If you’re in the market for an insurance policy and are overwhelmed with all of the types of life insurance options available, don’t worry – you’re not alone.
According to Policy Genius, only 57% of American adults have life insurance. More troubling, one-third of those do not have adequate insurance. Being underinsured can be due to the amount of coverage you purchase (experts recommend 10 or more times your annual income), but also the type of policy you select.
In this post, we will walk you through each of the major types of life insurance and share important considerations for you to keep in mind when selecting a policy.
The easiest way to get started is to understand that there are two major kinds of life insurance policies. These are Term Life Insurance and Whole Life Insurance.
Term Life Insurance
Term Life Insurance lasts for a specific amount of time and expires at the end of the policy. Your designated beneficiary will receive a set amount of money known as the death benefit if you die before the policy expires. These policies are typically set up for 10, 20, or 30 years.
This type of program is the most straightforward and most affordable sort of life insurance. However, the downside is if you don't pass away within the time frame specified in your policy, it expires with no payout.
Whole Life Insurance (aka Permanent Life Insurance)
Whole Life Insurance does not expire and only ends at the end of the policy holder’s life or as long as the premiums are paid. These policies cost much more than a term life policy; premiums can cost anywhere from 4-10 times as much. It does provide unique benefits though that can make this an attractive option.
On top of the death benefit, premiums are invested which builds cash value over time. This cash value acts as a tax-deferred savings account that accrues interest at a fixed rate. The value pays out upon your death. It can also be withdrawn during your lifetime but will incur penalties and fines. This policy type is most useful for people who want to cover more than basic expenses after their death. This type of policy can help you leave money to your beneficiaries.
Apart from the principal categories, there are other classifications of permanent life insurance policies, which are continual, although there are some key differences worth noting.
Universal Life Insurance
A common type of life insurance sold in the United States, the Universal Life Insurance allows you to change the premium and death benefit amounts without having to setup a new policy. This allows you to maintain an insurance policy when or if your financial circumstances change. Similar to whole life insurance, these policies build cash value over time as excess premium payments are applied to the cash value of the policy.
Complexity is the primary drawback of these policies. Unlike a standard whole life policy, interest rates are not fixed. Premium payments could change due to increases or decreases in interest rates.
Variable Life Insurance
Variable Life Insurance policies (VLI) is another type of permanent life insurance with a cash value component. In this policy type, your premium is invested in quasi-mutual fund accounts that grow or fall based on market conditions. This means you could make much more money than with a standard policy, but you are also highly exposed to losing it during a market downturn. Additionally, the types of funds available to invest in are quite limited. You may not have the ability to invest in the best performing funds, and you need a basic stock market understanding to pick the best option.
An alternative policy type, Variable Universal Life Insurance, adds the ability to change premium and death benefit amounts over the life of the policy. It also provides a guaranteed cash value payout.
Simplified and Guaranteed Issue Insurance
Do you want a life insurance plan without undergoing a ton of paperwork, medical exams, background investigations, and health questions? If you prefer a no-questions-asked type of policy, a Simplified Issue or Guaranteed Issue Life insurance serves as the perfect choice for you.
Both of these policies enable elderly adults or adults in poor health to obtain life insurance. Simplified Life Insurance requires you to fill out a health questionnaire, but does not require a full medical exam. Guaranteed life insurance allows you to skip both the questionnaire and the exam.
The primary drawback of these plans is the cost. You will pay a much higher premium for a limited amount of coverage. One estimate cites a $200/month premium for $10,000 death benefit. A 2-3 waiting period is the other drawback. The full death benefit will not be paid out if you pass within this period.
Burial or Final Expense Insurance
A final expense policy is best for those who are only looking to cover expenses related directly to their death. Typically these policies will cover any final medical costs such as hospice, funeral arrangements, and cremation. These policies are most often used by older people who do not have another life insurance policy and don’t want to leave their families stuck with the expenses. Similar to Guaranteed Life Insurance, these policies can be quite expensive for a small benefit payout.