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Don’t let the confusing terms and overwhelming options of life insurance drive you to an early grave. Here, we review the different types of life insurance, including the pros and cons of each, to help you find the best policy type for you and your family’s needs.
If you’re young and reasonably healthy, you should seriously consider buying life insurance now rather than later. Why? Your regular premiums will be significantly less for optimal coverage.
If you’re older (in your 40s or 50s), it still makes sense to invest in life insurance if you had children later in life or you want to make sure your spouse is provided for once you’re gone.
Life insurance is more expensive to purchase once you get older compared to when you’re young, but if you’re worried about leaving your loved ones with a financial strain, it’s worth it. Find out how much life insurance you need based on income, debts and other factors.
There are two broad types of life insurance — term and permanent. Out of our major categories of life insurance, permanent insurance includes whole life, universal life and variable life.
Term life insurance, or temporary life insurance, is the cheapest and easiest way to buy life insurance, but there can be some drawbacks. First, term life only pays out if death occurs during the term of the policy (the upper limit is typically a 30-year policy).
Second, most term policies have no other benefit provisions. Term policies have no investment component (unlike permanent — or lifetime — policies).
There are two basic types of term life insurance policies:
- Level term: the death benefit stays the same throughout the entire policy.
- Decreasing term: the death benefit drops, typically in one-year increments, during the policy’s term. People rarely buy this type of term life insurance, so we’re focusing on level-term insurance in this article.
When you buy the policy, you choose the term length. Standard terms are 10, 20 or 30 years. With most policies, the payout (the death benefit) and the premium (out-of-pocket cost) stay the same throughout the term.
Tips When Shopping For Term Life
Choosing the best term life insurance takes a great deal of forethought:
- Select a term that coincides with the years you’ll be paying bills, a mortgage, college expenses, etc.
- Consider the timing: ideally, your family’s need for the payout would end just before the term expiration, i.e., your kids will be on their own, you’ll have paid off your house, and you’ll have enough savings to serve as a financial safety net for your spouse.
- Buy an amount your family would need if you were no longer there to provide for them. Think of the payout as a replacement for your income.
- Keep in mind: every dollar spent on term life insurance gets taxed first by the IRS, and there’s no savings component to term life (unlike permanent life insurance).
- Consider buying a policy that is convertible into permanent insurance. Most term policies will allow you to convert to either whole or universal life insurance within a certain time frame. This could become important if your life insurance needs or your health changes during the conversion period.
Term Life Insurance Pros
Term Life Insurance Cons
There are two substantial differences between term vs whole life insurance — the policy’s term length and tax-deferred savings aspect.
Whole life policies are a type of permanent life insurance that combines death benefit coverage for your entire life with an investment fund (called the “cash value” of the policy).
How does cash value benefit you? The cash value grows each year, tax-deferred, meaning you won’t pay taxes on its gains while they’re accumulating, and you can borrow against the cash value fund without being taxed. You can even surrender the policy for the cash. Some people choose to “cash in” their policies once they’ve reached retirement age and the insurance protection is no longer needed. In this case, the investment portion has worked as a tax deferred retirement savings account.
Whole life insurance is more expensive (per dollar of your death benefit) than term life, but it offers advantages in its lifelong duration and its cash value investment component.
There are, however, some downsides to whole life insurance. You’re fixed into a stated death benefit and cash value rate for life, so if you need to make adjustments to either depending on your changing financial needs during your lifetime, it’s pretty inflexible. This is where universal life insurance can come in handy (see our next category).
Whole Life Insurance Pros
Whole Life Insurance Cons
Universal life insurance is another type of permanent insurance that includes a death benefit and cash value component.
The most significant advantage of universal life insurance vs whole life is that it delivers the greatest flexibility for policyholders to adapt their policy to meet changing financial needs across time. You can change your premium payments and adjust the size of your death benefit or cash value (with some limitations).
The challenge of universal life insurance is that it requires you, as the policyholder, to assume a higher degree of risk and responsibility for maintaining your policy. It’s up to you to ensure that there is no lapse in coverage due to unpaid premiums and to make sure that you don’t exhaust your cash value.
Universal Life Insurance Pros
Universal Life Insurance Cons
Variable life insurance, like whole life and universal life, is a type of permanent coverage that includes a death benefit and investment aspect.
The most significant advantage of variable life insurance over whole and universal life is that it gives policyholders the ability to choose how to invest the cash value of their insurance policies.
