Let’s Break Down the 5 Different Types of Life Insurance Policies

The information surrounding purchasing a life insurance policy can confuse people. Most people must trust their life insurance agent and hope that the agent is looking out for their best interests. Fortunately, when recommending a specific life insurance policy, most agents do so with their client’s best interests in mind. Unfortunately, most people will not know if an agent does not have the best intentions until it is too late.

It is recommended that you take your time to educate yourself regarding the different types of life insurance policies.  This is for the protection of everyone purchasing a life insurance contract. Understanding the fundamentals of life insurance, such as the different types of life insurance and how they all work in different ways.

By taking some time to educate yourself, you will be able to understand what it is that your life insurance agent is suggesting. The small amount of effort that this takes could change the trajectory of your life.  While an agent will do their best based on the information provided, you are the only one who truly knows your situation.

In this article, let’s take a look at the five major types of life insurance policies, what they mean, the pros and cons, and more.

What are the fundamental characteristics of a life insurance policy?

A life insurance policy is, at its core, a promise to provide financial security to your loved ones at your death. Let’s first take a look at the few key features that define how a policy fulfills that promise:

• The premium – The monthly or annual payments required to keep the policy active.
• The length of the policy, also known as the term, is the time period for which the insurer agrees to pay a death benefit. A policy is defined as a set number of years, such as 10, 20, or 30. A permanent policy lasts for the insured’s life.
• Beneficiaries: The individual or individuals who receive the death benefit. It can be given to a single person (for example, a surviving spouse) or divided among a few people in proportion (e.g., a spouse could get 50 percent, and two adult children could each get 25 percent ).
  By the way, a beneficiary does not have to be a blood relative. In fact, it doesn’t even have to be a person – you can leave all or part of your death benefit to an entity, such as a charitable cause if you so desire.
• The death benefit is the sum of money paid by the insurance company when the insured person dies. This benefit is typically tax-free.
• The cash value – The investment component of the policy that accumulates over time.  It can be cashed out or borrowed against.

Keep in mind that a term policy does not have any monetary value.  We will go over this later.

What are the 5 Main Types Of Life Insurance?

There are different types of policies for different reasons. We will go over the term, whole, universal, variable, and final expense Life Insurance policies to give you a better understanding of each. However, should you have questions, you should contact an independent life insurance agent or advisor.

Life insurance policies are classified into five types. Term life insurance, whole life insurance, universal life insurance, variable life, and final expense life insurance. There are additional variations within each of these life insurance policy types classes.  But most of all, policies fall into one of these five categories. Let’s take a look at all of these, the benefits of each, and the differences.

Term Life Insurance Policy

A term life insurance policy is exactly what it sounds like: coverage for a set period of time.  It is usually between 10 to 30-year terms. However, some companies like Banner Life Insurance offer a new 40-year term life insurance policy. It is the one type of life insurance that has no cash value. Its sole purpose is to pay your beneficiaries out if they die during the term.

Most individual term policies have level premiums, meaning you pay the same amount every month. When the term expires, there is no more coverage.  You must either go without or obtain a new policy.  Most of the time, this new policy will most likely be more expensive.  The older you are, the more expensive it is to obtain a policy. Many providers will, however, allow you to convert a term policy to permanent life insurance for a portion or all of the coverage period.

While you can obtain this policy independently, some get it through an employer.  If you get term life insurance through your employer.  The rates are usually issued “on attained age,” which means they will rise over time due to you being placed in age band group cost. Also, if you were to leave your job or get laid off, the coverage typically is not portable. This means you don’t have the coverage with you when you leave.

Best for: Most people. Term life insurance is simple and inexpensive; the main objective is to replace your income when you die.

Pros: It is frequently the cheapest life insurance.  It is considered the most adequate for the majority of people.

Cons: If you outlive your policy, your beneficiaries will not be paid.

Whole Life Insurance Policy

A whole life policy is the most basic type of permanent life insurance.  It provides coverage for the rest of your life. It includes a cash value component, as do other permanent policies.  This means that your premium dollars will be placed into a cash-value account that will grow over time.  This amount will be taxed deferred, and you won’t have to worry about paying gains on it. 

