What Are the Different Types of Life Insurance?
There are two basic types of life insurance, term life and whole life. Depending on your age, health, and overall financial goals you need to weigh the benefits of both before deciding which type of insurance to purchase. You may only need one type or you may need both. Understanding what each has to offer is key in making a sound decision.
Here are the different types of life insurance that exist and what you need to know.
Term Life Insurance
- Term insurance only pays a benefit as result of a death within the term period. The term period usually ranges from one to thirty years.
- There are two types of term insurance, level term and decreasing term.
- Level term means that the death benefit will remain the same throughout the existence of the policy.
- Some level term policies may contain an increasing benefit rider, which increases the death benefit each year over the course of your term. You will, however, agree to pay slightly higher premiums each year as well.
- Decreasing term means that the death benefit is steadily reduced, usually in one year increments, throughout the existence of the policy.
Whole Life Insurance
- Whole life does not expire. It will be pay a death benefit no matter when you die. It does not limit you to a term period.
- There are four types of whole life insurance. They are traditional, universal, variable, and variable universal.
- In a traditional policy, the death benefit and premium stay “level” throughout the life of the policy. What this means, is that a higher than needed premium is paid in the early years to offset the cost of benefits in the later years. Basically, the “overpayments” are invested to cover the death benefits of older policy holders. Companies are legally bound to adhere to limitations of these “overpayments.” Once they reach a certain amount, the money becomes available to the policy holder if they choose not to maintain the policy until death. Essentially, it is like having a savings account.
- A universal policy has its own key characteristics. You may be able to increase your death benefit if you pass a medical exam. The cash value account or “savings account” earns interest at a money market rate. Once you have enough money in your cash value account you may be able to adjust your premium payments.
- A variable policy allows you to invest your death protection and cash value in stocks, bonds, and mutual funds. You have the opportunity to grow your policy quickly. You also, however, assume more risk and may end up with a decreased benefit or cash value.
- The variable universal policy combines the principles available in both universal and variable policies. You can adjust premiums and death benefits like you can with universal, but you can also invest aggressively with the potential for greater rewards as with variable.
Educating yourself and understanding the life insurance options that are available is the first step. Next, you will need to examine your own family structure and financial goals to determine which policy will be best for you and your loved ones. A financial advisor can help you determine which life insurance is right for you.
Erik O. Klumpp, CFP® is Founder and President of Chessie Advisors, LLC, a fee only financial planning and investment management firm. Based in the Metro Detroit city of Rochester Hills, Michigan, Chessie Advisors specializes in providing financial planning and investment management guidance to teachers, engineers, and young professionals both within Michigan and virtually throughout the United States. He is also Founder and President of Chessie Tax, LLC, a firm that specializes in providing income tax preparation, planning, and bookkeeping services to individuals and small businesses. Chessie Tax, LLC is also based in Rochester Hills, Michigan.
Erik and I met through NAPFA and I asked him to write some thoughts on “What Are the Different Types of Life Insurance?” as an educational topic for this site.