Around half of all Americans have some form of life insurance. Another 16 percent report needing such insurance but not yet having it.
One of the reasons adults fail to secure the coverage they need is confusion around the types of life insurance available and their relative merits. Keep reading for a breakdown of the primary types of insurance and how to buy the life insurance policy that’s right for you.
What Is Life Insurance?
Before you can choose the best life insurance for your needs, it’s helpful to understand exactly what life insurance is and what it does. Traditionally, families bought life insurance to help cover funeral and burial costs and to replace the income of the home’s breadwinner to provide for survivors if that person died.
Today, families often purchase life insurance on both spouses. This reflects the fact that it is more common for both spouses to work. Policyholders may also use a life insurance policy as a tax-protected investment vehicle.
While life insurance policies do not offer the highest return among investment vehicles, they can be an attractive choice for individuals or families who need or desire to buy a policy anyway. Buyers who want to use their policy for investing need to choose their policy type carefully as not all policies offer the same investment opportunities.
Term Life Insurance
Term life insurance is one of the three over-arching kinds of life insurance available. It is the only one of the three big types that does not have a cash value and cannot be used for investment purposes. It is also the most affordable and accessible type of insurance for most Americans to buy.
Pros of Term Insurance
Term life insurance requires the least amount of money to buy into. It offers predictable and consistent premiums and flexible payment terms. Policyholders can usually choose if they prefer to pay premiums:
This makes them simple, accessible, and affordable even for households on a budget. Many policies also give policyholders the option to transition them into a different type of insurance, such as Whole Life, when the policy term ends.
Cons of Term Insurance
Term insurance is good only for the set period of time dictated by the policy. If policyholders die during the covered term, their survivors receive benefits. If the policy expires before the policyholder dies, the policyholder and their family receive no benefits from the money they invested in that plan.
While premiums remain fairly stable, they can increase incrementally each year. Over the duration of the policy, this can lead to huge increases in premium costs. While policies tend to be convertible, doing so is often extremely expensive.
Is It Right for You?
Term insurance can be a good choice if:
- You are older and do not expect to outlive your policy term
- You need affordable life insurance that you can purchase quickly
- You want to secure insurance with a conversion clause now to ensure that possible future health problems do not lock you out of coverage
- You want a policy that does not carry cash value or interfere with other investment vehicles and plans
Whole Life Insurance
Whole life insurance is just what it sounds like: a policy that covers policyholders for their whole lives, regardless of how long they live. It is also a cash value-bearing account that policyholders can use as an investment vehicle.
Pros of Whole Life Insurance
Policyholders cannot outlive a Whole Life policy, thus guaranteeing that they will receive the promised benefits. Premiums remain mostly consistent over time and may eventually be payable out of the policy’s cash value. Policyholders can also earn dividends on their policy’s value and often borrow from that value via short-term loans.
This type of policy can help people build wealth they want to transfer to their heirs upon death and can play a key role in estate planning.
Cons of Whole Life Insurance
Once a policyholder has invested in a policy, they are committed to the premiums for life. This can drain cash reserves and make it harder to save for or meet other expenses. Failure to keep the policy paid up can result in its loss or failure to receive payouts upon death.
As investment vehicles, these policies are steady and secure but offer a relatively low return on investment over time compared to alternatives.
Universal Life Insurance
Like Whole Life insurance, Universal life insurance lasts from the time a person buys a policy until they cease paying for it or pass away. Also like Whole Life policies, Universal policies carry cash value and are often used as investment and estate planning tools.
What sets Universal policies apart is their premiums. Instead of the largely stable premium structure that Whole Life policies offer, Universal policy premiums intentionally go up over time. In theory, these rising costs can be balanced out if policyholders invest heavily in the first few years that they hold the policy.
When that happens, the growing cash value of the policy and the dividends on that growth should compensate for the rising premiums. Whether or not this is feasible can determine whether or not this type of plan offers the most benefits of life insurance options to a given buyer.
Before purchasing, buyers should do careful math on a plan’s premiums, expected returns, and average fees to determine if that particular policy is right for them. It may also be helpful to consult a tax or investment specialist for assistance.
Other Types of Life Insurance
There are many subtypes within the three main categories of life insurance. Examples include:
- Variable life insurance
- Final expense insurance
- Group life insurance
More information on unique subtypes of life insurance polices is available at Paradigm Life.
Smart Financial Management
Understanding the different types of life insurance and choosing a policy that’s right for you is a key part of smart money management. Learn more about how to make informed and empowering financial choices by exploring the other great articles in our Money section today.