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Life insurance is a contract between you and the life insurance company. You pay premiums (monthly or annually) for a payout that your relatives will receive, known as the death benefit. Should you die, the insurance company pays the death benefit to your chosen beneficiary.
“If you don’t make it home and someone relies on your income to live, you need life insurance,” Mark Williams, CEO of Brokers International, told Insider.
The best life insurance policy for you depends on your budget as well as your financial goals. There are two main types of life insurance policies to choose from: permanent life and term life.
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Term life vs. permanent life insurance
The difference between term life insurance and permanent life insurance is similar to the difference between renting an apartment (term life) and owning a home (permanent life).
When you rent, you have a lease for a certain term. When that lease is over, you can renew — but most likely with a rent increase. Likewise, term insurance lasts for a specified period, and when it’s up you can reapply for coverage, but the premiums most likely will go up as you age and your health deteriorates.
Permanent life insurance has a death benefit for your beneficiaries and a cash value that you can use during your lifetime. It’s like owning a home, where you gain equity that can be used as collateral — and your home can be left to your heirs leaving a legacy.
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Whether you choose permanent or term life insurance, you will need to go through the underwriting process. The underwriting process is how the insurance company determines your insurability — determining how much of a risk you are and how much to lend you.
It collects information about your health (medical history), job, income, finances, and other personal information to determine how much they will insure you and what your premium will be. It may require a medical exam, which includes the collection of a blood and urine sample.
Types of permanent life insurance policies
There are different types of permanent life insurance. They all have death benefits and a cash value that grows with tax deferred.
The biggest difference between the types of permanent life insurance policies is how the cash value component of the plan is invested.
- Whole life: Guarantees the exact same payment for the life of the policy. The insurance company invests your premium with its own portfolio. The attraction is that your payment stays the same for the life of the policy. Many whole life insurance companies also offer to increase the death benefit over time.
- Universal life: Created in the 1980s when interest rates were high, universal life insurance policies allow you flexibility. You can raise or lower your death benefit, and you can change your premium payments if your circumstances change.
- Variable life: This type of permanent life insurance policy was created years after universal life for people who didn’t like how whole and universal life commingled their investments with the insurance company. Variable life is for those who want control over the way their cash value earns interest. You money is invested in the stock market, rather than with the insurance company. If the market does well, so do you, but if the market falls, so does your cash value, making it riskier than whole and universal life.
- Variable universal life: Variable universal life is a combination of universal and variable life insurance. You can raise or lower your death benefit and have your cash value invested in the stock market. Again, this is risky, but if the market goes up, so does your cash value.
Types of term life insurance policies
There are several types of term life insurance policies. Some are more popular and expensive than others. Below is a list of the top term life policies.
- Level premium: A level term policy pays the same benefit amount if death occurs at any point during the term (five, 10, 20, or 30 years). This is the most popular type of term life insurance.
- Annual yearly renewable: If a policy is “renewable,” that means it continues in force for an additional term or terms, up to a specified age, even if your health (or other factors) would cause you to be rejected if you applied for a new life insurance policy.
- Return of premium: For most types of term insurance, if you haven’t had a claim under the policy by the time it expires, you get no refund. But some insurers have created term life with a “return of premium” feature, which returns part or all of the money you’ve already paid if you haven’t used the policy once your term ends. You’ll pay exta for this feature.
- Guaranteed issue: These policies are easier to get because they don’t require a medical exam. You must be 50 and older. Also, the policy might not pay a full death benefit for the first few years of coverage, according to Guardian Life.
- Simplified issue: No medical exam is required with a simplified issue policy, but you still have to complete a health questionnaire and provide access to medical records. There is no age limit. If you fail to disclose a condition and die, the insurance company can deny death benefits to your beneficiaries. Some insurance companies may not pay a full death benefit for the first few years of coverage.
- Convertible: This allows you to convert a term life policy into a permanent life insurance without additional evidence of insurability.
- Group life insurance: This is employer-provided life insurance and is usually offered for free. However, if you are discharged, retire, or quit, you will lose coverage.
- Final expense: Is a type of guaranteed issue policy that can be term or whole life, with a low death benefit that covers funeral and burial expenses.
What type of life insurance should you get?
Your life insurance needs change as you age, and you’ll need to consider children, marriage, divorce, retirement, and caring for aging parents. Consider consulting a financial advisor, estates attorney, and accountant to ensure you have the proper coverage for your goals and life changes. The best life insurance policy for you depends on your budget and financial situation.
If you are on a fixed income with limited means, final expense could be best for you. If you have health issues that may prevent you for traditional coverage, you may want to consider no medical examination life insurance. If you want coverage for your dependents in the event of your untimely death, then a term life policy works. If you are looking to build wealth and leave a legacy, a permanent life insurance policy is best.
Talk to your insurance agent or financial planner about what works best for you and your budget based on your financial situation.
FAQs
If you purchased a term life policy, some life insurance companies allow you to renew your term while others give you the option to convert your policy. Neither is guaranteed, and the policy you get is based on your qualifications at that time. So because you’re older, possibly with more health issues, you might not qualify for conversion when you want to. Your death benefit could also drop significantly.
Universal life insurance gives buyers the option to keep paying and increasing their death benefit. In short, unlike some other permanent policies, you don’t have a fixed limit to your death benefit. The longer you live, the more your beneficiaries get later on.
Accelerated death benefits are referred to as living benefits by some companies. Sometimes added as a rider, users can pull money out of their life insurance policies without penalty if facing a terminal illness or disability. It depends on the terms of the individual life insurance company.
