If you’re going to consider purchasing life insurance, you need to understand the different types of life insurance, how they work, how much they cost and which type might be right for you. The four basic types are term, whole, universal and variable.
Term life insurance provides a death benefit for a fixed number of years – usually, 5, 10, 15, 20, 25 or 30 – that you choose when you buy the policy. You pay premiums for each year of the term. If you purchase level-premium insurance, which is common, you’ll pay the same rate each year. When the term is up, you stop paying premiums and you no longer have coverage. If you die at any point during the term, your beneficiaries receive a death benefit. If you die after the terms ends, your beneficiaries get nothing.
Term life insurance is generally the least expensive type of life insurance for the amount of coverage you get and it is the easiest type of life insurance to understand. For these reasons, it is also the best type of life insurance for most people. (To learn more, read What is term insurance?)
A variation on basic term life insurance called convertible term insurance can be turned into a permanent whole or universal life insurance policy at any point during your policy term without having to requalify medically. Your policy might specify that you can only convert the policy up to a certain age, such as age 70.
Whole life insurance provides a death benefit no matter how old you are, as long as you continue to pay the policy’s premiums. For this reason, it’s considered a type of permanent life insurance. (See Buying Life Insurance: Term Vs. Permanent.)
In addition to providing a death benefit, a whole life insurance policy also accumulates cash value that is guaranteed to grow by a certain amount each year. As a result, whole life premiums are significantly higher than term life premiums for the same death benefit. Part of your premiums for the first few years of the policy will go toward administrative fees and the agent’s commission. The premiums are the same each year, and you can choose to pay premiums every year for as long as the policy is in effect or for a set number of years. Spreading your total premiums out over just 10, 15 or 20 years instead of over a lifetime will result in a higher annual premium during those years, but may be an appealing feature for someone who wants to eliminate the ongoing expense of life insurance premiums before retirement. A variation called single-premium whole life insurance lets you pay the entire premium up front in a lump sum. (For more, see Whole Life Insurance: What You Need to Know.)
You can borrow against the policy’s cash value for any reason, such as paying for your children’s college tuition or covering an emergency expense. Whatever part of the loan you haven’t repaid at your death gets subtracted from the policy’s death benefit. But any accumulated cash value that exists at your death does not get added to the policy’s death benefit; it goes back to the insurance company. (Read 6 Ways To Capture The Cash Value In Life Insurance to learn how to put this money to better use.)
The other reason whole life insurance costs more than term life insurance is that whole life insurance policies often pay annual dividends. These dividends can be used to help pay premiums or to purchase more insurance, or the insurance company can simply send you a check for the dividend amount.
Because whole life is difficult to understand and expensive for the amount of coverage it provides, it is not the best option for most people. That’s why you’ll often hear the phrase, “Buy term and invest the difference.” Investing the money you save by purchasing term instead of whole life insurance rather than putting it into a cash value and paying an agent’s commissions will be a better use of that money for most people. That being said, whole life is simpler than universal or variable life insurance. (Learn about a particular type of whole life insurance in Burial Insurance Vs. Life Insurance.)
Universal life insurance is another type of permanent life insurance. It is similar to whole life in many ways, but offers greater flexibility. You can increase or decrease the death benefit and the cash value after you take the policy out if your needs change. The premiums will go up or down accordingly. Increasing the death benefit requires you to pass medical underwriting; decreasing the death benefit may result in surrender charges. The cash value earns interest based on the performance of investments chosen by the insurance company. This type of insurance also offers flexibility in the timing of premium payments. (See Permanent Life Policies: Whole Vs. Universal.)
Universal life is even more complicated than whole life and can also be more expensive. Also, these policies can become underfunded over time because the interest the cash value earns isn’t always enough to cover its sometimes rapidly increasing premiums. If a policy becomes underfunded, you have to pay extra to keep it in force. Otherwise, the policy will lapse. Universal life insurance also has expensive administrative and management fees that come out of your premiums. Because of its complexity and cost, universal life is not recommended for most consumers. However, as with other types of permanent life insurance, the ability to borrow against the policy’s cash value at low interest rates and without a credit check is an attractive feature for some consumers. (For related reading, and Is Life Insurance a Smart Investment?)
Guaranteed Universal Life (source: https://www.jrcinsurancegroup.com/what-is-guaranteed-universal-life-insurance/ and http://www.pivot.com/Learning-Center/Pivot-Blog/Post/2106/What-are-the-Pros-and-Cons-of-Guaranteed-Universal-Life-Insurance and http://www.lifehealthpro.com/2011/01/12/the-growing-popularity-of-guaranteed-universal-lif and https://www.nationwide.com/yourlife-no-lapse-guarantee-ul.jsp)
Guaranteed universal life insurance offers coverage until age 90, 95 or even until your death but is less expensive than whole life insurance or universal life insurance. It doesn’t have a cash value or investment component, or the accompanying management fees, and the premiums can be paid as level premiums for a lifetime or for a shorter term, similar to whole life insurance. Unlike regular universal life insurance, the policy is not at risk of becoming underfunded and requiring additional premiums to remain in force. This type of policy can be appealing to seniors who still need coverage; it can be cheaper and provide better protection than term life insurance in that situation. The policy has a guaranteed death benefit in amount you select when you take out the policy. Some guaranteed universal life policies are at risk of lapsing if the policyholder misses a premium payment; other policies are no-lapse policies and do not carry this risk. It is a relatively simple product can be a good alternative to term life insurance for individuals that want permanent coverage.
