What Are The Types of Life Insurance Policies and Their Key Features?
A life insurance policy is a legal agreement between you and an insurance company.
If you pass away, the company will pay a lump sum of money, otherwise called a death benefit, to whoever you designated at the time of the application. In exchange, you pay monthly premiums, and the younger and healthier you are, the lower the premiums will be. Your beneficiaries can use the money to pay for funeral costs, everyday expenses, cover the mortgage, or meet any other financial responsibilities they have.
Types of Life Insurance
Purchasing a life insurance policy is an important part of your financial plan to ensure your family's financial security and well-being.
People have different preferences and goals, so there are different life insurance products out in the market to meet everyone’s needs. If you are just getting started, it’s always a good idea to learn the basics first. So, here is our breakdown of the five main types of life insurance, with their main features highlighted.
Term Life Insurance
Pros: Affordable, Easy to apply, Flexible
Cons: No cash value, No surrender amount, Increased premiums
Term life insurance is the most cost-effective option if you are looking for low premiums and comprehensive coverage. You get the coverage for a specific period and can renew it once it ends. You can typically get term coverage for anywhere from 10 to 40 years. You can also enhance your coverage by purchasing additional riders like accidental death or critical illness insurance.
While Term life Insurance has low premiums, it has a few drawbacks compared to other, more comprehensive coverage options. First, it can have higher premiums when you decide to renew it connected with your health and older age.
Whole Life Insurance
Pros: Permanent protection, Guaranteed coverage, Stable premiums
Cons: Higher cost, Complex
In exchange for regular premium payments, whole life insurance provides a guaranteed death benefit for the policy owner's entire life.
The cost of whole life insurance varies and is determined by a number of factors, including your age, occupation, and health history. Again, the younger and healthier you are, the less you will end up paying. The premium is also determined by the face amount of coverage; the higher the face amount, the higher the premium. It's also worth noting that whole life insurance is more expensive than term life insurance for the same amount of coverage.
Universal life insurance
Pros: Flexible, Cost-effective, Permanent, Builds cash value
Cons: No fixed premiums, You must monitor your policy
Universal Life Insurance is a type of permanent life insurance; that is, it provides guaranteed coverage lasting the policyholder’s lifetime. It has lower premiums than Whole life Insurance and is also more flexible in terms of where you can invest your policy’s cash value.
In contrast to term life insurance, Universal Life Insurance can accumulate interest-bearing funds like a savings account. In addition, policyholders can change their premiums and death benefits, and those who pay more toward their premiums receive interest on the excess.
Variable Life Insurance
Pros: Flexible premiums, Potential to earn more
Cons: Exposure to risk, Requires to monitor the policy, Complex
Variable life insurance is another type of permanent life insurance that has an investment component. The policy includes a cash-value account that is invested in a variety of sub-accounts. A sub-account functions similarly to a mutual fund, but it is only available through a variable life insurance policy. A typical variable life policy will have several sub-accounts you can choose from, with some policies offering up to 50 different options.
A variable life insurance policy, like mutual funds and other types of investments, must be introduced with a document detailing all policy charges, fees, and sub-account expenses.
As with any investment, you must manage risk and reward, account for expenses, keep track of asset allocation, and do everything else necessary to achieve peak performance. You must also understand how to work within the confines of existing tax laws. There are correct and incorrect ways to grow and withdraw cash from life insurance. If you are unwilling to do all this, consider choosing a more straightforward insurance plan.
Final Expense Insurance
Pros: Low premiums, Builds cash value, No medical exam
Cons: Small death benefit
Final expense insurance provides a death benefit designed to cover end-of-life expenses. It is also called funeral insurance or burial insurance and helps to pay for funeral services, casket or cremation, medical bills, nursing home bills, an obituary, flowers, and other expenses.
Final expense insurance also builds cash value that can be borrowed against during your lifetime. Unpaid loans reduce the amount of money your beneficiaries receive when you die. The premiums for final expense insurance, like any other type of life insurance, are determined by your age and health.
Final expense insurance is mostly favored by seniors who don’t want to burden their family members with funeral costs. It does not require a medical exam and is thus a good option for those who are turned down by traditional life insurance policies due to their health.
How much Life Insurance Do You Need?
To determine which type of life insurance is best for you, you first need to determine how much life insurance you need. Most financial advisors recommend multiplying your annual pre-tax salary by 8 to 10 times to find out how much you need. For example, if your annual salary is $70,000, ideally you should have $700,000 coverage.
The Bottom Line
If you want to determine the best type of life insurance for you, there are a few things to consider. First, you need to have your goal in mind. Whether you want to provide for your family in the event of your death, maintain your current living standards in case of a serious illness, or cover your funeral costs, there are different options. What you choose needs to meet your requirements and fit your situation. If you aren’t sure which way to go, seek professional advice and don’t fall into common marketing traps.