The cash value component of a variable life policy is similar to a mutual fund, in that you can invest in stocks, bonds, or a variety of options depending on the insurance company that issues you your policy.
The most significant disadvantage to variable life insurance is that it presents greater risks (like any other investment). Performance can fluctuate depending on the markets. If the market doesn’t perform well, your cash value and death benefit may decrease. Although, some policies guarantee that the death benefit does not fall below a minimum level.
If you’re confident in your ability to manage the investment, however, variable life has the potential for bigger rewards than other types of life insurance.
Tips When Shopping For Variable Life
Investment choices can vary widely depending on the insurance company — some companies have a considerable number of options, while others only have a select few stock and bond funds to choose from.
Research your investment options carefully and review the company’s fund prospectus before committing to a variable life policy. A financially solid insurance company should provide enough options to satisfy the investment style of most policyholders. If not, you should probably look elsewhere.
Variable Life Insurance Pros
Variable Life Insurance Cons
What Is Variable-Universal Life Insurance?
As its name suggests, this type of life insurance combines the features of variable and universal life policies. You get the same investment risks and rewards you’ll find with variable life insurance, coupled with the flexibility to adjust your premiums and death benefit that are characteristic of universal life insurance.
What Is Survivorship Life Insurance?
Survivorship (or joint) life insurance is a type of variable life insurance policy that covers two individuals and pays a death benefit to a beneficiary. There are two types of survivorship policies:
- First-to-die: Pays out upon the death of the first person, regardless of who it is. The surviving spouse typically would be the beneficiary of the death benefit. The policy then would expire and doesn’t continue to cover the surviving spouse or partner.
- Second-to-die: Pays out after both people have died. People typically use this type of policy when heirs will need money to pay estate or inheritance taxes, so as not to have to sell off assets.
What Is Guaranteed Issue Life Insurance?
Guaranteed issue life insurance is the most expensive way to buy life insurance. Why? There are no medical exams, and very few underwriting questions asked, If the answers to these few questions meet the insurance company’s guidelines, you can’t be turned down. In many cases, however, you might find only low death benefit coverage amounts.
Also, if you die within the first few years of holding the policy, your beneficiaries may only receive a partial death benefit or a check for the premiums you paid. Review any guaranteed issue policy carefully before purchasing to see if this is the case with the particular insurance company you’re considering.
This type of life insurance is common for people who’ve been turned down elsewhere but want to cover final expenses, such as funeral costs.
Watch the brief video below to get some more tips on what you need to consider when choosing the right policy.
Experts recommend following these tips before purchasing life insurance1:
- Check with your state insurance department to make sure the company and agent are licensed in your state.
- Look for a company that is reputable and financially strong. You can get such information from your agent, on the Internet, or at public or business libraries. Rating agencies include A.M. Best Company, Fitch Ratings, Moody’s Investor Services Inc., Standard & Poor’s Insurance Ratings Services, and Weiss Ratings.
- Shop around. Life insurance is a very competitive business so quotes can vary significantly between companies.
- Ask for outlines of coverage so you can compare the features of several policies.
- When you buy a policy, make your check payable to the insurance company, not the agent. Be sure to get a receipt.
- Beware of offers for “free” life insurance. Investors may approach some seniors to offer them money to buy life insurance and then sell the policy to the investors. The investors expect to profit by receiving the death benefit when the senior dies. Often called stranger-originated life insurance, legislators and regulators are concerned about these transactions because they violate public policies against wagering on human life. Also, there may be hidden pitfalls, such as unexpected taxes, fees, and loss of privacy.
Here are some of the latest statistics on the U.S. life insurance industry in 20161:
- 75 million American families depend on life insurance products to protect their financial and retirement security.
- Americans purchased $2.9 trillion of new life insurance coverage in 2016, a .1% decrease from 2015.
- By the end of 2016, total life insurance coverage in the United States was $20.3 trillion, a decrease of 2% from 2015.
- The average size of new individual life policies purchased has decreased since its peak in 2008 to $153,000 in 2016.
- Of new individual life policies purchased in 2016, 40%, or 4.3 million, were term insurance and 60% were permanent insurance.
Are you in the throes of planning for your future and your family’s financial well-being? If you haven’t gotten on board with a retirement plan, now is the time. Be sure to read our informative guide on types of retirement plans.
We also have a comprehensive review of how to create a will online, including the best online sites to create a legally-binding will.
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If you have questions about what life insurance product might be right for you, please ask us in the comment section below. Our team includes a licensed life insurance agent that can answer any questions you might have.
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Sources:  American Council of Life Insurers