Life insurance can be a key component of many people’s overall financial planning. This is because, without it, there could be a large gap left if the unexpected should occur. In this scenario, other assets such as savings or retirement funds may need to be used for paying final expenses, paying off debt, or used to fund living expenses if a family breadwinner should pass away.
With that in mind, having a good solid life insurance policy in place can allow you to ensure that loved ones will be financially secure and that you can keep your promises to protect them – even if you won’t be there.
When considering the purchase of a life insurance policy, one of the biggest decisions that you will make is how much coverage will be “enough.” The face amount of your policy will often be determined by how much debt your survivors may need to pay off, as well as other important financial factors.
An equally important decision in the life insurance buying process is the type of coverage to purchase. This is because today, there are many different types of life insurance to choose from – and this can allow you to virtually “custom design” your policy to more closely fit your and your loved ones’ specific protection needs.
Types of Life Insurance
Today, there are numerous types of life insurance to choose from. These, however, primarily stem from two key categories – term and permanent (also called whole). And, within each of these two categories, there are many variations.
Term Life Insurance
Term life insurance is considered to be the most “basic” form of life insurance protection that is available to purchase. One of the biggest reasons for this is because it provides just pure death benefit protection only, without any cash value or investment component.
Because of this, term life insurance can be very affordable for an insured – this is particularly the case if the insured is younger and in good health at the time they apply for the coverage.
Term, however, as the name indicates, will last for a certain period. For example, some term life insurance policies are sold as 1-year renewable options. In this case, the amount of the premium will typically increase each year.
Other term life insurance policies will have premiums and death benefits that remain level for longer periods of time, such as for ten years, 15 years, 20 years, 25 years, or even for 30 years. After that, the policy will expire – unless the policyholder converts the policy over to a permanent insurance policy, an option that is available on some term life insurance policies.
Types of Term Life Insurance Coverage
There can be many different types of term life insurance to choose from. These can include the following:
- Level Term Life Insurance – A level term life insurance policy will have a death benefit amount that remains the same throughout the entire life of the policy. In addition, the premium amount will also usually remain the same.
- Renewable Term Life Insurance – On a renewable term life insurance policy, the policyholder will be able to renew the policy after each of the period expires. This can typically be accomplished without the need to pass a medical examination, or to complete a new application for coverage.
- Convertible Term Life Insurance – With convertible term life insurance, the policyholder may convert the existing term life insurance policy over into a permanent policy – typically without having to prove evidence of insurability.
- Decreasing Term Life Insurance – On a decreasing term life insurance policy, the amount of term life coverage will decrease over time although the premium amount due will often remain the same. The policy will end when the amount of the coverage gets to $0. These types of policies are oftentimes purchased by those who wish to cover the unpaid balance of a home mortgage. As the remaining balance goes down over time, so does the amount of the life insurance.
- Increasing Term Life Insurance – Converse to decreasing term is increasing term life insurance. Here, the amount of the life insurance coverage will go up over time, usually as the insured’s coverage requirements increase (such as having more children, buying a bigger home, etc.) Often, this type of coverage may be bought as a cost of living rider to a whole life insurance policy.
Whole Life Insurance
A type of permanent policy where the insured obtains death benefit coverage, and a cash value account where funds are allowed to build up on a tax-deferred basis.
This means that there will be no taxes due during the time of growth, unless or until the policyholder actually withdraws the money from the policy. The cash in a whole life policy will grow at a set minimum rate of interest over time.
Generally, the cash will grow slowly at first in a whole life insurance policy. However, as time goes on, the cash can build up due to the compounding and the tax-deferred nature. Also, there are some types of whole life insurance that offer dividends.
While not guaranteed, if dividends are also added to the cash component, these can also help to increase the amount of cash that is in the policy.
The policyholder is allowed to either withdraw or to borrow the funds from the cash component of the policy. These funds may be used for any reason, such as paying college costs for a child or a grandchild, supplementing retirement income, paying off debts, or any other purpose.
While there are several forms that permanent life insurance can take, whole life insurance is considered to be the most basic. This type of coverage is intended to remain in force for the “whole” of the insured’s lifetime.
With whole life insurance, the premium will remain the same – regardless of the insured’s increasing age, and regardless of if the insured contracts an adverse health condition. The insurance company is not allowed to cancel a whole life insurance policy – provided that the policyholder continues to make the policy’s premium payments.
Types of Whole Life Insurance Coverage
There can be numerous variations of whole life insurance coverage. These may include the following:
- Participating – Whole life insurance policies that are participating will offer dividends. Dividends are considered to be a return of a portion of the policy holder’s premium and are therefore not taxed.
- Non-participating – A non-participating whole life insurance policy will not offer dividends to its policyholders. In this case, if the cost of the insurance company’s future claims has been over-estimated, then the insurer will be able to retain the difference.
- Straight or Level – Most whole life insurance policies are considered to be straight or level whole life plans. This refers to the fact that the premium payments will be due by the policyholder until the insured reaches the age of 100, or they pass away.
- Limited Pay – A limited pay whole life policy will allow the policyholder to pay up the policy with just a few premium payments. As an example, a 7-pay whole life insurance policy will provide the policyholder to pay off the entire policy with just seven premium payments, rather than a lifetime of premiums. These policies will also build up a higher amount of cash value within a shorter amount of time.
- Single Premium – Similar to a limited pay whole life insurance policy, a single premium policy will allow the policyholder to make just one single lump sum premium in order to pay up the policy. Because of this, the cash value in a single premium whole life insurance policy is typically quite a bit from the very beginning of the policy’s inception.
- Modified Whole Life Insurance – With a modified whole life insurance policy, the policyholder will be required to pay premiums over the life of the policy, but the initial premiums will be discounted. Then, over time, the premium amount will increase.
- Graded Premium – With a graded premium whole life policy, the initial premium amount will also be discounted. However, rather than having just one premium increase like the modified whole life insurance policy does, these policies will have several increases over time.
- Indexed Premium – The indexed premium form of whole life insurance will have an increase in the death benefit that is based on an increase in an underlying market index. The underlying index may be the Consumer Price Index, for example.
Other Life Insurance Options
There are some types of life insurance that may be purchased either as a whole life insurance policy or as a term life insurance policy. Some of these may include:
Final Expense Life Insurance/Burial Life Insurance
A final expense life insurance policy (frequently called burial insurance) is typically purchased by those who are in the age range of 50 to 85 for the purpose of paying funeral and other final expenses. These policies will have a face amount of between $5,000 and $25,000 – although there are some insurance carriers that will provide higher death benefit amounts.
Burial life insurance may be purchased either as a term or as a whole life insurance policy. Different life insurance carriers may offer just one form of coverage, and some may offer both options for consumers so that they can choose the one that is best for their needs.
No Medical Exam Life Insurance Coverage
No medical exam life insurance coverage is a great option for those who do not qualify for a policy that goes through the regular underwriting process. As its name implies, there is no medical examination required as a part of the underwriting process.
While the premium for this type of coverage can be more expensive than a the same face value policy with the medical exam, for some, this type of policy may be the only way to obtain life insurance protection.
Here, too, the coverage may be purchased as either term or whole life insurance – and, depending on the individual insurance company, one particular option may be offered, or an applicant may have the opportunity to choose from both.