If you want to ensure that your family members or other loved ones have enough money to pay household monthly expenses, college tuition and other costs in the event of your death, life insurance is essential. Not every life insurance policy is a good fit for everyone, though. To purchase the best type of life insurance for your lifestyle, you must first understand the basics of how each type works. Then you can determine the amount of coverage you need and whether you want life insurance that can also serve as a type of savings plan for retirement funds.
The Different Types of Life Insurance
First, here are some key points to understand about different types of policies before diving into the nuts and bolts of each:
1. Term life insurance lasts for a set number of years. If you die before the term expires, the insurer pays the death benefit amount on the policy to designated beneficiaries. If you're still alive when the term ends, the policy expires without a payout.
2. Permanent life insurance lasts your entire life. These policies usually have a cash value that can work as a savings plan, allowing you to make withdrawals or borrow against. When you die, your beneficiaries receive the death benefit.
With this background information in mind, we can now break down how each type of life insurance works.
Term life insurance policies typically last 10 to 30 years but can also be a renewable one-year policy. The death benefit can be paid as a lump sum, a monthly payment or an annuity, under which the insurance provider pays the benefit incrementally over a set number of years with remaining funds earning interest.
A whole life insurance policy never expires, and premiums and the death benefit usually stay the same. Whole life insurance policies accrue interest and have a cash value that increases over time, acting as a tax-deferred savings account and investment vehicle with a guaranteed rate of return. Whole life insurance policies can cost five to 15 times more than a term life policy that has the same death benefit.
Universal life insurance has a cash value that grows over time and a death benefit that won't change. You can change the premium and death benefit amounts on a universal life insurance policy. Once you have enough cash value in the policy, you can use those funds to pay the policy premium, allowing you to skip making premium payments until the cash value is depleted.
Indexed universal life insurance links the cash value element of the policy to a group of bonds and mutual funds in a stock market index. This type of policy has a guaranteed death benefit and minimal financial risk, but investment earnings may be capped at a certain amount.
Variable and Variable Universal
Variable life insurance and variable universal life insurance are linked to investment accounts in a pool of investor funds offered by the insurance provider. Both types of policies have a guaranteed death benefit. Variable universal life insurance is protected from risk, and you can deplete the cash value to pay premiums. On the other hand, a variable life policy has no guaranteed cash value.
Final expense life insurance has a death benefit that can be used to cover costs associated with your death, including medical, funeral and cremation or burial expenses, which can cost upward of $10,000.
Choosing Your Life Insurance
With so many options, choosing the best type of life insurance for your lifestyle may seem daunting. However, asking yourself these questions from the National Association of Insurance Commissioners to determine how much coverage you need can help narrow your choices:
1. Does anyone depend on me financially?
2. How much household income do I provide?
3. How will my family pay my final expenses and debts after my death?
4. Do I want to leave money to family members or charity?
5. If I have employer-sponsored life insurance, is the death benefit enough to meet my financial obligations?
Once you determine how much coverage you need, you can choose the best policy for you. Here are some examples of how certain types of life insurance may be a good fit.
- Term life insurance policies are more affordable and offer more straightforward coverage than other types, making this insurance appealing to many. For starters, premiums are the least expensive of any type of life insurance, generally ranging from only $25 to $35 a month. Term policies also have no cash value or investment options or risks. You can match the term to how long you'll need the policy. For example, if you have young kids or grandchildren and want a death benefit to fund their college tuition, you might buy 20-year term life insurance. Or if you have a debt that won't be paid off for 10 years, you may purchase a term policy that expires in 10 years to cover the debt if you die. Term life insurance can be a good option if you need a large death benefit but also need an affordable premium.
- Whole life insurance or another permanent life insurance policy could be the best life insurance type if you want a policy that also works as a "forced savings" vehicle. However, keep in mind that the premium for whole life insurance is generally around five to 15 times more expensive than a term life insurance policy. The cash value component can help with estate planning, and the policy never expires as long as you keep paying the premium. However, the high premium for whole life insurance can lead people to sign up for less coverage than they need or surrender the policy early. If you're struggling to set aside enough money for retirement, a permanent life insurance policy could be a way to accumulate cash value that can go toward retirement income.
- Indexed universal, variable and variable universal policies are tied to investment accounts, so these types of life insurance can bring greater returns but also include risks associated with investing.
- Final expense life insurance could be a good choice if you're an older adult with no other life insurance. That way, your family won't have to pay funeral costs or wait for your estate to settle to recoup funeral and burial expenses.
Guidance on Life Insurance
After assessing life insurance coverage needs, don't make the decision alone. The NAIC recommends meeting with an insurance agent, financial advisor or insurance company representative to help evaluate your life insurance coverage needs.