There are two types of life insurance policies.
- Term Insurance
- Permanent Insurance
How do you decide which type to buy? That depends.
The answer depends on several things. For instance:
- Why do you need coverage?
- Are you on a tight budget?
- Do you want to rent or own your policy?
Those are some starting questions. You also have to find out what type of policy you can medically qualify for as well. If you have pre-existing health issues you may not have the same choices as someone who is healthy.
Unlike many years ago when there were only just a few types to choose from, today there are many different types of life insurance that are available in the market. In turn, this long list of available coverage can allow you to better “customize” your specific insurance protection needs.
Throughout the years, the industry has grown a great deal. With that growth has come the emergence of many different life insurance types.
Today, there are types of life insurance that are designed to fit a wide variety of needs. These range from “temporary” death benefit only plans to permanent coverage with an underlying tax-deferred savings or investment plan. Therefore, it is often used today as part of the overall financial planning process.
Term and Permanent Overview
In today’s market, there are many different life insurance types available to you. But overall, there are two key categories of coverage. These are
These two types of life insurance are term and permanent.
With term insurance, only a death benefit is paid out to a named beneficiary upon the insured’s death. Because term coverage is considered to be “plain vanilla” coverage, term insurance can typically be purchased fairly inexpensively. This is especially true for those who are young and in good health at the time that they apply for the policy.
Permanent types of life insurance policies offer death benefit coverage, along with a cash value or investment component. There are several sub-classes of permanent life insurance, including:
The premiums that are charged on permanent policies are typically higher than those of term life coverage. At least initially. However, this is primarily due to the fact that a portion of each permanent insurance premium is going towards the cash or investment component of the insurance policy.
The money that is inside of a permanent life insurance policy’s cash value component is allowed to grow on a tax-deferred basis. This means that there is no tax due on the gain of these funds unless or until the money is withdrawn with this type of policy. And this can allow the cash value to essentially grow and compound exponentially over time.
Understanding is Important
It is important to have a good understanding of the many different life insurance policy types that are available. One reason for this is because, even though you may already be covered by insurance, you also need to ensure that your policy will perform the way that you want or need it to. You also want to be sure that your coverage will continue to provide the proper amount of financial protection over time.
With that in mind, in addition to knowing how both term and permanent life insurance work, it is also essential to understand that within each of these categories, there is a host of options.
Different Types of Term Life Insurance
Term life insurance is considered to be the most “basic” life insurance types that are available in the market today. One of the main reasons for this is because it offers only pure death coverage, without any type of cash value or savings component.
This type of life insurance policy will have a specific coverage time period. In other words, these plans are typically purchased for a set amount of time such as 10 years, 15 years, 20 years, or even for 30 years. If the insured on the policy passes away during the time that the policy is in force, the insurance company will pay out the stated amount of death benefit on the policy to the named beneficiary.
But, even though term insurance may be a more basic type of insurance when compared to permanent policies, there are still many different types of term life insurance that you can choose from. These types include the following:
Level term life policies have a death benefit that remains the same throughout the policy. Typically, the amount of premium paid on a level term plan will also stay the same during the “term” of coverage.
With annual renewable term life, the policy can be renewed by the insured after each time period – or term – has elapsed. The policyholder can oftentimes do this without the need to complete a new application for coverage or even having to pass a physical exam. In this case, while the insured is allowed to renew the insurance policy, the amount of the premium on the new term life insurance policy will likely increase. In some cases, by quite a bit. This is because of the insured’s older age at that time, as well as any possible adverse health issues.
A convertible policy will give the insured the option to “convert” his or her term life insurance policy to a permanent type of coverage in the future. Provided that the premium payments have been made and that all of the other conditions of the initial policy have been met, the insured will not typically be required to undergo any new or additional health screening at the time the policy is converted. This may be the case, even if they now have an adverse medical condition.
Increasing term life insurance is a policy that maintains the same premium throughout the plan, but that has an increasing amount of coverage. This type of benefit can oftentimes be purchased as a cost of living rider to a whole life policy.
Decreasing term offers a death benefit that decreases each year (even though the premium will typically stay the same throughout the life of the policy). This type of term life insurance policy will end when the death benefit reaches zero. You might want to consider going with a decreasing term life policy in order to cover an unpaid mortgage balance over time. In this case, as the amount of the mortgage balance decreases over time, so too does the amount of death benefit on the decreasing term life insurance policy.
Different Types of Permanent Life Insurance
Just like with term life insurance, there are many types of permanent life insurance, too. These can include
- Whole life
- Universal life
- Indexed universal life
- Variable life
Whole Life Insurance – Whole life is a type of permanent life insurance that is intended to stay in force throughout the “whole” life of the insured, or until the policy pays out the proceeds at the insured’s death. It is the most simple form of insurance.
One of the biggest reasons that whole life policies can be so attractive for policyholders is that the premium stays the same throughout the entire life of the policy. This is true, regardless of the insured’s increasing age, and whether he or she contracts certain health issues over time. Whole life insurance policy premiums may initially be higher in comparison to a term policy with the same face amount (with all other criteria being the same). But, as the insured ages, in this type of life insurance policy, the premiums will not increase. This can be particularly beneficial for those who are on a fixed budget, or those who want to plan out their life insurance costs over a long period of time.
Universal Life Insurance – Universal life is another type of permanent life insurance policy. It also offers both a death benefit and a cash value component. However, it is considered to be more “flexible” than a whole life insurance policy. This is because the policyholder can – within certain guidelines – change the timing of when their premium is due, as well as the amount of money that goes towards the policy’s cash component and its death benefit component.
