June 23, 2024
Types of life insurance

 

Life insurance is a critical component of a family’s financial strategy, so it’s vital to select the right type of coverage. There are several options available, though, making it challenging to determine which is ideal for you. Most life insurance is categorized as a term policy or permanent policy. In this guide, Bankrate’s insurance editorial team breaks down life insurance to help you decide which type is best for you and your loved ones.

 

Different types of life insurance

There are two main types of life insurance available: term and permanent. Once you understand these types, the nuances of more specialized policies become easier to digest. Below, we explain term life and permanent life insurance and review some of the more specialized product types within each category.

 

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Term life insurance

Term life insurance is typically more affordable than permanent life insurance because it is only active within a set period. Among the various types of term life insurance, level term life insurance is the most common and widely offered by insurers. Some kinds of term life insurance also maintain constant premiums throughout the policy’s life.

 

The four primary types of term life insurance are:

 

Level term policies

Yearly renewable term policies

Decreasing term policies

Return of premium policies

Level term insurance

Level term insurance policies cover the policyholder for a specified period, such as 10, 20 or 30 years. The death benefit remains fixed throughout the term, with coverage amounts typically ranging from $100,000 to millions. The premium is set at the time of purchase and typically stays the same for the entire term. When people refer to “term life insurance,” they are usually talking about level term life insurance.

 

Yearly renewable term insurance

Yearly renewable term insurance policies usually provide coverage for one year at a time. You can typically renew your coverage each year without needing to prove you’re still insurable. The period during which you can renew is often set for a specific time frame or until a certain age, such as annually renewable to age 80 or for 10 years. While premiums are fixed for each year, they generally increase slightly each time you renew.

 

Decreasing term insurance

Decreasing term insurance policies typically have fixed premiums that are slightly cheaper than level term policies. However, the death benefit decreases over time, often annually. This type of policy might appeal to those with children, as the need for a high death benefit diminishes as children grow and become financially independent.

 

Decreasing term insurance can also be useful for individuals who want coverage while paying down debt. As the debt decreases each year, the death benefit reduces to match the remaining amount of debt. This kind of policy is often offered by banks and lenders for people obtaining mortgages or other significant loans, so it may not be available from all insurers.

 

Return of premium insurance

A return of premium rider is a useful feature that can be added to several types of term life insurance. While not actually a specific life insurance policy type, adding a return of premium rider means that if you have not passed away when the policy term expires, you will receive back all the premium you paid into the policy. That said, a return of premium rider usually increases the cost of life insurance.

 

Learn more: Best term life insurance companies

 

Permanent life insurance

Permanent life insurance is designed to last your entire lifetime, with premiums that need to be paid continuously. However, there is a maximum coverage age limit, typically ranging from 90 to 121 years. If you outlive a permanent policy, the insurer may either pay out the death benefit as a lump sum or pay out the cash surrender value, depending on the terms set in your policy.

 

Permanent life insurance is generally more expensive than term coverage, but it offers additional benefits, such as cash value.

 

The cash value component is a portion of your premium that is set aside to grow over time. The growth rate can be steady or fluctuate with the market, depending on the policy type. While cash value growth is usually slow, it can be beneficial. If you’ve accumulated enough, you could use it to pay premiums, borrow against it or withdraw it. Keep in mind that borrowing against the cash value is a loan that accrues interest, and if you don’t repay it, it reduces the death benefit paid to your beneficiary.

 

There are more types of permanent insurance than there are term policies. The main types of permanent life insurance are:

 

Whole life insurance

Universal life insurance

Equity Indexed Universal Life

Variable Life

Simplified issue insurance

Guaranteed issue insurance

Final expense insurance

Whole life insurance

Whole life insurance is the most basic form of permanent life insurance coverage. With traditional whole life insurance, both the premium and death benefit typically remain unchanged. You’ll be covered (to a maximum age ranging from 90 – 121) as long as you pay your premiums, and your policy will generally build up cash value at a steady, albeit slow, rate.

 

There are two main types of whole life insurance policies: participating and non-participating. Participating whole life policies provide potential dividend earnings to policy owners, while non-participating policies do not offer dividends. This difference can affect the overall value and cost of the policy over time.

 

Learn more: Best whole life insurance companies

 

Universal life insurance

Universal life insurance, sometimes called adjustable life insurance, adds flexibility by allowing policyholders to adjust death benefits and premium payments. This policy type might appeal to those who value the ability to adapt their coverage to changing life insurance needs as they age.

 

Universal life insurance policies offer additional financial options. Policyholders can withdraw the cash value from it. Unlike loans, withdrawals don’t accrue interest or require repayment, but they reduce the death benefit and impact future cash value growth.

