Types of Life Insurance

Types of Life Insurance
Eileen St. Pierre, The Everyday Financial Planner

Life insurance puzzleThere are five basic types of life insurance polices. You need to make sure you choose the right type of policy to suit your needs. You’ll notice as we move down the list the types become increasing more complicated – the commissions paid to life insurance agents also rise accordingly.

Term Life

This insurance provides coverage for a specific time. It pays a benefit only if you die during the period covered by the policy. Keep in mind that the longer the term, the more expensive the premium. It’s a good idea to purchase a policy that is renewable without requiring a medical exam. Your premium will rise with age unless a level premium policy is purchased.

Term insurance provides the most protection for your dollar because it has no savings element, which increases the premium.

  • It is useful to parents of young children because of high future needs as well as people who need large amounts of coverage for a home mortgage and other debts.
  • It is also appropriate for those who need life insurance for just a short period of time (to cover college education expenses).
  • If you purchase a policy that is convertible, you can exchange it for a whole life policy without proof of insurability but you will pay a higher premium.

Whole Life

This insurance combines protection with a savings plan – this protection covers you for your entire life. The premium and death benefit stays the same for your entire life. The premium will be higher than that of a term policy – the difference goes into the savings plan. Many choose whole life because the need for life insurance does not end after a set period of time.

The insurance policy will state the guaranteed interest rate you will earn on this excess premium. As a result, the policy will build up a cash value.

  • The policy will allow you to borrow on the cash value. In other words, whole life can offer excess debt capacity in the case of emergencies.
  • The interest on the cash value is tax-deferred.
  • If you decide to cancel (also referred to as surrender) the policy, you will receive the cash value but it may be subject to income taxes.

Universal Life

Universal life is similar to whole life, except the premiums and the death benefit can be adjusted up or down by the policyholder. Interest on the savings plan (cash value) is at current market interest rates, with a guaranteed minimum interest rate.

Variable Life

This insurance is also similar to whole life except the policyholder (not the insurance company) controls the investments made in the savings plan. The growth of the cash value will depend on the performance of the investments chosen by the policyholder. If investments chosen by the policyholder were to fall in value, additional premiums may be required to keep the policy in force.

The cash value is placed in a separate account at the insurance company. Why is this important? If the company were to fail, the assets in this separate account would not be frozen. With whole and universal life, cash values are placed in the company’s general account and can be frozen (no surrenders, loans, or withdrawals of the cash value can then be made by the policyholder).

Variable Universal Life

Similar to variable life, but the premium and death benefit are no longer fixed. They can be adjusted up or down by the policyholder. The policyholder decides where to invest the policy’s cash value. Assets are placed in a separate account.

Personally, I think all you need is term or whole life insurance. The other types of policies are way too complicated for you to understand. If you want to invest in the stock market, invest directly. Keep your life insurance separate.

Visit my Estate Planning page or read my Life Insurance Fact Sheet for more information.