Life insurance comes in many forms. Each type of life insurance has a different cost, offers varying features, and serves different purposes.
Here is an overview of the different types of life insurance.
With a guaranteed issue policy, you automatically qualify for life insurance coverage once you submit an application. There is nothing about your age, health, or other factors that disqualify you from coverage. Most group life insurance policies are guaranteed issue.
Group life insurance covers the lives of several individuals, usually based on employment with the same employer or on membership with the same organization.
Group life insurance is typically cheaper than an individual policy because the life insurance company is collecting premiums and spreading its risk among multiple people. Also, group policies are sometimes provided at no cost to the insureds by the plan sponsor, be it an employer or association.
This is a term used for life insurance offered by your employer that you can decide to buy or not. It requires employees to pay a monthly premium, though the premium is typically less than an individual policy bought without employer sponsorship.
Many voluntary plans allow you to buy insurance above the guaranteed issue amount. They also allow you to take your coverage with you if your employment is terminated.
As its name implies, this is life insurance you buy to supplement your existing coverage. Supplemental life insurance is often provided by employers as an employee benefit. You may find supplemental life insurance that covers burial costs or provides accidental death and dismemberment coverage.
Term life insurance is the most common and affordable type of life insurance policy. It covers you for a specified time period. Most terms are 10, 20, or 30 years. The shorter the term, the less you will pay in premium. Your premium amount will be the same for the entire term.
If you pass away within the term of your policy, the insurance company will pay a death benefit. If the term expires before your death, your coverage will terminate. You will have to decide whether to renew your life insurance.
The opposite of term life insurance is permanent life insurance. Permanent life insurance doesn’t expire as long as you pay the required premium. You can be covered by the same policy for your entire life.
Because they don’t expire, permanent life insurance policies are considerably more expensive than term policies. Many permanent life insurance policies have a cash value component. You can access this cash value through loans or withdrawals. However, many experts advise that the higher premium cost does not justify the availability of cash value.
There are several types of permanent life insurance, some of which are listed below.
Whole life insurance is designed to provide coverage for the life of the insured. As long as you pay the required premium, you will always have life insurance coverage. A whole life policy’s premium and death benefit typically remain the same for the life of the insurance contract.
Each premium payment goes to pay fees and charges for providing the insurance. Anything extra is held in an account that earns interest. This extra amount becomes the policy’s cash value.
Adjustable life insurance is a hybrid of term and whole life insurance that allows policyholders to adjust the coverage term, face amount, premium amount, and length of premium payment period. There is also a cash value component.
It’s designed to allow you to change your policy as your life changes. You get the benefits of a whole life policy with the flexibility to alter policy features. For example, you can increase the face amount when you get married or have children, or you can lower premium payments during a period of unemployment.
Similar to whole life insurance, universal life (UL) is a type of permanent coverage that can cover an individual for his or her entire life.
Universal life is much more complicated and typically more expensive than whole life.
In a universal life policy, your premium payments support the amount of coverage you elect to own, also known as the face amount. Each premium payment is placed in the policy’s account value. From that account, the insurance company deducts fees and charges for providing the insurance. Whatever is left over is considered the policy’s cash value, which earns interest.
The amount of premium you pay and the death benefit you receive can vary from month to month and year to year. This is largely dictated by how much interest is credited to the policy.
If your policy earns excess interest, you accumulate more cash value. Over time, this can result in a higher death benefit. It can also reduce the amount of premium needed to keep the coverage active.
But if your policy does not earn enough interest to cover policy charges, you could lose your life insurance coverage. It’s not uncommon for policyholders to have to dramatically increase their premium payments to make up for the lack of interest their policies earned in their early years.
What makes universal life even more complex is that there are multiple ways a policy can earn interest:
- Fixed UL credits interest based on a fixed interest rate. This rate is determined by the insurance company. It largely depends on the overall interest rate environment.
- Variable UL policies allow the policyholder to invest in mutual fund-like subaccounts. The interest you earn will vary based on the performance of those investments. You would be taking a risk with your insurance coverage. If the investments decline in value, your cash value will decrease as well. This means you could be forced to increase your premium to make up for those losses or risk losing your life insurance coverage altogether.
- Indexed UL is considered a hybrid of fixed and variable UL. It credits interest based on the upward movement of a market index, such as the S&P 500. But the policy’s cash value won’t decline if the index loses value. It just remains the same if there is a market loss. In exchange for offering downside protection, the insurer applies a cap to interest growth.
Final expense life insurance is a type of permanent coverage designed to provide funeral expenses and any final medical bills. The market for this type of insurance is people without dependents who would need a traditional term life insurance policy. It is for those who want a policy to pay for final expenses so family members do not have to pay for them.
This is a permanent type of life insurance policy, so it does not expire as long as you pay the premium. Final expense insurance typically does not require full underwriting.
Mortgage life insurance will pay off the balance of your mortgage if you die before paying it in full. It is typically sold by your bank or mortgage lender at the time you take out your mortgage. The death benefit goes to the lender to pay off the loan, not to your family or other beneficiaries. Plus, the death benefit is equal to the balance at the time you die, so it decreases over time as your mortgage balance decreases.
Credit life insurance is similar to mortgage life insurance. The difference is that it can also be used to pay off a car loan or a line of credit.
This is a type of life insurance policy that covers two lives with one policy. The death benefit is paid to the policy’s beneficiaries upon the deaths of both insureds.
Survivorship life insurance is often used as an estate planning tool by wealthy couples. Once an estate passes from both spouses to children or other beneficiaries, there are often estate taxes owed. A wealthy couple's beneficiaries can use the death benefit from the survivorship policy to cover the estate taxes owed.
This type of life insurance policy is also used by parents of special needs children to provide ongoing care once they pass away. It also has applications in transferring business between family members or partners.
Split-dollar life insurance refers to a strategy of buying life insurance, not a specific type of policy. Split-dollar allows two or more parties to share in the cost and benefit of a permanent life insurance policy. Most of these plans are used in business settings.
Split-dollar life insurance isn’t an insurance product or a reason to buy life insurance. Split-dollar is a strategy that allows the sharing of the cost and benefit of a permanent life insurance policy. Any permanent life insurance policy that builds cash value can be used.
A key person life insurance policy is one that a company buys on the life of one of its owners, executives, or key employees. The company pays the premiums and is the policy beneficiary.
It’s purchased in situations where the sudden death of a key person within the company would have a considerable negative effect on the company's operations. The death benefit of the policy would allow the company to continue operating and fund the cost of finding a replacement.
This is a strategy employed by people with millions in annual income and a net worth of at least $20 million. It’s a way to shelter assets from potentially high tax bills.
This is an uncommon type of life insurance used by banks to fund employee benefits on a tax-advantaged basis. The bank purchases the policy and is also the beneficiary and policy owner.
Jack Wolstenholm is the head of content at Breeze.
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