What are the types of life insurance?
It’s hard to believe that life insurance has been around since the 1700s and even still is so misunderstood in its purpose. The original intent of life insurance was to provide a source of income for beneficiaries of the insured, in the event of the insured’s death.
This purpose makes sense when you put it in the context of the 1700s in which, typically the wives in society would tend to the children and all the income would be provided by the husband. This meant that the loss of a husband would be financially devastating for the spouse and children, thus life insurance solved a problem.
Nowadays there are multiple types of insurance, all with varying features that make it much more complicated to understand (1) if you as an individual or family need a policy (2) what type of policy is best suited for you and (3) what features are part of the policy you choose. This blog post is aimed at providing a brief overview of the types of life insurance.
First, it’s important to note the two categories of life insurance and differentiate them. There is what is called “Term” insurance and “Permanent” insurance. Term insurance simply means that the policy insures the life of individual for a period of time (a term of 30 yrs for example) and upon the death of that individual, it pays the beneficiaries a lump sum. Permanent policies are not for a period of time, but instead offer coverage on an insured for the life of the individual, providing a payout at death as long as the premiums are kept up with and the policy doesn’t lapse.
Now that we have stated the two major categories, lets explore the types within each a little further:
As aforementioned, a term policy is relatively straight forward. There are multiple types of term with varying premium calculations but at the end of the day, the policy itself is temporary. It’s typically meant to cover a person’s life just until there is either enough assets built up that would support his/her beneficiary or commonly, the children are grown by age 30 and can tend for themselves so there is really no need to cover the insureds entire life. Within term policies, there are some that have fixed premiums, others that have decreasing premiums, and even some that renew each year (called annual renewable term and typically meaning premiums increase each year). These types are beyond the scope of this post but will be shared in future blog posts.
There are essentially 3 types of permanent life insurance; whole life insurance, universal life insurance, or variable life insurance.
Whole life insurance has two elements to it. Similar to term insurance, it has a death benefit that gets paid out at the death of the insured but it also has something called “cash value” that accrues. First it’s important to note that because this type of insurance is permanent, the premiums are more expensive. When a premium is paid, a portion of that premium goes towards the death benefit just like the term policy but the rest of the premium that gets put into what is called cash value. This accrues over the years as premiums continue to get paid. This cash value is considered a living benefit and usually the policy owner can withdraw or take a loan from it tax free as long as the amount doesn’t exceed what has been paid into the policy. At a high level, this cash value provides liquidity so if the contract owner needs cash, he or she is able to use those funds. It’s important to note that there are impacts of taking the cash value out and when the insured dies, the cash value is not part of the death benefit paid out; again, it is simply a living benefit that can be tapped into when needed during life.
Universal life insurance is also in the category of permanent insurance but differs from whole insurance in that it has additional flexibility. There are two types within universal life (indexed and variable) but both types can have additional flexibility such as (1) premiums able to be paid by cash value (2) face value/death benefit can be increased or decreased (3) the frequency and amounts of the premium payments can differ. The major differences between indexed and variable are just that indexed policies don’t have direct exposure to the market whereas variable has the cash value directly invested in subaccounts (similar to mutual funds) that can gain or lose value. Indexed policies follow an index such as the S&P for example and try to match returns up to a certain amount but protect the policyholder if the markets don’t do so well.
Finally, there is a permanent variable policy which has exposure to the market, meaning you could gain or lose some of your investment into the policy. The premiums are level (don’t increase or decrease) and these policies have less flexibility than the universal policies just discussed.
So do you need life insurance? Some questions to get started include:
· Does anyone depend on my income right now?
· If I were to die, could my husband/wife and/or kids comfortably sustain themselves into the future?
· Have I co-signed on debt that would leave the cosigner in trouble if I were to pass away?
· Do I have intentions of passing along tax-free money to my family as part of my legacy?
These questions are a good start but don’t fully answer how much, when, and which type to purchase so talking to a financial professional to determine your needs is of the utmost importance. Hope this helps and look for more posts digging deeper into these and other types of insurance.
The author, Maddi Napier, CFP®, MBA, QKA, FSRI, is the founder and financial planner at Minerva Wealth Planning, LLC in Columbus, Ohio. If you have questions or comments, don’t hesitate to reach out to Maddi at email@example.com.