It’s a common misconception that life insurance is something you only need at an older age, when you’re thinking about retirement or are getting ready to leave money to your loved ones. But in reality, life insurance can be beneficial for almost everyone, regardless of your age or your current financial situation.
If you’re exploring the idea of investing in a life insurance policy, there are a few things you’ll need to consider first. Most importantly, you have to decide what type of policy is best for your family’s needs. Life insurance is not a one-size-fits-all—there are lots of different policies available, and they each serve a different purpose.
In this guide, we’ll go over the most common types of life insurance, explain how each one works, and highlight some of the benefits and drawback. But first, let’s quickly discuss the basics of life insurance and review some important terminology.
How life insurance works
A standard life insurance policy has two main components—a premium and a death benefit. To keep your policy in force, you pay a monthly or annual fee, called the premium. When you pass away, a beneficiary of your choosing receives a payout called the death benefit. The money is typically distributed tax-free and can be used for any purpose.
There are two main categories of life insurance—term life insurance and permanent life insurance. Term life insurance protects you for a certain number of years, whereas permanent life insurance protects you for your lifetime. Term life insurance is usually cheaper than permanent life insurance, but the cost of term life insurance gets more expensive with age.
Permanent life insurance policies also have a component called cash value, which most term life policies do not include. When you pay your premium, a portion of the money goes into a savings account, where the cash value grows overtime. You have the option to withdraw the cash value or borrow the money like a loan if you need to access funds from your policy while you are still living.
If you’re wondering how much life insurance costs, the answer is—it depends. Life insurance premiums are based on lots of individualized factors, like your age, current health, family medical history, and the type of policy and amount of coverage you get.
For most life insurance policies, you are required to take a medical exam where a physician will check your vitals, draw blood, and ask questions about your health history and your family's medical history. You can get life insurance without taking a medical exam, but the premiums are more expensive, and you may only qualify for a limited amount of coverage.
Types of life insurance
There are several types of life insurance which differ in a variety of ways, including cost, how long the coverage lasts, and what benefits are included. Here are the main types of life insurance you can get, keeping in mind that not every life insurance company will sell these exact policies.
Term life insurance
Term life insurance offers coverage over a fixed period of time, called a term. When you purchase a policy, you get to choose the term, which typically ranges anywhere from 10 to 30 years (and is often available in 5-year increments).
Term life policies have fixed premiums that stay level over the duration of the term, as well as a guaranteed death benefit that gets paid out if you pass away during the term. As mentioned, most term life insurance policies do not accumulate cash value.
If you outlive the term, a few things can happen:
- If your policy is convertible, you can roll the term policy into a permanent policy from the same company.
- If your policy is renewable, you can renew your term coverage every year after the initial term ends (at a higher premium).
If neither of these options are available, your coverage terminates when the term ends, and you are no longer covered. You will need to apply for another life insurance policy if you want to continue your coverage.
Whole life insurance
Whole life insurance is a form of permanent coverage that offers lifetime protection, starting the moment your policy takes effect and ending when you pass away. Whole life policies have level premiums and a guaranteed death benefit, as long as your premiums are paid.
Whole life policies also build cash value. In most cases, the cash value associated with a whole life insurance policy grows based on current interest rates and has a guaranteed rate of return. The money can be borrowed or withdrawn, but there are some strings attached—whatever you take out gets subtracted from your death benefit, unless you repay the balance.
Universal life insurance
Universal life insurance (UL) is similar to whole life insurance in the sense that it offers permanent coverage and builds cash value. The difference is that universal life policies have a flexible death benefit and adjustable premiums.
Universal life insurance can be a good option if you want the ability to change your policy’s death benefit based on your family’s financial needs. Similarly, you can tap into your cash value to change the frequency and amount of your monthly premiums.
Universal life is available as a standalone policy, but there are also two derivatives of universal life insurance—indexed universal and variable universal life insurance. The main difference between these policies is how the cash value grows.
Indexed universal life insurance
With an indexed universal life insurance policy (IUL), the cash value growth is tied to a stock market index, such as the S&P 500. Your cash value has the ability to make gains based on market upswings, but similarly, market downturns can cause your cash value to diminish. There are also caps, so you can’t make infinite gains during a great market year.
Variable universal life insurance
With a variable universal life insurance policy (VUL), the cash value gets invested into investment accounts (commonly in mutual funds and bonds). Variable universal life is often considered to be the riskiest form of universal life insurance because the money is actually invested into stocks. There are also fees and administrative costs that are required with variable universal life, which makes this policy more expensive than other types of life insurance.
Final expense life insurance
Final expense life insurance provides permanent coverage for people who want to put money aside for their end-of-life costs, such as a funeral, cremation services, final medical bills, or unpaid debt.
Final expense insurance policies are a form of guaranteed issue life insurance, which means you don’t have to take a medical exam or submit a health questionnaire, and everyone who applies gets approved. However, this type of life insurance offers a very small amount of coverage, usually around $50,000 or less, and has high premiums.
As a result, final expense life insurance is typically recommended for people with pre-existing medical conditions, or those who have struggled to get approved for traditional life insurance. It’s not the best option for people who are healthy and can qualify for a standard policy.
Group life insurance
The last “type” of life insurance you should know about is group life insurance, which is more commonly known as employer-sponsored life insurance. When you opt into your employer’s group life insurance plan, you usually have a few policies to choose from, which are all issued by the same company.
The biggest benefit of group life insurance is that the premiums are subsidized by your employer, so your out-of-pocket premium is cheaper than if you had an individual policy. However, if you quit your job, you typically lose your life insurance benefits, which can leave you unprotected until you get a new job or buy a policy on your own.
Elizabeth Rivelli is a freelance insurance and personal finance contributor for CompareOffers.com and enjoys making home, auto and life insurance understandable for readers so they can prepare for the future. Her work have appeared in numerous online publications.