Variable life insurance is a type of permanent life insurance with a cash value component, which means that like whole life and universal life, it is significantly more expensive than term life. It has fixed premiums and a guaranteed minimum death benefit, but beyond that, the death benefit can change and the rate of return on the cash value, which varies based on the investments the policyholder chooses within the life insurance account (called subaccounts). Part of your premium goes toward the policy’s cash value/investment component, and the cash value changes with the value of the investments you select, such as stocks, bonds and mutual funds. If the investments increase enough in value, the policyholder can use the increase in value to buy more coverage or pay policy premiums. The policyholder can also borrow against the policy’s cash value. If the investments decrease in value, the policy’s cash value declines, reducing borrowing ability and requiring you to pay premiums out of pocket. Any policy loans outstanding at death reduce the death benefit. Variable life insurance is regulated by the Securities and Exchange Commission because of its investment component. Variable life insurance is complicated and is not the right choice for individuals who are simply concerned with providing a death benefit for loved ones. (For more on this, read Variable Vs. Variable Universal Life Insurance and Vary Your Options With Variable Insurance.)
Variable Universal Life
Variable universal life insurance makes up a small percentage of all life insurance policies sold. It is a combination of variable life insurance and universal life insurance. As with variable life insurance, it lets policyholders invest their cash value and easily change the amount of insurance coverage they carry. These policies, like variable life insurance, are regulated by the SEC because of their investment component. As with universal life insurance, you can adjust a variable universal life policy’s premiums or use some of the policy’s cash value to pay premiums or take out a loan. Most of your premiums go toward the investment component, though a percentage goes to management and administration fees.
Variable universal life insurance has a variable death benefit based on how the policy’s investments perform and may also have a guaranteed minimum death benefit. You can increase the policy’s death benefit if you are still in good enough health, and you can also decrease the policy’s death benefit, though you may pay surrender charges to do so.
The policy’s investment performance also affects its cash value. If your cash value declines to the point where it doesn’t cover the policy’s expenses and the cost of pure insurance, you will have to pay additional premiums, decrease the policy amount or allow your policy to lapse. You can borrow against a variable universal life policy’s cash value, but any outstanding loans reduce the policy’s death benefit.
Variable universal life insurance can be difficult to understand and is only appropriate for sophisticated individuals with a thorough understanding of insurance and investments. This type of policy, as well as regular variable life insurance, may be appealing to wealthy individuals who have maxed out their contributions to tax-advantaged retirement accounts and want another vehicle for tax-advantaged investing. Variable universal life insurance is not the best option for consumers who are purely concerned with providing a death benefit for their beneficiaries. (Read more in Variable Vs. Variable Universal Life Insurance and Should You Buy Variable Universal Life Insurance?)
Life Insurance After Retirement
You may not need life insurance once you reach retirement age, assuming that your children, if any, have moved out and are supporting themselves and you have enough of a nest egg that your spouse could live off of that and would not need a life insurance payout to pay his or her living expenses after your death. Also, life insurance for seniors, especially when taken out late in life, can be quite expensive since seniors’ chances of dying and the insurance company having to pay a death benefit are much higher than they are for younger policyholders.
However, there are some circumstances where it can make sense to continue to carry life insurance past retirement:
-you don’t have a sufficient nest egg to provide for a surviving spouse
-you have disabled adult children or relatives who are relying on you for lifelong care
-you need a way to reimburse adult children who will provide for your care from their own savings and/or by taking time out of work
-you are wealthy and need a tax-advantaged savings and investment vehicle because you have maxed out your retirement savings in other tax-advantaged accounts
-you can comfortably afford the premiums and want to provide a benefit for relatives or a favorite charity when you die
-your estate is large enough to be subject to estate taxes when you die and you want to use life insurance to help you reduce your liability or to prevent assets from being sold to pay those taxes
(For further reading, see Strategies to Use Life Insurance for Retirement.)
In the next section, you’ll learn about designating a beneficiary for your life insurance policy, different ways the policy’s death benefit can be distributed and more.
Intro To Insurance: Life Insurance Considerations
RetirementUnderstand the various types of life insurance, how each can be used in personal or business financial planning, and for whom they are best-suited.
Financial AdvisorFind out how Americans in their 20s can benefit from a well-thought-out life insurance policy, especially if they are able to build cash value for retirement.
Financial AdvisorLife insurance was initially designed to protect the income of families, particularly young families in the wealth accumulation phase, in the event of the head of household's death.
InsuranceLife insurance can be a difficult decision to make, especially for a young adult. Here's a look at the benefits and costs of getting whole life insurance.
InsuranceWould your death leave loved ones financially stranded? Find out how to ease your mind and keep them protected.
InsuranceFind out the reasons why term life insurance may not be for everybody, and why you may want to avoid it in favor of a permanent life insurance policy.
InsuranceDifferent stages of life call for different amounts of life insurance coverage. Find out what you need, when and why.
InsuranceLife insurance needs will likely change over the client’s lifetime and again financial advisers can provide an objective sounding board.