In comparison to other types of permanent coverage, a whole-life policy has three distinguishing features:

• The policy contains guaranteed cash values that grow at a fixed rate.
• The death benefit is guaranteed as long as the guaranteed premiums are paid.
• For the rest of one’s life, the level premium remains constant.

Cash value provides several significant advantages that you can take advantage of while you are still alive. It will take a few years for it to grow into a useful amount.  But once it does, you can borrow against it and surrender it for cash to live on in retirement or pay your premiums.

More about the whole life…

When you purchase a whole life insurance policy from a mutual company, your cash value can earn annual dividends. You will receive a portion of the insurer’s profits.  These profits can be used to increase the value of your policy and provide additional benefits.

Various types of whole life insurance are appropriate for various groups of people. Whole life insurance can also be used to:

• Ensure that money is available for family members in the event of death, an accident, or a serious illness.
• Pay off mortgages
• Liquidate business debts
• In some cases, provide funds to family members due to the breadwinner’s death.

Unlike term life insurance, which only pays out after the insured’s death, whole life insurance policies provide living benefits and a cash accumulation for family members after the insured’s death.

Best for: Individuals wanting a permanent policy and can afford higher monthly premiums.

Pros: It protects you for the rest of your life and accumulates cash value.

Cons: It’s usually more expensive than term life, so if you’re looking for cheap life insurance, you should look into other options.

Whole Life Insurance vs. Term Life Insurance

The following are the primary distinctions between term and whole life insurance:

The premium: For a given death benefit – say, $100,000 – whole life premiums will be higher.  There is a certainty that your beneficiaries will be paid a death benefit at some point.

The cash value: Once a term policy expires, it has no value. A whole-life policy is a long-term asset.  It can be used to help meet financial goals before, during, and after retirement.

The policy’s duration: A whole-life policy covers you for the rest of your life.  A set number of years is only covered by a term policy. 

Universal Life Insurance Policy

A universal life policy is a type of permanent insurance that provides the cash value and lifetime coverage benefits of a whole-life policy. However, there is a significant difference between whole life and term life.  This difference is that the premiums are flexible.

With a universal policy, you can adjust the amount you pay into the policy as you see fit, within the policy’s limits. Paying less may eventually necessitate paying more later to maintain your coverage. This type of policy can be tailored to your specific needs.  It will still provide the same level of cash value growth as whole life insurance. Having taken out a loan for a business, changing jobs, or having another child are all examples of situations where a balance of flexibility and security is required. This balance is why some people choose universal over whole-life insurance.

Universal Cash Value 

A universal life insurance policy has a cash value.  It then grows at a rate determined by the insurance company’s performance and current interest rates.  Typically, there is a guaranteed minimum annual growth rate of 2%.

Best for: Individuals who want a permanent policy but have the flexibility to change payments in the future.

Pros: The low cash value makes it less expensive than whole life and other types of universal life insurance.

Cons: If you fail to pay, you may lose your policy. You’d walk away with nothing because the policy has no cash value.

Variable Life Insurance

Variable life insurance is a type of life insurance policy that combines a death benefit (money paid to your beneficiaries when you die) with an investment component. Here’s a simple breakdown:

1. Death Benefit: Like other life insurance policies, variable life insurance provides a sum of money to your beneficiaries if you pass away. This money helps support your loved ones financially after you’re gone.
2. Investment Component: What makes variable life insurance different is that part of the money you pay into the policy (the premiums) is invested in different investment options, like stocks, bonds, or mutual funds. These investments can potentially grow over time.
3. Cash Value: As your investments grow, the policy accumulates cash value. You can often borrow against this cash value or even withdraw some of it, but doing so might affect the death benefit and could have tax implications.
4. Risk and Reward: Risk is involved since your money is invested in the market. Your policy’s cash value and death benefit may increase if the investments perform well. However, your cash value and death benefit may decrease if the investments perform poorly.

In essence, variable life insurance offers both insurance protection and an opportunity for investment growth, but it also comes with risks and complexities that you should understand before purchasing. Before deciding if variable life insurance is right for you, reviewing and understanding the policy details, including fees, investment options, and potential risks, is important.

