Life insurance coverage can provide crucial financial protection for your loved ones after you die.
“At its core, life insurance is protection — a hedge against the unexpected,” says Aaron Ball, senior vice president and head of insurance solutions, service, and marketing at New York Life. “You are paying premiums in exchange for the promise that the insurer will be there when you need them most.”
While many people understand the importance of this coverage, choosing exactly the right policy can be difficult.
“There are different types of life insurance, and choosing a policy is an important decision,” says Brian Bayerle, senior actuary at the American Council of Life Insurers. “Everyone’s needs are different.”
Here is a guide to the different types of life insurance and some tips on finding the right kind of coverage for your situation.
What are the different types of life insurance?
There are many different life insurance policy types. Choosing the right coverage can help you get the most from this type of insurance.
- There are multiple types of life insurance, including term life, whole life and final expense insurance.
- The best life insurance for you depends on what you want and need from coverage.
- Term life is usually less expensive than whole life, but you may outlive your policy.
- You can often benefit from permanent life insurance policies while you’re still alive, including tapping into the policy’s cash value and riders that help with long-term care and critical illness.
Here are the basic types of life insurance options.
Term life Insurance
Term life insurance provides coverage for a specific period — or term. For example, if you purchase a term life insurance policy, you typically will be covered for between 10 and 30 years.
Term life is more affordable than permanent life insurance and can be purchased in large amounts. People often buy term insurance during their peak earning years and when they’re raising a family.
“Term insurance is often used to cover financial obligations that will disappear over time, such as tuition or mortgage payments,” Bayerle says.
When a term life policy expires, the policy simply ends. However, these policies often are renewable or can be converted to whole life policies.
“Term insurance makes sense if you are looking for protection and a death benefit over a certain period of time, with a lower monthly financial commitment,” Ball says.
Premiums can be level term or may increase over time. It depends on which type of term policy you choose.
Guaranteed term is the most common type of term life policy. In those policies, you pay the same amount through the period.
However, you can instead get a term life policy with lower premiums at first and higher costs later in the term. This policy may be for someone who expects to make more money later in life.
Whole life insurance
Whole life insurance is a type of permanent life insurance. A whole life policy remains in place for the insured’s lifetime as long as he or she pays premiums. Unlike term life insurance, a whole life insurance policy doesn’t expire after a specific period.
“Your rate is locked in with no end date, ensuring your assets are protected for the long term with a guaranteed death benefit,” Ball says.
A whole life insurance policy includes a “cash value” component. As the money grows over time, it provides a resource you can dip into to cover expenses during your lifetime.
“Cash value takes time to grow,” Bayerle says. “But after several years, a policy’s cash value can offer policyholders several options.”
Policyholders can use a policy’s cash value to:
- Borrow from the insurer using the cash value as collateral
- Use the cash value to pay premiums or to buy more coverage
- Exchange the policy by using the cash value to purchase an annuity
- Cancel (surrender) the policy and receive the cash value in a lump sum
A whole life contract is designed so that you can take advantage of the cash value. Your beneficiaries only receive the death benefit when you die — not the cash value that’s accumulated.
Whole life policies’ earnings usually grow faster than your “mortality cost” (which is the cost to insure you) during your life. At that time, you could take those earnings and put them toward your premium payments.
Premiums tend to be higher with whole life insurance than they are with term insurance.
Permanent life plans like whole life offer riders. Policy riders can include:
All of these provide supplemental coverage that goes beyond a death benefit. Find out more about life insurance riders.
Universal life insurance
Universal life insurance is a form of permanent life insurance that offers extra flexibility to the policyholder. You can raise or lower your coverage or premiums as needs change. This type of policy also allows you to build a cash value account that typically earns money market rates of interest.
“Under the terms of the policy, the excess of premium payments above the current cost of insurance is credited to the cash value of the policy, which is credited each month with interest. The insurance company offers no guarantees and the policy requires an annual review by the agent or advisor each and every year,” Maloney said.
People look to universal life insurance if they want to maximize their long-term coverage, are less concerned with building cash value and want “the ability to customize their protection upfront and make adjustments down the road,” Ball says.
Variable life insurance
Another type of permanent life insurance, variable universal life insurance offers the policyholder a savings component that can be used to invest in stocks, bonds and other instruments. The upside is that a variable life insurance policy’s value has the potential to grow quickly. But there is a risk with this type of policy.
“If the market doesn’t perform well, the cash value and death benefit may decrease,” Bayerle says. “But some policies guarantee that the death benefit won’t fall below a certain level.”
Group life insurance
group life insurance is a type of coverage that groups provide to their members. Employers most often offer this type of coverage to their employees. While it’s easy to qualify for this coverage and group life insurance costs are cheap — and often free — the type of coverage you receive is limited.
The death benefits are often much lower than an individual policy and you usually lose coverage when you leave that job.
Term life insurance vs. whole life insurance
Term and permanent policies, such as whole life insurance, are two very different forms of coverage.
With term life insurance, you pay for coverage that lasts for a specified time frame. This type of policy only pays out if you die during the term. The coverage itself tends to be relatively affordable.
A whole life insurance policy doesn’t end until you die or stop paying premiums. Not only does this type of policy pay a death benefit, but it also builds cash value that you can borrow or withdraw over time. Whole life policies tend to be more expensive than term life policies.
There are fundamental differences between term life and whole life insurance:
- Term life insurance provides coverage for a specific period, with 10, 15 or 20 years being the most common term lengths.
- Whole life is for your entire life.
