At least 60% of Americans have some form of life insurance. Of those, at least 20% don’t believe they have enough life insurance. This lack of life insurance could be directly tied to a lack of knowledge regarding the life insurance types that exist.
Before shopping around, you should know about the different types of life insurance and how they work in terms of premiums and benefits in the event of your passing. Once you understand these life insurance basics, you can start thinking about whether it’s a good time for you to purchase a life insurance policy and how to go about doing so.
Keep reading to learn everything you need to know about life insurance policy types and when you’ll need to think about buying one!
What Is Life Insurance?
Life insurance is a legally binding contract between you and a life insurance company. The insurance company agrees to pay a certain sum of money out when the insured person dies, which is why this payment is also called a death benefit. A life insurance death benefit can be used for funeral expenses, mortgage payments, paying for a child’s college tuition, and other expenses. The payment is given to beneficiaries that the insured person names in their life insurance policy.
However, if an insurer finds out that the policyholder was dishonest about their past and current health conditions, the life insurance contract may not be enforceable. The same can be said if the insured takes part in high-risk activities.
What is a Life Insurance Premium?
Essentially, the death benefit is paid out in exchange for the premiums paid by the insurer throughout the term of the life insurance policy. Premiums can take many forms, depending on the life insurance types. A premium can be a monthly, bi-annual, or annual payment. If the insured stops paying the premium, the policy lapses and the insurer keeps whatever money has already been paid.
What are the Different Types of Life Insurance?
Within the parameters outlined above, there are several life insurance types. We’ve outlined what the three main types of life insurance are below, as well as some additional life insurance types you might want to consider.
Term Life Insurance
This is considered the most simple type of life insurance policy to understand. It’s also more accessible in terms of affordability.
Term life insurance lasts for a specified number of years. If the insured dies before the term finishes, then the death benefit is paid out to the beneficiaries named in the policy. With term life insurance policies, your premium goes directly toward the death benefit that’s paid to beneficiaries. Beneficiaries can elect to receive the death benefit as a monthly payment, an annuity, or as a lump sum.
The downside of term life insurance is that if you outlive your policy, you have to buy another if you still need life insurance. That leaves you having to buy life insurance when you’re older and potentially in worse health. The rule of thumb with buying life insurance is that the younger and healthier you are, the cheaper it is.
Whole Life Insurance
Whole life insurance is considered permanent life insurance because it doesn’t expire. As long as you pay the life insurance premiums, you will have life insurance under this arrangement. Whole life insurance has a death benefit, like term life insurance, however it also has a cash value that grows over time. The cash value is a tax-deferred savings account, and it grows at a predetermined and fixed rate. This feature means that whole life insurance is generally more expensive.
The good thing about whole life insurance is that you have insurance for your entire life, or as long as you pay premiums. The problem with this option is that that guaranteed payout means these types of life insurance policies are quite expensive.
Universal Life Insurance
Universal life insurance is another type of permanent life insurance. Albeit, this type of life insurance has more flexibility than whole life insurance, because universal policies allow more flexibility in terms of adjusting premiums and death benefits. At the same time, you still get an accumulating cash value for your universal life insurance policy, as you would with whole insurance.
The premiums paid in this type of life insurance policy consist of a cost of insurance (COI) amount and the cash value saving component. The beneficiaries only receive the latter while the COI is what you pay to keep the life insurance policy. The COI includes charges for the administration of your policy, for mortality, and other expenses involved in keeping the policy active. This premium for universal life insurance is based on your age, risk, and insurability.
Other Types of Life Insurance
There are some other life insurance policy types worth knowing about that are slightly less popular than the main three explained above.
Final Expense Insurance
This type of life insurance policy is essentially burial insurance. The cash value of final expense life insurance covers the costs associated with your funeral.
Joint Life Insurance
Joint life insurance is also known as first-to-die insurance. The cash value of this type of life insurance is a way to share an insurance policy between a couple. The death benefit is paid to the surviving spouse, should the other die.
Survivorship Life Insurance
This is called second-to-die insurance and is also split between couples. With this type of life insurance policy, no death benefit is paid out until both spouses die. Then, the death benefit is given to the children.
Accidental Death & Dismemberment Policy
This is an inexpensive life insurance policy type that provides a death benefit in the event of accidental death or dismemberment. The accidental death and dismemberment policy terms can be complicated, so make sure you understand what you’re buying if you choose this option.
No Medical Exam Insurance
This type of life insurance is exactly what it sounds like, it means you can get life insurance without taking a medical exam, which is required for term and whole life insurance policies. However, you’ll have to pay more for this type of life insurance policy because of the risk the insurance company takes by not requiring a medical exam.
Who Needs Life Insurance?
Life insurance is most beneficial for people who have dependents. Dependents can be any person who is financially dependent on you for their survival, such as children that live at home or who haven’t graduated from college, an aging person, a sibling, or a spouse. You should purchase life insurance to help those dependents carry on after you’ve died. If you’re a working parent, this may be the equivalent of the salary you bring in. If you’re a stay at home parent, this could help your surviving spouse cover the costs of child care or tuition when you pass away,
There are also life insurance types you can purchase without having dependents. For example, burial insurance covers the cost of your funeral so surviving members of the family aren’t left to pay those costs.
It’s generally accepted that, by the time you retire, you don’t really need to purchase life insurance, since by that time in your life your children should be financially independent or you and your spouse may be living on savings and investment income. However, you might benefit from a life insurance policy during these years to help cover medical and long-term care costs for your spouse. Remember that buying a life insurance policy at this stage in life is more expensive than buying it when you’re young and healthy.
How To Buy Life Insurance
Buying life insurance is rather straightforward. Here the steps you need to take to buy a policy, regardless of what type of life insurance you’re looking for.
1. Think About How Much You Need
This means adding together the expenses you and your family currently have, plus any that may accumulate in the future. Think about mortgage payments for your home, outstanding loans, child care, and the cost of tuition. The size of your life insurance policy’s death benefit must reflect all of those expenses, minus any liquid assets you have.
2. Get A Quote
To get a life insurance quote, you’ll need to provide your age, gender, location, and basic medical history. A quote will give you an idea of the premiums you’ll pay, the life insurance policy types you qualify for, and how much coverage you can get.
3. Compare Different Types of Life Insurance
Compare your options, don’t just go for the cheapest life insurance policy! You should compare features and riders, customer service, and how well the policy lines up with your health profile.
Once you’ve narrowed it down to the best type of life insurance policy for you, then you have to complete an application. Any life insurance application will ask for things like proof of identity, citizenship, and age. You’ll also need to provide proof of income and residency.
To confirm what you’ve put in your application, you may also need to complete a phone interview depending on the type of life insurance you apply for. In this interview, you may be asked about hobbies and lifestyle, your financial health, and whether you hold any other types of life insurance policies. You’ll also have to authorize your doctor to share your information with the insurance company.
5. Complete the Medical Exam
Most term and whole life insurance policies require you to take a medical exam. These are free and only take about 30 minutes of your time. The examiner will come to your home or office to get an accurate, in-person idea of your health.
6. Get Approved!
Once you’re approved, you’ll sign your new life insurance policy and you’ll be officially insured.
Trying To Figure Out What Type Of Life Insurance You Should Get?
After you review the three main types of life insurance, term, whole, and universal, and explore the other types of life insurance explained above, including burial insurance, joint and survivorship policies, and accidental death and dismemberment policies, then it’s time to choose the best type of life insurance for you. The life insurance type you need and how much coverage you should get is entirely up to your life circumstances and what you expect in the future.
For more helpful personal finance information and advice, be sure to check out our other Personal Finance blogs!