When someone is new to purchasing a life insurance policy, the information surrounding a policy can be overwhelming. As such, having trust in a life insurance agent is a key component of securing a good policy. Thankfully, in most cases, agents are recommending life insurance policies that are in their clients’ best interests.
But, what happens if you are working with an agent that is acting in bad faith? Not only can this be costly, but it may also be too late before you realize the damage that has been done.
In either situation, it’s always for the best for you to educate yourself about life insurance prior to buying a policy. Doing so will protect you, as well as your loved ones. And, most importantly, this can guide you in picking the right type of life insurance policy.
An Overview of Life Insurance
Regardless of the exact type of policy your buy, life insurance is designed to help protect your family financially in many ways. And, generally, there are two main types; term and permanent.
With a term life policy, you are covered for a specified period of time, let’s say for 10 years. When the term ends, the money is paid out to your beneficiaries. But when the term is over, new coverage is required as the policy is no longer active.
A permanent life plan, which includes universal life and whole life, can help you protect yourself for life as well as provide financial benefits over the long run. For example, assisting to build up your nest egg for retirement.
Which type of life insurance is best for you? Well, that depends on several factors, such as the length of the policy, the price, and if you want to use it as an investment vehicle. But, to help you make this decision a little easier, let’s explore the basic features of a life insurance policy and the various types of policies you can choose from.
The Basic Features of a Life Insurance Policy
The primary purpose of life insurance is to provide financial stability to your dependents if you die. However, several key characteristics define how a policy fulfills that promise:
- Death benefit. The amount that the policyholder’s insurance company will pay when they die. Most of the time, these benefits are tax-free.
- Beneficiaries. A person or persons who are entitled to receive a death benefit. One person can inherit it all, like a surviving spouse, or it can be divided up among a few people. For instance, a spouse could receive 50%, and two children each could receive 25%. Also, you do not have to name a blood relative as a beneficiary. If you want, you can name a charitable organization as the beneficiary.
- Policy term. The amount of time during which an insurer is obliged to pay a death benefit to the beneficiary. With a term policy, the number of years is specified. For example, 10, 20, or 30 years. If the policy is funded properly to pay monthly expenses, then a permanent policy covers the insured for life.
- Premium. The amount paid each month or each year to maintain the policy.
- Cash value. The investment component of the policy accumulates over time and can be borrowed or cashed out. FYI, a term policy has no cash value.
The Different Types of Life Insurance
At this point, you should be familiar with Term and permanent life insurance. But, let’s take a closer look at what other life insurance options that are available to you.
Term life insurance.
The lengths of term life insurance policies tend to be one, five, 10, 15, 20, 25, or 30 years. The amount of insurance coverage can vary but can reach millions depending on the policy. The cost of term life insurance is locked in for the entire term of the policy. Term life insurance that renews every year is known as “annual renewable.” If you have a short-term debt problem or need coverage for only a short amount of time, annual policies are worth considering.
One of the main advantages of this type of policy is that it is often the cheapest. Also, a life insurance quote can be obtained online.
On the other hand, a drawback is that beneficiaries will not receive payouts if you outlive the policy.
Whole life insurance (permanent).
Whole life insurance offers lifetime coverage, which pays your benefit regardless of when you pass away — just as long as you continue to pay. A portion of the premium you pay for whole life insurance will also go into a savings account. In many cases, whole life policies cost more than term life policies with similar coverage (sometimes 5 to 15 times as much) because the savings component contributes to the cash value of the policy.
What’s more, the death benefit payable upon your death is not affected by the cash value of your whole life policy. At a certain age, your insurer will terminate your policy if the cash value reaches the death benefit amount. Usually, this is when you reach the age of 100 or 102.
Even if you don’t plan to live to 100, your cash value can still be valuable. As long as you have enough money left over in your policy, you can take out a loan based on its cash value. Since you’re borrowing money from yourself, you typically don’t need a credit check or an approval process. Your beneficiaries will receive the remainder of the loan amount and interest if you pass away before paying everything back. If you pay back the loan with interest, your beneficiaries will receive the remainder of the loan amount and interest.
Universal life insurance (permanent).
As long as the premiums are paid, universal life insurance provides lifetime coverage. Another perk is that unlike a whole life policy, this type of policy is more flexible. Hence why it’s sometimes called adjustable life insurance. In some policies, you can earn more money or pay less in premiums, or even skip some of them — but only up to a limit.
Similar to whole life insurance, universal coverage provides a growing cash value component that can be borrowed. There are, however, two key differences exist between the cash value of a universal and a whole policy:
- There is no fixed interest rate for the cash value of universal policies. Generally, the rate at which your cash value accumulates over time can change with market conditions. But you will have a minimum guaranteed interest rate.
- A universal policy’s cash value can eventually grow to a point where you can use it to pay all your premiums. That effectively turns it into a zero-cost policy.
Indexed universal life insurance (permanent).
The cash value of indexed universal life insurance (IUL) is different than the cash value of universal life insurance (UL).
An index is a collection of investments, such as stocks or bonds. The most well-known indexes include the S&P 500 and the NASDAQ-100. For your policy, the interest rate is determined by the interest rate and the performance of a specific index, not directly by the insurer.
Unlike the interest rates on some permanent insurance policies (which are fixed or vary), indexed universal life insurance has a minimum guaranteed interest rate. IULs may also have an earnings cap, which means if the index performs better than the capped amount, you may be unable to turn a profit.
