How To Understand The Different Types Of Life Insurance
Estimated reading time: 12 minutes
Let’s face it — life insurance isn’t the most exciting topic. In fact, most of us would prefer to avoid thinking about it or discussing it altogether because it makes us ponder and face our own mortality. But as they say, the only certainties in life are death and taxes.
Life insurance is a necessity. It’s not for you as much as for those you leave behind when you die. To understand how it works, we’ll need to explore the different types of life insurance available and why it’s important not to brush off this opportunity to mitigate risk.
You probably wouldn’t think of driving without car insurance. You likely hold a health insurance policy and a homeowner’s insurance policy as well. Life insurance is another critical component of your risk management portfolio. Here’s why life insurance is crucial and what you need to understand about the different types of insurance options available.
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Why Life Insurance is an Important Investment
There are a lot of misconceptions out there about life insurance. First of all, people may think they don’t need life insurance if they don’t hold assets or have beneficiaries. But the truth is, life insurance isn’t for you — it’s for those left behind.
Life insurance is especially crucial for women. Whether you’re the primary earner in your household or not, you should still consider life insurance. If something happened to you, could your family cover your funeral and burial expenses (often thousands of dollars), settle your estate, and get by on monthly expenses — maybe for years to come? That’s not even considering covering medical bills, especially if have a prelonged illness before your death.
If you’re single and don’t have dependents, you should still consult with a financial advisor you trust. Your business could be left at risk, as well as your home — especially if you leave an outstanding mortgage. If you have any assets, you’ll want to direct where they go (even if it simply means leaving them to charity). Your liabilities could fall on your siblings, your elderly parents, or other distant relatives if you don’t plan for the future.
There are many reasons to consider life insurance, but the biggest reason is to ensure you aren’t leaving a mess behind for someone else to deal with. Your life insurance investment will help provide for your beneficiaries, pay off your debts, and possibly leave you with a legacy after you pass.
When Should You Buy Life Insurance
So, if you’re convinced of (or at least considering) the merits of life insurance, you’re probably wondering if now is the right time. If you’re young and healthy, it’s a great time to buy insurance. Your premiums will be low and you can get a very robust policy for a minimal investment.
But what if you’ve had health issues? You can still qualify and purchase life insurance. See my guide on how to secure life insurance after a heart attack for more details. Of course, you might have other (or additional) preexisting health issues, that we’ll cover at a later date. And, yes, your premiums may be higher, but it’s still possible.
Of course, no matter your situation, the best time to consider life insurance is right now. Don’t wait until you have a near-death experience or face a health issue. We often think we’re invincible until something comes along and makes us face up to our mortality — we ignore the importance of life insurance until it’s too late.
The truth is, life is uncertain. Life insurance is always a good idea. Some critical times to consider life insurance (or to explore changing your policy) are:
- Change in marital status
- Birth or adoption of a child (or grandchild)
- Death of a family member
- New home or mortgage refinance
- Change in employment benefits
- Health changes or concerns
- And more…
In our FREE resource library, I’ve created a comprehensive list of all the Life Event Triggers that should spur you to consider your life insurance coverage. I urge you to take a look to ensure you are securing the right coverage for your family.
Temporary (Term) vs. Permanent (Universal Life & Whole Life) Life Insurance
If you’re ready to consider life insurance, it’s essential to familiarize yourself with the different types and terminology used in the life insurance world. For those of us (like yours truly) who have worked in the industry, it’s easy to forget that it all sounds like gibberish to those unfamiliar with life insurance basics.
I try to break everything down into simple terms for my readers. It’s easier to understand when you know the difference between the types of insurance and the many options available.
The first aspect of life insurance you might hear about is “temporary life insurance versus permanent life insurance.” You may also hear it referred to as “term” versus “whole life” or “universal life.” Let me break those two down for you.
Temporary Life Insurance
Temporary life insurance is often referred to as “term” because it’s broken into various terms: 10, 15, 20, 25, and 30-year options. Term life insurance is usually very affordable (at first, but it’s vital to realize most term life insurance isn’t meant as an investment strategy). In some cases, you can convert your term policy to permanent policy down the road (check to see if your policy has this option since some do not).
Once your term policy has ended, the policy is now an Annual Renewable Term (ART) policy. Meaning, if your 20-year Term policy ceases at the end of your age 60, your new premium will be based on your current age of 61 — and will continue to increase each and every year as long as you keep your policy. So keep in mind these policies may be appropriate in the early years, but they can ultimately become cost-prohibitive as the years go on. More on this below.
Temporary life insurance is often used to secure loans (home mortgage and business coverage, for example). These policies ensure that the lender will still be paid even if you should pass away. There’s no cash value in the policy. In other words, you can’t trade the policy in for value once the term is up. Should you pass away, your proceeds from the life policy are transferred to either the lender of your home (depending on if the lender is the beneficiary) or to your beneficiaries.