Best for: Individuals with a high-risk tolerance and who can manage control over their cash value investments.

Pros: The significant advantage of variable life insurance is the potential for investment growth, flexibility of payments, tax-deferred benefits, and protection from creditors.

Cons: The investment risk is the biggest drawback of variable life insurance. It’s a complex financial product with a range of various fees, including administrative fees, mortality and expense charges, and investment management fees. This financial product does not typically offer guaranteed returns or fixed premiums, and if you surrender the policy or cancel early, you may be subject to surrender charges or penalties.

In summary, while variable life insurance offers the potential for investment growth and flexibility, it also comes with significant risks and complexities. It’s essential to carefully weigh the pros and cons and thoroughly understand the terms, fees, and risks of variable life insurance before purchasing a policy. Consulting with a fee-only financial advisor- an advisor who doesn’t earn a commission based on product sales rather than is paid by you directly. Can help you make an informed decision based on your individual financial situation and goals.

Final Expense or Burial Insurance

Final expense insurance is a type of life insurance that only covers end-of-life expenses. These expenses are things such as burial expenses or funeral expenses. The coverage is permanent because the policy will remain effective if you pay your premiums. However, these policies typically do not have a cash value or an investment component. If so, it’s of a very small cash value amount. Typically, older people frequently purchase final expense policies to ensure that their dependent children are not left worrying about the cost of their final expenses, or they wish to leave a legacy behind for their grandchildren.

While the premiums for these plans are typically low, the death benefit is also modest.  It is not intended to provide your beneficiaries with years of financial support. Younger, healthier people who want to build cash value or a significant death benefit for their families will likely find a whole life, universal life, or term life policy to be more valuable.
Best for: Individuals who want to cover their own funeral, cremation or burial, and other end-of-life expenses.

Pros: No medical exams are required! However, they typically ask some health-related questions to qualify.

Cons: The coverages are typically low face amounts in the range of $5,000 to $50,000. Also, depending on your health, some carriers may have a two or three-year waiting period before the policy will pay out the full death benefit.

Insurance with a simplified issue and insurance with a guaranteed issue

Most life insurance policies are underwritten.  This means a medical exam is required for the application process. This allows the provider to assess your risk of insurability. A medical exam is not required for simplified issues or guaranteed issue policies. These policies are primarily intended for older applicants or those with serious health issues.  These applicants may not be eligible for policies requiring a medical exam.

Frequently Asked Questions about Life Insurance Policy Types

What is Variable universal life insurance?
Variable life insurance, like universal life, is permanent insurance.  It allows you to adjust your premium to account for changes in your income or expenses. The value may rise or fall depending on the performance of those investments. Because of this flexibility – and variability – you should review your policy regularly.  This will help you to avoid a policy lapse.  This is especially important when market conditions change.

What is the definition of permanent life insurance?
Permanent life insurance is life insurance that covers you for your entire life,  as opposed to a set period of time, as is the case with term life insurance. Whole life insurance and universal life insurance are two types of permanent life insurance.  They not only provide indefinite coverage but also accumulate cash value.

What is the definition of cash-value life insurance?
Cash-value life insurance is a type of permanent life insurance policy.  It accumulates cash value. This cash-value insurance includes both universal life insurance and whole life insurance.

What is the best kind of life insurance policy to get?
Your needs and financial situation determine the best life insurance policy for you. Term life insurance is sufficient for most people and the least expensive type of coverage. It lasts for a set period of time and guarantees a payout if you die during that time.

A permanent policy, such as whole life insurance, may be a good fit if you want lifelong coverage. Over time, these policies accrue cash value. Once you’ve saved enough, you can begin borrowing against your policy.

In Conclusion: Choosing the Best Life Insurance Policy

Whatever type of life insurance you choose, it is critical to understand the specific rules and terms of each type of insurance and each specific policy. Different types of policies may be appropriate for different people depending on their age, needs, and risk tolerance. Each type of policy has a different cost. Working with an independent life insurance advisor whom you trust and are comfortable discussing your future with is very important.