The cash value account on an IUL policy is different from that of a universal life insurance policy. With this policy, the cash value depends on an index chosen by the insurer as opposed to the variable interest rate of universal life.
Variable life insurance (permanent).
You can get some decent growth with the money you pay into a variable life insurance cash-value account. But, it ultimately depends on the market and there’s a risk that you’ll lose money. However, this can also be utilized as an investment option.
A policy with this type of cash value behaves more like an investment. The potential growth of a variable life policy is greater than that of a whole life policy. The downside is that you can only invest in sub-accounts. As a result, you’re not given the chance to choose from the wealth of mutual fund choices that are publicly traded.
Additionally, it’s a riskier product. The reason? Because most people aren’t informed about the stock market so they cannot make informed decisions about their investments. Further, the average person cannot effectively manage the many variables involved.
Because of all of this, variable life insurance policies are have minimal investment and coverage options.
Variable universal life insurance (permanent).
Variable universal life insurance resembles universal life insurance because they share several of the same features. But, there are stark contrasts between these policies.
With variable universal life insurance, you can adjust the policy’s premiums and death benefit amounts while investing in its cash value. As with the other types of insurance, it comes with many of the same risks. Unless there is a compelling reason to purchase universal life insurance, most people won’t require a complex universal life insurance policy. As such, it makes much more sense to explore other investment and insurance alternatives.
As an example, a cheaper term life insurance policy could be added to a mutual fund investment strategy. With such a policy, you get the same insurance coverage as a variable universal life insurance policy, but at a lower premium.
Final expense insurance.
The costs associated with a funeral or burial may be too high for you to qualify for whole life or term life insurance. The good news? A final expense life insurance may be the solution.
This type of insurance covers the costs of your medical care, funeral arrangements, and cremation after your death.
People who don’t have sufficient savings to pay for their funeral, which costs $7,000 to $12,000 on average, tend to purchase this policy since they usually don’t have other life insurance coverage — or perhaps their term life policy expired.
Coverage is commonly in smaller amounts. And, these policies usually have a higher premium. However, this policy is preferable for those who have no other means to cover final expenses,
Final expense policies come in two different forms: simplified issue and guaranteed issue.
- Simplified issue life insurance. This policy is a type of whole life insurance that covers final expenses. You can, however, bypass the medical exam. You still will have to fill out a health questionnaire regarding your medical history and habits. A smoker, someone over a certain age, or someone suffering from severe underlying health conditions may not be eligible for simplified issue life insurance.
- Guaranteed issue life insurance. With guaranteed issue life insurance, you don’t have to undergo a health exam or answer any health-related questions. In fact, the insurer doesn’t care about your age, sex, or place of residence as long as you can pay the premiums and complete the application. The applicant will not qualify for guaranteed issue life insurance if they are unable to answer questions on the application because of advanced dementia and Alzheimer’s. As a result, those with declining health or terminal illnesses may find it to be more appealing than other insurance plans.
Group life insurance policies.
A group life insurance policy, which is also called term life insurance coverage, is an employee benefit offered by some companies. Although it isn’t a type of life insurance technically, it’s still important to understand the difference between it and privately purchased term life insurance.
It’s common for people to think they have sufficient coverage through their employer-sponsored life insurance. However, in most cases, they don’t. Still, never underestimate the potential benefits of no-cost life insurance that are offered by your employer. Just note that the policy you receive through your employer may not be sufficient to protect your family though.
Employer-sponsored life insurance typically only provides one to two years’ worth of coverage. But, basic coverage can be had for free. So, it wouldn’t hurt to obtain such a policy for supplemental coverage.
Other Types of Insurance
While not as popular as the policies listed above, there are some additional life insurance types.
- Accidental death and dismemberment insurance. When you die in an accident, such as in a car crash, this policy provides you with financial protection. AD&D insurance also provides coverage for losing limbs, sight, or hearing.
- Credit life insurance. You would use this to pay off an existing loan, such as a home equity loan. In fact, if you take out a loan with your bank, they might offer you this option. In the event of your death, the lender will be paid off and not your family.
- Joint life insurance. Under this policy, both lives are insured, usually those of the spouses. Upon the death of the first policyholder, a first-to-do plan pays out. The policy will then expire and the second person is no longer covered. There is very little demand for these types of policies. Alternatively, a second-to-die policy will pay out if both policyholders are deceased. After both policyholders die, these policies are available to cover estate taxes and provide for dependents.
- Mortgage life insurance. When you die, this pays the current mortgage balance to your lender rather than your family members.
What Type of Life Insurance is Best For You?
In most cases, term life insurance policies are the best solution for those looking for life insurance. Most people looking for a policy prefer these because they are often the most affordable and simple to understand.
That does not mean other life insurance policy types are ineffective. As an example, since many people struggle to adequately save for retirement, a permanent insurance policy provides separate cash accumulation that they would most likely spend elsewhere.
People who may not otherwise be able to buy life insurance due to their age or health can get insured by simplified issue and guaranteed issue policies. Elderly consumers who do not want their families to bear the burden of funeral costs can purchase final expense insurance.
Whenever you are looking for the best insurance company or policy, it is always a good idea to speak with a licensed independent broker or financial advisor. An insurance agent can help you shop for the right type of policy based on what type of coverage you need and the pros and cons associated with each one.