Indexed Universal Life Insurance – Indexed universal life insurance is similar to regular universal life insurance. But, with these policies, the return on the cash value will be determined by the performance of an underlying market index (or, in some cases, more than one market index), such as the S&P 500.
One of the primary advantages of owning an indexed universal life insurance policy is the fact that it allows for a higher return than a whole life or a regular universal life insurance policy. At least, up to a stated cap. Yet the cash value principal is protected if the underlying index suffers a negative return during any given time period.
Variable Life Insurance – Variable life insurance offers a component with permanent death benefit proceeds to the insured’s beneficiary upon death. If you have a variable life insurance policy, however, the death benefit may increase or decrease. (Although it will not go below the guaranteed minimum amount. This is typically the original amount of death benefit that was purchased).
However, in addition to this permanent protection, variable life policies also feature an investment component. In fact, these policies are referred to as “variable” because, when premiums are paid into the plan, the portion that is allocated to the investment account will be subject to the fluctuations of the market. These types of permanent insurance policies are usually geared towards those who have higher risk tolerance. This is because the cash value component can tend to move up and down over time. There is also the possibility that the cash value component may lose money in a down market.
Even within each of the permanent life insurance categories, there can be numerous options for coverage. For example, there are several different types of whole life insurance. These include the following:
Participating (Par) – Participating whole life policies are oftentimes offered by mutual life insurance companies. These companies may offer a dividend to their policyholders. And, even though dividends are not guaranteed, there are some insurance companies that have paid out dividends for over 100 years consistently. There are several ways that you can receive a dividend. These include taking it in cash (by receiving a check from the insurance company), using it to purchase additional amounts of insurance coverage on your policy, and/or by adding the amount of the dividend to the policy’s cash value component. Because dividends are considered to be a return of premium, they are not taxed to the policyholders who receive them.
Non-Participating (Non-Par) – Non-participating policies do not pay out dividends to the policyholder. With non-participating insurance coverage, the insurance company assumes all risk of future performance. This means that if the cost of future claims has been underestimated by the insurer’s actuaries, the insurance company will need to make up the difference. If, however, the cost of the insurer’s future claims has been overestimated, then the insurance company may keep this difference.
In addition to being categorized as par or non-par, oftentimes, whole life policies can also be categorized by their method of premium payment. Various life payment methods can include:
Straight / Level Whole Life – Most whole life insurance policies are considered to be straight life plans. This means that the premium payments for the coverage will continue to be due throughout the life of the policy.
Limited Pay Whole Life – A limited pay plan allows the policyholder to pay for the entire policy over a set period of time. For instance, with a 7-pay plan, the premiums would no longer be due – and the policy would be completely paid – up after just seven years. This type of whole life insurance policy can provide a solution for long-term coverage, yet without an ongoing premium payment in the future.
Single-Premium Whole Life – A single premium policy will be paid up after paying just one single lump-sum premium payment. Due to the large amount of money that is initially deposited, this type of whole life insurance policy will typically start out with a substantial amount of cash value. In addition, because the premium is all being paid upfront, single premium policies generally are purchased at a large discount as compared to the total premium amount of a straight life policy over a number of years.
Modified Whole Life – A modified policy requires that the premiums are paid through the life of the policy. However, with this type of life insurance coverage, there is an initial premium discount in the early policy years, as well as only one premium increase in the future. Modified life policies may be a good option if you want permanent life insurance coverage, but may have a difficult time paying the initial amount of premium that is due.
Graded Premium Whole Life – A graded premium policy will also offer premiums that are discounted in the early policy years. But, instead of having only one premium increase down the road, these policies will oftentimes have several. Therefore, the premium can – and often does – grade upward over time. Eventually, the premiums that are charged on a graded premium life policy may level out at a higher amount than the premiums that are paid with a straight life type of policy.
Indexed Premium Whole Life – With an indexed policy, the policy’s face amount will increase based on increases in an underlying index such as the Consumer Price Index (CPI). Here, the policyholder can choose whether or not to accept the increase when it is offered. (If the higher amount of coverage is chosen, the increase in life insurance protection can also typically cause an increase in the premium that is due going forward). Insurers will usually place a cap on the total increase in coverage that is permitted.
What Type of Life Insurance Do You Need?
Just as you would do when purchasing an important product or service, it is essential that you have a good understanding of what type of life insurance you need. You should also know approximately how much protection will suit your particular needs the best.
Likewise, it is also important that you ultimately choose what’s best for you. For instance, if you just simply need death benefit protection, then a term policy could be the best type for you. However, if you are also seeking cash value or savings build-up, then a permanent insurance policy may be the best type for you. You can also see our term vs whole life insurance article here.
When you are determining what type of life insurance you need, there can be several different criteria to consider. These include the amount of protection that you require in order to secure financial peace of mind for your loved ones. See our do I need life insurance article here to learn more about this.
Because there is no one-size-fits-all solution when it comes to purchasing coverage, it is best to discuss your situation with an independent broker or agent. Independent insurance professionals will have access to multiple types of life insurance policies, as well as numerous carriers. So, you will be able to narrow down your particular coverage needs and then immediately compare your policy options, as well as premium quotes.
When it comes to finding the protection that you need, we can help. We work with more than 40 of the top carriers in the industry today. So, when you’re ready to take the next step, contact us and we’ll walk you through the process.