Eighty percent of households without life insurance would have trouble making ends meet within a few years if the primary breadwinner died prematurely, according to LIMRA. The research firm also found that more than half of those households would start experiencing financial problems immediately.
Even if you don’t have kids, you might need life insurance. But with so many types of life insurance available, it can be hard to know which one to choose.
As a former life insurance agent, I can tell you that many life insurance agents recommend the insurance policies that make them the most money — and cost you the most money — rather than what works best for you.
Here’s how you can differentiate between the types of life insurance and decide which one is right for you.
3 types of life insurance you should know about
Although there are more than three types of life insurance policies, they all fall into three groups: term life insurance, whole life insurance, and universal life insurance.
1. Term life insurance
Term life insurance is the cheapest life insurance option. It’s also the best option for most people.
As the name suggests, a term life insurance policy is good for a specific term. If you die during the specified period, the insurance company pays out the death benefit to your beneficiaries. But if you don’t, you don’t get anything back.
Here are the most common types of term life insurance policies you’ll come across.
Level term insurance is the most popular kind of term life insurance policy. You can typically choose your term — say, 10, 20, 30, or 40 years — and your monthly premiums stay level throughout the life of the term.
The longer the term, the higher the monthly premium. That’s because you’re extending the time frame in which you could die prematurely, increasing the risk to the insurance company.
Who it’s good for: Level term life insurance is best for someone who wants coverage on the cheap. If you’re a healthy 35-year-old woman, you could get a 20-year policy with $500,000 worth of coverage for as little as $18 per month.
Instead of offering the same monthly rate over the life of the policy, annually renewable term insurance renews every year at a higher price.
You don’t have to prove every year that you’re still eligible, though. Instead, you lock in a period from the start — say, until you’re 80 years old — and remain eligible, even if your health declines.
Typically, annually renewable policies are cheaper than level term policies up front but end up being more expensive over time.
Who it’s good for: Young people who anticipate little or no change in their health in the next five to 10 years. At that point, when their annually renewable term policy gets more expensive, they can consider replacing it with a cheaper level term policy.
Guaranteed issue term
Not everyone can qualify for a regular term insurance policy. If you have or have had major health issues, most insurance companies don’t want to risk insuring you.
Guaranteed issue term is just that. Even if you have a terminal disease, you qualify. The caveat is it comes at a high cost, which makes it unaffordable for some people.
Who it’s good for: People with major health problems who can afford the premiums but not an untimely death.
With this type of term policy, your death benefit decreases over time as you pay a level premium. It’s typically cheaper than a level term policy.
Who it’s good for: This option might be a good if your only life insurance need is to pay off a debt with a decreasing balance, such as a mortgage. If you also need insurance for other expenses, though, opt for level term.
In contrast to a decreasing term policy, your death benefit increases over time with this option, and so do your monthly premiums.
Who it’s good for: An increasing term policy might be worth considering if you don’t have room in your budget now for a big policy but expect to earn more money in the future.
2. Whole life insurance
Whole life insurance is a kind of permanent life insurance and is guaranteed to remain in force for your whole life as long as you keep paying the premiums. Your premiums typically will remain the same over the life of the policy.
Here are the different features of whole life insurance you’ll come across.
In addition to a death benefit, whole life insurance also has a cash-value component that acts as a type of savings account. Over time, the earnings in the cash-value account grow tax-deferred.
That said, the rate of return you receive on a whole life cash-value account typically is lower than what you might earn if you invest the money instead. As a result, it’s often recommended that you buy term insurance and invest the difference you save on the policy.
Since whole life insurance is guaranteed to pay out and also includes cash value, it’s much more expensive than term life insurance.
For example, the same healthy 35-year-old woman who could get a 20-year $500,000 level term policy for $18 per month would pay at least $450 per month for the same coverage with a whole life policy. That’s 25 times more expensive.
Who it’s good for: Whole life insurance is expensive, so it isn’t a good choice for most people. Here are just a couple of situations in which it might be worth considering:
- You’ve maxed out all your tax-advantaged retirement accounts and are looking for other options to save for the future with a tax shelter.
- Your estate is large enough to be liable for estate taxes. Whole life insurance can be used by your loved ones to pay the tax.
3. Universal life insurance
Universal life insurance, another form of permanent insurance, also offers a lifetime death benefit and a cash-value account. The main difference is you might get more flexibility than you would with whole life insurance, depending on which type of universal life insurance you have.
There are three main types of life insurance in this group. Here are the details of each one.
Traditional universal life
With this type of universal life insurance, your monthly premiums are flexible. You typically have to pay enough to cover the cost of the policy’s death benefit but can pay more toward the cash-value account if you want.
There’s a guaranteed minimum rate of return on your cash-value account, so your balance will grow over time, even if the market doesn’t.
You can use funds from your cash-value account to pay your premiums, giving you the option to forego paying out of pocket.
That said, if your cash-value account dries up and you don’t pay enough to cover the cost of the insurance, the policy will cancel.
Who it’s good for: People who need permanent insurance but don’t like the inflexibility of a whole life insurance policy.
Variable universal life
The main difference between variable universal life and traditional universal life is that a variable policy allows you to choose how to invest your cash-value funds. You’ll also have access to investments with a higher return potential — although they come with more risk.
What’s more, there’s no minimum guaranteed rate of return like there is with a traditional universal life policy. Both traditional and variable universal life insurance policies can be as expensive as a whole life policy.
Who it’s good for: People who need permanent insurance and want flexibility and a higher return potential.
Guaranteed universal life
This insurance policy is a type of term-permanent hybrid. It typically offers lifetime insurance coverage but doesn’t come with flexible premiums, and there’s little to no cash value involved.
Going back to our 35-year-old healthy woman, she could pay as little as $170 per month for a guaranteed universal life policy — more expensive than a term policy but cheaper than whole life.
Who it’s good for: Someone who wants permanent insurance coverage but doesn’t care about the cash-value feature.
How to choose the right life insurance policy
With so many types of life insurance policies, it can be daunting to narrow them down.
For most people, a level term insurance policy is the best option. It’s simple and inexpensive and does the job without any frills or complications. If your situation is more complex, though, you might want to enlist the help of an insurance agent.
The good news is there are trustworthy life insurance agents out there. Do some research and go into the conversation with what you’ve learned about the different life insurance types. The right agent can get you the best life insurance rates from the best companies.
Once you know what type of life insurance is right for you, find out how much insurance you need before you start shopping around.
Coming up with that number can be as simple as multiplying your annual income by 10 to 20, depending on your family’s lifestyle.
Alternatively, you can list out the different things you want to be covered by the insurance, such as:
- Paying final expenses, including funeral and medical costs
- Paying off outstanding debt
- Covering future college costs
- Replacing your income
Getting the right kind and amount of life insurance can be a long process. But if you do it correctly, your family members will have the protection they need if something unexpected happens and you can no longer provide for them.
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