 

Universal life can be further divided into indexed universal and variable universal life. These policies can be complex, so it’s typically best to consult with a licensed life insurance agent to determine if they are right for you.

 

Learn more: Best universal life insurance companies

 

Simplified issue life insurance

Simplified issue life insurance isn’t a specific policy type but rather a streamlined application process available for various life insurance types. Unlike many traditional life insurance policies that require a medical exam, simplified issue policies allow applicants to skip this step. Instead, applicants complete a health questionnaire and disclose any habits that might increase their risk.

 

While this process is more convenient, it typically comes with higher premiums due to the added risk insurers take on without a medical exam. Additionally, the death benefit amounts for simplified issue policies are often lower than those for traditionally underwritten policies.

 

Guaranteed issue life insurance

Guaranteed issue life insurance generally requires an age eligibility of 50 to 80, and no medical questionnaire or exam is required to qualify. This type of policy is particularly beneficial for older individuals or those with health conditions that might make it difficult to get other types of life insurance coverage.

 

Death benefits for guaranteed issue life insurance are usually lower, typically maxing out at $50,000. These policies often include a graded death benefit, meaning that if the insured dies within the first two years, only the paid premiums are refunded, and the death benefit is not paid out, except in cases of accidental death.

 

While guaranteed issue policies provide an easy way to obtain coverage, they usually come with higher premiums due to the lack of medical underwriting. These policies typically fall under the whole life insurance umbrella.

 

Final expense insurance

Final expense insurance and guaranteed issue life insurance are essentially the same product, just marketed differently. Final expense insurance is typically marketed to cover end-of-life costs, while guaranteed issue is usually aimed at people who have been declined for traditional policies.

 

A final expense policy is a type of whole life insurance designed to cover end-of-life expenses, such as funerals and medical bills. It can be useful for those who don’t need to leave substantial financial support to loved ones but want to ensure their final expenses are covered. Coverage limits for final expense insurance are typically lower than many other types of life insurance, and the premiums may be higher due to the lack of medical underwriting.

 

Choosing the right type of life insurance policy

Choosing the right life insurance policy can feel overwhelming, but breaking down your needs and priorities can help simplify the process. Consider the following factors:

 

What is your budget? A tight budget might mean term life insurance is a better fit than permanent insurance, which is usually more expensive.

If you have children, what are their ages? A 30-year term policy might be more suitable for young children, while a 10-year policy may suffice for high school-aged children.

Do you plan on paying for your children’s education? If so, you need to consider the cost of these education expenses and when they are to occur and strategize your policies accordingly.

Do you have any loved ones who will rely on you indefinitely? For example, someone with a special needs family member may prefer permanent coverage to ensure ongoing financial support.

What is the goal for your coverage? Do you want just enough coverage to pay for funeral expenses, or do you want to leave a financial gift to someone?

Do you want the flexibility to change the coverage amount in the future? Some policies offer more flexibility than others.

How long will you need coverage? If you only need the policy for a specific time, term life insurance might be the best option. For long-term peace of mind, permanent insurance is likely the better fit.

If you are still having trouble narrowing down your options, working with a financial planner or licensed life insurance agent can help you determine the type and amount of life insurance you need.

 

Term life vs. permanent life insurance: Which is better for me?

Despite the comparatively cheap premiums associated with term life insurance, there are a couple of drawbacks. Permanent insurance policies generally include a cash value component, which accrues money over time and can be used to pay premiums or to take out as a loan. Term life insurance doesn’t have this option.

 

Another drawback of term life insurance is that it only provides coverage for a set period. If a policyholder buys a 10-year term policy but dies 11 years after purchasing it, no death benefit is paid. If a policyholder outlives the term of their policy, they may have the option of renewing it, converting the policy to a permanent insurance policy—such as whole life insurance—or letting the policy end. You will have to ask your insurance agent which options are available when initially purchasing the policy.

 

One option to consider is having both term and permanent life coverage. Use term life insurance to cover “big ticket” items like housing, car loans and raising children, which are finite since the loans get paid off and children eventually become independent. Then, supplement your protection with a permanent life policy with a smaller death benefit for end-of-life expenses and a safety net for unexpected situations.

 

Another strategy is laddering policies, which involves layering multiple life insurance policies to cover various obligations with different guaranteed level premium periods. This approach can save money in the long run compared to buying one large term policy that lasts 40 years or a permanent policy.

 

Ultimately, the best policy for you will depend on your unique financial situation. If you’re seeking lifelong coverage that builds cash value, a permanent life insurance policy is likely ideal. But if you’d prefer affordable coverage to meet your short-term needs, a term life insurance policy could be the better option. Experts recommend consulting with a licensed insurance provider to ask questions and explore your options in greater depth before purchasing a policy.

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