- If you outlive your term life policy, you have to shop for another one if you want coverage or convert the term life to a permanent life policy.
- A whole life policy doesn’t expire — until you do.
- Your premium for term life either increases over time or is set depending on the policy.
- Whole life premiums are consistent.
- Term life usually costs less.
- Whole life has smaller payouts.
- Term life doesn’t offer savings components.
- Whole life policies have a cash value component.
What type of life insurance is best for you?
Choosing the right life insurance depends on what you want out of your life insurance.
- Do you want investment options?
- Do you want a simple, no-nonsense coverage benefit that is paid to the people you love when you’re gone?
- Do you want to protect your loved ones during your peak earning years?
- Do you just want enough to pay off your expenses, your funeral and provide for a few mortgage payments?
- Do you want to add riders?
- Do you want level premiums?
Answering these questions can help you narrow your focus.
“I am an advocate for cash value insurance,” says Robert Maloney, chief listener and a fee-only retirement planner at Squam Lakes Financial Advisors in Grafton County, New Hampshire. “However, term insurance has its place if it is used for a specific period of time.
If used properly and with the understanding that the policy needs to be reviewed each year, as a fee-only financial advisor, I will typically recommend a low-load fixed universal policy for my clients who can afford to make larger premium payments that develop early cash values in the very first year.”
Maloney says a family’s situation determines which policy is best for any individual client.
“For young couples facing a mortgage and college education, 20- or 30-year level term may provide the assurance that the family needs at minimal costs. On the other hand, a family further along in life where they are looking for a form of payments that will develop a savings reserve may look to universal life or whole life insurance. Term insurance is always better than no insurance,” Maloney said.
When deciding on life insurance, make sure to get quotes from multiple life insurance companies. If you need assistance in deciding on coverage,our life insurance advisor can help, too.
Let’s take a look at various types of life insurance to see which ones might benefit specific situations.
|Specific Situations||Term||Whole||Universal||Variable||Final Expense||Group|
|Best for paying mortgage and future education needs||✓|
|Best for getting the most coverage||✓|
|Best to guarantee a death benefit||✓||✓||✓||✓|
|Best for people who want policy riders||✓||✓||✓|
|Best for peak earning years||✓|
|Best for people with limited life insurance options||✓||✓|
|Best to pay only funeral costs||✓|
|Best for those who may want to tap into policy while still alive||✓||✓||✓|
|Best for those who want to make investments||✓|
|Best for those who want coverage and payment flexibility||✓|
|Best for those who want cheapest option||✓||✓||✓|
|Best for those who don’t want to take medical exam||✓||✓|
Compare the different types of life insurance
Let’s take a look at the different life insurance types to help compare plan types.
|Life Insurance||Length of policy||Cash value?||Death benefit|
|Term||Often between 10 and 30 years||No||More than $100,000|
|Whole||Lifetime||Yes||More than $50,000|
|Universal||Lifetime||Yes||More than $50,000|
|Variable||Lifetime||Yes||More than $50,000|
|Final expense||Lifetime||Yes||$5,000 to $25,000|
|Group||Usually connected to employment||No||Often one or two times of annual salary|
Frequently Asked Questions
What are the three main types of life insurance?
Life insurance is often divided into three major categories: term, whole and final expense insurance.
Term life is for a period and you can outlive your policy. Whole life is for a lifetime and has a cash value component.
Final expense insurance, also known as burial insurance or funeral insurance, is usually one with a low face value that you purchase directly from a life insurance company. It’s usually simple to set up.
As the name suggests, final expense insurance is meant to help with funeral costs and other final expenses. Final expense insurance could be a good choice if you can’t get a regular term or whole life policy. This might be because of your age or health.
Usually, you can get a final expense policy that falls under a simplified issue. In that case, you have to answer medical questions but don’t have to take a medical exam. You may also find a guaranteed issue policy, which doesn’t require any questions or a medical exam.
If you have a serious health problem, you may get what is called a “graded death benefit,” which increases the coverage amount over time.
Keep in mind that while you can get final expense insurance, your term life or whole life insurance could also be used for the same purposes.
Which is better — term or whole life insurance?
When comparing term insurance to whole life insurance, it’s impossible to say one is better than the other. Each type of coverage can make sense, depending on the policyholder’s needs.
“Many people own both types of policies to address their long-term financial needs,” Bayerle says.
What type of life insurance is best?
There is no one best type of life insurance for everybody. Each type of insurance has its pros and cons, and the best policy for you may be very different from the policy that is best for your neighbor.
“A licensed life insurance agent can help someone find the right life insurance policy to meet his or her needs,” Bayerle says.
Term life vs. permanent life insurance
Term policies allow you to pay for coverage that lasts for a specified time frame. This type of policy only pays out if you die during the term. The coverage itself tends to be relatively affordable.
Permanent insurance remains in place until you die or stop paying premiums. This type of policy pays a death benefit to loved ones.
Types of permanent life insurance are whole, universal and variable.
What does life insurance typically cover?
Life insurance helps loved ones cover their expenses after you die.
“Life insurance is critical financial protection for families,” Bayerle says. “It provides the resources they may need to pay immediate and continuing expenses after the death of a wage earner.”
The death benefit that beneficiaries receive can be an important financial resource that helps cover the cost of:
- Daily living expenses
- Loans loans
- Credit card bills
- School tuition
“Some experts suggest that a life insurance policy should pay a benefit equal to seven to 10 times a policyholder’s annual income,” Bayerle says. “An individual’s needs could be higher or lower depending on his or her unique situation.”