Generally speaking, there are two main types of life insurance that can meet your family’s needs: term life insurance and permanent life insurance. The specific policy you go with will largely depend on your budget and the level of protection you are looking for.
Term Life Insurance
Term life insurance provides coverage for a limited period of time, typically 25 years. This option allows you to choose the amount you want to be insured for and the period for which you want cover. Your premiums are guaranteed to stay the same for the duration of the policy.
If you die during the specified period, the insurance company pays the cash lump sum to your named beneficiary. If you don’t die during the term, the policy doesn’t pay out. However, term life does not build cash value, so at the end of the term the policy will have no value and the premiums you’ve paid are not returned to you. After that period expires, coverage at the previous rate of premiums is no longer valid. Typically, by the end of the term your need for life insurance is gone.
Common types of level term are:
- yearly- (or annually-) renewable term
- 5-year renewable term
- 10-year term
- 15-year term
- 20-year term
- 25-year term
- 30-year term
- term to a specified age (usually 65)
A level term policy pays the same benefit amount if death occurs at any point during the term. You can renew your term life policy after it expires, although your premiums may increase as you age. But all in all, because of the “temporary” nature of term life insurance, policies are generally the cheapest options and are therefore an attractive option for young people and families with a limited income. According to the Insurance Information Institute, most people purchase a 20-year term policy, although smaller terms are available.
Advantages of Term Life Insurance
Here are some of the most common benefits of term life insurance.
Personal Costs Due to Death
When a spouse or family member dies there will be immediate costs. You can purchase a relatively small term life insurance policy to cover these costs rather than putting a burden on your loved ones in the event of your untimely passing.
Banks and financial institutions often insist that mortgage holders retain a term life insurance policy sufficient to pay out their mortgage. Such policies make the bank the beneficiary of the policy. This means that if the mortgage holder happens to pass away before the mortgage is paid off, the insurance policy will pay out. This is also a significant benefit to a spouse whose earning power will likely be decreased due to the death of his or her partner.
Business Partner Insurance
If you have a business, you can use term life insurance to cover outstanding loans with your bank, or to purchase a deceased partner’s shares on death, if you had an agreement to do so. Most partnerships have an agreement of this sort, and the policy premiums are paid by the business.
Key Person Insurance
When a company loses key individuals due to death, this can often result in hardship to the company. Key person insurance is purchased by the company for any individual it deems to be “key”. The company itself is made the beneficiary of the policy. So if a “key” person dies, the company receives a cash injection to handle the financial problems associated with replacing that individual.
Permanent Life Insurance
Permanent life insurance, as you might have guessed, is permanent. It is different from term life in that while term policies are primarily created to last only for a finite period of time that will likely end before you die, permanent policies are designed to carry on until you die whether that happens tomorrow or in 80 years.
Permanent life insurance is also an appealing option for many because of the added benefit of the policy growing on a tax-deferred basis, which can grow to be fairly large over time. It typically provides both a death benefit and cash savings. As a policyholder, you may be able to borrow against this cash value whilst you’re still alive, and this has been of great help to some. Of course, most loans need to be paid back otherwise they will be subtracted from the death benefit, and your beneficiaries may have to liquidate assets to pay back the loan.
Nonetheless, permanent life insurance offers a wide variety of saving and investment options. Because of this, policies are generally more expensive than term policies, which may be hard for young adults to handle.
Here are the different types of permanent life insurance policies:
This is the most common type of permanent life insurance policy. Whole life insurance is guaranteed to remain in force for the duration of the insured’s life, and offers a death benefit along with a savings account. Premiums are fixed and usually do not increase with age.
Over time, whole life insurance generally builds up a cash value on a tax-deferred basis, and some even pay its policy holders a dividend. Whole life insurance is popular due to the cash value that is accessible to you or your beneficiaries before you die. A whole life insurance policy charges higher premiums than other kinds of life insurance because of this cash build-up feature. The interest generated by the investment part is often tax-free, unless it is withdrawn.
The withdrawal may be tax-free if it hasn’t exceeded the total amount of premiums paid minus any previous withdrawals or dividends paid. The cash earned by the insurance can be used to pay the remaining premiums.
Universal (Adjustable) Life
Universal life offers you more flexibility than whole life insurance. You can choose your coverage amount and have the ability to adjust the amount of insurance, cash values and premiums during the term of the insurance as the need arises. It also offers a tax-deferred savings account that earns interest at a set rate that is credited every month. You can add term life riders for your spouse and your children or other dependents, waive monthly premiums if you become disabled, and are treated to guaranteed insurability. It also offers you the option of withdrawing from the cash value account or taking a loan out against it.
Any money taken out as a loan will be deducted from any death benefits if it remains unpaid at that time. Furthermore, unlike a lot of other insurance policies, a universal insurance policy carries tax-free death benefits which is quite a bonus when you take into account the deceased’s final tax return and estate taxes. You can usually choose the option of whether or not your beneficiary gets the life insurance payout, the cash value account only, or both.
This policy combines death protection with a savings account. You are able to control investment of the policy’s cash value by investing in stocks, bonds and money market mutual funds instead of relying upon the pre-established rate of return provided in a whole life solution. As with whole life and universal life insurance, you may withdraw against the cash value. Essentially, being able to control how the money should be invested makes variable life insurance very attractive to those who believe the rates of return offered by more traditional insurance policies can be easily outstripped with superior investment strategies.
However, although variable policies create an opportunity for tremendous growth, they also carry with them a level of risk which can decimate the cash value of the policy. Fortunately however, there is some safety net, as variable life policies will retain a death benefit that will not fall below the amount of insurance initially purchased.