Permanent Life Insurance
Permanent life insurance is also referred to as “whole life” or “universal life insurance.” These policies are meant to provide for your loved ones when you die. The cash value of a permanent life insurance policy grows, tax-deferred. The proceeds of a life insurance policy are eventually transferred to beneficiaries income-tax-free, though they may still be included as part of your taxable estate for estate tax purposes. Although these policies are more expensive than term life, the cost over time remains constant.
The other advantage of permanent life policies is that they’re flexible and you can borrow against the policy if needed. There aren’t as many restrictions with these policies and they’re an excellent option for creating a legacy or establishing an opportunity for charitable giving. These policies typically cover your final expenses, settle your estate, and support your family after you pass away — think of it as long-term, permanent coverage.
Learn more about whole life insurance in my post, Insider Tips on Whole Life Insurance You Need to Know. We’ll explore these policies in greater detail and give you all the background you need to decide what’s best for your situation.
I’ve also created an easy printable breakdown with the advantages and disadvantages of both policy types. The guide is available in the free resource library under “Two Things to Know When Buying Insurance.” I suggest you print it out and use it as a handy reference as you decide what policy type you’re looking to purchase.
The Five Different Types of Term Life Insurance
Once you understand the different types of life insurance, you can break down your knowledge a little further by exploring the nuances of the different types of term life insurance.
Now before we go on, this isn’t an endorsement of one type of life insurance (term versus universal life or whole life). Your insurance needs are entirely based on your unique situation. Factors like your health, your finances, your expectations, and other investments should all be considered before buying a policy. In fact, I would say if anyone encourages you to buy a life insurance policy without looking at your personal circumstances, run!
As I’ve said before, term life insurance is coverage for a set term of years. The terms typically range from 5 to 30 years. Term life is useful in some situations, like covering outstanding liabilities (loans, business partnerships, etc.) and defraying some funeral costs.
Of course, I’m a bit biased, but I firmly believe everyone, even young children should have some life insurance, even if it’s just to help soften the costs should the unthinkable happen. I can’t tell you how heartbreaking it is to see families establish a GoFundMe account to cover the costs of a funeral for their child, and no one wants to be in that position. GoFundMe is not a life insurance policy.
So, in some situations, term life is a good consideration. Here are the different types of term life policies available to help you make an informed choice.
Guaranteed Level Term
Guaranteed level term life insurance is also referred to as specified term insurance. In this type of policy, the death benefit stays level over the years and the premiums don’t increase during the set length of the term.
Return of Premium Term
Return of premium policies is also referred to as ROP term insurance. The primary benefit of an ROP policy is that all of the premiums you have paid into your policy are returned to you at the end of the term length of the policy (assuming you’ve paid all your premiums and the death benefit hasn’t been paid out). ROP policies are often more expensive than other term life policies, and it’s important to realize that you don’t earn interest on all that money you’ve put in during the term.
Decreasing Term
Decreasing term life insurance is also referred to as “mortgage term” insurance. Over the life of the policy (the term), the death benefit decreases in correlation to the mortgage or personal debt it’s tied to. Decreasing policy insurance is often inexpensive, and the idea is that as you pay off your mortgage, you have less need for the higher death benefit.
Yearly Renewable Term
As I mentioned above, this is what your term policy becomes once your term-length has ended. You may hear yearly renewable term life insurance referred to as an annual renewable term (ART) or increasing term life insurance. With an ART policy, you can renew the policy each year without submitting to another medical examination, but the new premiums will continue to increase based on your age.
Group Term Life Insurance
Group term life insurance is precisely what it sounds like — a term life insurance policy that covers a group. This is usually provided through an employer, professional organization (like a union), or as part of another group. These policies are generally quite affordable, although the death benefit is often low. Premiums typically increase yearly or every five years (based on age).
To help you understand the various nuances of term life insurance policies, I’ve created a term life insurance guide in the resource library as well. This guide is a helpful, printable option you can keep on-hand as you decide on the right insurance coverage for your particular situation.
Life Insurance: Not Sexy, but Necessary
So, while life insurance isn’t the sexiest or most fascinating topic for your next dinner party, it’s an essential piece of your financial landscape. If you’re working on organizing your finances and getting control over your money, don’t overlook life insurance.
This investment seems like something that’s far off in the distance and it’s nothing any of us like to consider, but the reality is life is uncertain. We never know what could happen to us when we walk out the door each day. It’s far better to take these precautionary measures to protect your loved ones.
On a personal note, I’ve seen what happens to families (clients’ and my own) when someone doesn’t have a life insurance policy in place. It adds another layer of stress and confusion to the grieving process. Don’t leave your family in a dangerous, painful position. Make life insurance a priority for their protection and your peace of mind.
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