combining benefits from both term life insurance and whole life insurance, universal life insurance is something of a middle ground. Policyholders can often negotiate premiums and death benefits payout size when applying for their plan. Cash value that has accumulated and been left unused when the insured dies is retained by the insurer. However, the insured can withdraw from these funds while they are alive. Unlike whole life insurance, cash value with universal life insurance does not grow at a fixed interest rate, nor are premiums as fixed as they tend to be with universal life insurance.
Much like whole life insurance, universal life insurance policies are best for those who have maxed out other retirement plan options such as 401ks and Roth IRAs. If you are in this situation and you are more interested in low premiums than the cash value benefits, then universal life insurance may be a better choice than whole. However, for those who do not need permanent life insurance and who have not maxed out other retirement options, term life insurance is often a better choice.
Variable life insurance
Variable life insurance policies are a type of permanent life insurance that includes a cash value component. This cash value is invested in sub-accounts that function similarly to mutual funds. As a result, these investments fluctuate in tandem with the underlying markets. When the invested sub-account does well, the cash value of the life insurance policy will increase. But when the invested sub-account does poorly, the cash value of the policy will decrease. Because this investment system is part of these life insurance policy types, the cash value earned is not generally subject to income tax. Due to investment risks, these policies count as securities contracts.
Variable life insurance policies also include some degree of flexibility when it comes to premiums and death benefit amounts. These types of insurance plans have a more volatile payout, as it is affected by the fluctuations in the cash value sub-accounts. Variable life insurance plans are best for those who don’t mind the associated risks of investment. These policies present greater investment opportunities than whole or universal life insurance, but that increased opportunity comes with increased risk.
Variable universal life insurance
Variable universal life insurance combines elements from variable life insurance with features from universal life insurance. The result is a policy that functions like variable life insurance but with a higher degree of flexibility around investment and coverage choices. Within limits, policyholders can pick premium costs and death benefit payout amounts. Like with variable life insurance, the cash value component is invested into sub-accounts. The cash value accumulated on these policies is tax-deferred.
Variable universal life insurance policies are best for those who are looking to expand their investment opportunities beyond 401ks and Roth IRAs and are not averse to market risk. For those who have not pursued other retirement investments or who only need life insurance for a set period, another policy type would be best.
Variable vs variable universal life insurance
Variable life insurance and variable universal life insurance have several shared features but differ in a few ways. Both types of policies allow for investment through sub-accounts and include the associated market risk of such investments. Variable life insurance is often issued as term life insurance. In contrast, variable universal life insurance is inherently a type of permanent insurance. Variable universal also allows for a higher degree of policy customization, wherein the policyholder can request alterations to the size of premiums and death benefits.
|Feature||Variable life insurance||Variable universal life insurance|
|Death benefit guarantee||Some||More|
|Choice of investment||Yes||Yes|
|Cash value system||Yes||Yes|
Simplified issue life insurance
This type of policy has less stringent health information requirements. Instead of a full medical exam, the insured is only required to answer a few questions about their health and medical history. As a result of this streamlined process, the insurer has less information to calculate risk. So the average premiums for this type of policy tend to be on the steeper side. However, this is one of the quickest ways to gain life insurance, shortening a typical waiting period of months to weeks or less.
Simplified issue life insurance is best for those who want to avoid an insurance medical exam or who need life insurance as soon as possible. If time and medical exams are not a factor, then other policy types might serve you better.
Guaranteed issue life insurance
Guaranteed issue life insurance is a type of whole life insurance that requires fewer questions and no insurance medical exam. This type of policy tends towards smaller death benefits. It includes an initial waiting period of up to a few years. If the insured dies during this waiting period, there is no payout. However, the insurance company will return any premiums that have been paid, along with interest. Because this type of insurance is geared towards those with poorer health, the average premiums tend to be more expensive.
Guaranteed issue life insurance is best for those who have serious health issues. Such health complications can prevent people from being able to obtain other types of life insurance that would allow a payout within the first few years. If you are facing severe health problems and cannot get a policy that doesn’t have a waiting period, then guaranteed issue life insurance can be a good fit.
Group life insurance
Group life insurance is a policy type that uses one contract to cover multiple people within a specified group. Most commonly, this is seen as a component of employment benefits wherein the employer holds the policy contract that insures the employees. Because this situation is dependent on ongoing employment, these policies are often term contracts. As a result of group life insurance being a bulk arrangement, the cost tends to be notably lower than purchasing individual coverage.
Group life insurance is often an excellent option for anyone who has access to it. If your employer has a group life insurance option, using that can save you significant money on life insurance while still providing quality coverage.
Final expense insurance
This type of insurance is designed to provide for the financial costs of death and burial, and little else. Final expense insurance is more accessible than other types and often has lower premiums. Both benefits are a result of these contracts presenting the insurer with minimal risk, as the death benefits are very small, relative to other life insurance policies. Final expense insurance functions as permanent life insurance in that it covers the insured until death and not just for a set term of years.
Final expense insurance is best for those who only want their life insurance to cover their funeral costs and don’t have another life insurance policy and have not pre-paid their funeral expenses.
Other types of life insurance
- Mortgage life insurance goes into effect when a homeowner dies so that their family is not liable for any payments left on the mortgage. The policy pays the remaining balance of the mortgage to the lender, paying off the house.
- Credit life insurance is a policy designed to pay off any outstanding debt left behind when a policyholder dies.
- AD&D is a type of supplemental life insurance. Accidental death and dismemberment life insurance can be added to life insurance or health insurance policies, as it covers injuries as well as death.
- Joint life insurance is a policy type that covers two people and can either payout to the survivor when one dies or to specified beneficiaries after both have died.
- Life insurance policies vary in coverage length, premium cost, payout size and investment opportunities.
- Age and health can create barriers to many types of insurance.
- Life insurance is separated between permanent and term.
- Most life insurance payouts can be used at the beneficiary’s discretion, and not only for funeral expenses.
Life insurance policies are a big industry, and there are specialized versions of the product to accommodate a variety of situations. They range from term life insurance for young working families to final expense insurance for older individuals proactively covering their funeral expenses. The best life insurance policy for you will depend on your situation and what you want to get out of it. Before committing to any policy, make sure that you’ve read the fine print and understand what it does and does not provide.