Life Insurance 101: How to Decide Which Type of Policy is Right for You

Insuring your life for the benefit of your spouse, children and others is an important step for any adult, and it’s one that shouldn’t be put off. A life insurance policy can go toward funeral and burial expenses, mortgage payments and wage replacement when the insured was a wage earner for the family. Some insurance policies can also serve as safe and prudent financial investments or help to reduce the size of a large, taxable estate.

If you are new to the process of buying life insurance, the many options available may astound and confuse you. Below you’ll find brief descriptions of the most common types of life insurance policies. Visit insurance company websites for more information, or schedule a time to meet with a local insurance agent in your area. A well-reviewed independent insurance agent should take the time to understand your needs and provide you with the best options to make sure you are adequately and effectively covered.

Term Life

A term policy offers a fixed monthly premium for the term of the policy, which may be 10, 20 or 30 years or some other term. If the insured dies while the policy is in force, benefits should be paid to the beneficiary. At the end of the term, the insured will no longer be insured and will have to apply for a new policy. Term policies are considerably cheaper than whole life policies, but the policyholder has nothing to show for at the end of the term (other than having had affordable insurance coverage during the term). 

Not all term life policies offer a fixed premium for the stated term. Some are renewable every year, but premiums increase as the insured ages. Others may have a fixed premium but a declining death benefit. The lower cost of insurance for these variable options may offset their disadvantages.

If going with a term policy, it’s smart to keep an eye on the different age brackets and premium amounts and to renew your policy for a new term before you get into a more expensive bracket or before you may be rated worse after a new physical exam. You can also consider switching over to permanent insurance, like a whole life policy.

Whole Life

If term life insurance is like paying rent on an apartment, then a whole life policy is like owning a home and making monthly mortgage payments. You have a place to live while you are paying rent, but if you stop paying rent, you have to find a new place to live, and if your term life policy ends, you have to find a new one. With a whole life policy, you build up cash value in the policy each month, similar to building equity in your home. Even if your whole life policy expires or terminates, that cash value is yours.

The cash value in a whole life policy grows tax-deferred, and you can withdraw it or borrow against it as you wish. Ideally, this value will help fund living expenses during retirement, but many people use that cash value during their working years for vacations, home repairs or medical expenses. Many whole life policies also pay dividends which can be taken out or reinvested to add more value to the policy.

Whole life premiums are several times more expensive than term policies.

Universal Life

With a universal life policy, you decide how much you want to pay in premiums each month (although some universal life policies are single premium or fixed premium, most offer this flexible premium option). There is a cost of insurance that must be paid each month to keep the policy active, but you can pay whatever you like above that amount, and any payments above the current cost of insurance go toward building cash value in the policy, which grows tax-deferred and accumulates with interest.

The cost of insurance increases over time, but you can apply savings you have earned to keep the premium payments steady as you age. You can even skip premium payments if you have enough cash to cover the cost of insurance. You can also borrow against your accumulated cash value without adding to your taxable income.

Interest rates are typically not that high compared to other investment vehicles, but remember that you are also getting life insurance at the same time, with a great deal of flexibility on savings and premiums.

An indexed universal life policy has its earnings rate tied to a financial index such as a stock index, i.e. S&P 500, Dow Jones, etc.

Variable Life

In a variable life insurance policy, the bulk of the premium gets invested. You choose your favored investment vehicle, whether it be stocks, bonds, mutual funds or other instruments. Interest earned adds to the policy’s cash value, which grows tax-deferred. 

Note that depending upon your chosen investments, the value of your policy could go up or down. Beneficiaries can still get a death benefit at a guaranteed minimum amount, even if you lose all the cash value in your policy with risky investments. Establishing a guaranteed death benefit requires additional premium payments.

Variable-Universal Life

As you might have guessed, this type of policy combines aspects of variable life and universal life. You’ll have flexibility in how much of a premium payment to make and when to make payments (remember, you can even skip payments if your cash value covers the cost of insurance), and you can invest payments above the cost of insurance according to your investment objectives and risk tolerance. 

With variable-universal life, you can modify the death benefit up or down to meet your current and future needs. Also, you can choose a fixed death benefit or variable death benefit equal to the cash value of your policy plus its face value.

Accidental Death & Dismemberment

AD&D policies are not life insurance policies, per se. For one thing, they’ll only cover accidental death, so they are much more limited than true life insurance policies. If such a policy is available through your employer or as a member benefit through a professional association or other service, you may find the relatively small premiums worthwhile for added protection. Just don’t make the mistake of thinking AD&D is an adequate substitute for life insurance, because it isn’t.

Life Insurance Provides Comfort and Security… When it Works

Having life insurance coverage is great for peace of mind and security. Unfortunately for some, that security is shattered when the insurance company declines to pay. Some insurers deny claims in bad faith, saying the policy lapsed or the insured lied on the application, or they’ll interminably draw out and delay the payment process. As an insured, choose a reputable company, keep up your payments, and make sure your beneficiaries know where to find your policy and how to make a timely claim. If they wind up having trouble on their claim, they can refer the matter to an insurance law attorney who knows how to fight insurance bad faith practices.