What type of life insurance is best for you? That depends on a variety of factors, including how long you want the policy to last, how much you want your life insurance rates to be, and whether you want to be able to withdraw money from the policy later.
Term life insurance is suitable for most people. Permanent life insurance policies (such as whole life and universal life) usually contain a “cash value” account, which builds value over time. Eventually you may have enough cash value to take a loan against it to use for large expenses, such as college. Because permanent policies can be complex and expensive, it’s best to have a financial advisor guide you through the options and costs.
Here’s a deeper overview of types of life insurance:
You only have to make two decisions if you buy term life insurance: what amount you want, and how long you want the coverage to last. “Small” term life policies are available with under $50,000 in coverage, but policy amounts can go into the millions. Term life is typically sold in lengths of five, 10, 15, 20, 25 and 30 years. “Level premium” term life means you’re locking in a price for the length of the policy. Typically you will pay a monthly or annual premium to keep the insurance in force. “Annual renewable” term life is a one-year policy that renews every year for a higher price.
» COMPARE: NerdWallet’s life insurance comparison tool
Whole life insurance is a form of permanent life insurance, meaning it doesn’t expire. It’s the closest thing to “set it and forget it” life insurance. As long as you pay the bill, you don’t have to think much about the policy. Your payments stay the same, you get a guaranteed rate of return on the “cash value” investment component of the policy, and the death benefit amount doesn’t change.
Guaranteed universal life insurance offers insurance at a cheaper price than other permanent life insurance products. The policies promise a certain death benefit and payments that don’t change. There’s typically little or no cash value within the policy, and insurers demand on-time payments. Missing a payment could mean you forfeit the policy. And since there’s no cash value in the policy, you’d walk away with nothing if you forfeit. If you are sometimes late with bills, this is not the product for you. In addition, consider that future financial or health problems could cause you to miss a payment.
Indexed universal life insurance links the cash value component of the policy to a stock market index like the S&P 500. Your gains are determined by a formula, which is outlined in the policy. The policy will dictate how much your cash value “participates” in any gains. For example, if your participation rate is 80% and the S&P 500 goes up 10%, you get an 8% return. Fortunately, if the index goes down, you won’t lose cash value; you’ll just get zero rate of return. Some policies offer a small guaranteed interest rate in case the market goes down.
Your gains in cash value will also be limited by your “cap,” which is the maximum you’ll get no matter how high the market goes. For example, a cap might be 10%. If the index goes up 20%, and your cap is 10%, you still get only 10%. And remember, only a portion of your payments are going into the cash value to begin with.
There are additional moving parts to keep track of, such as your payments and death benefit. Within limits you can decrease your premiums or skip a payment, as long as your cash value covers the insurance costs. You need to keep track of this. If you’re skipping payments and you don’t have enough cash value to cover costs, your policy could lapse. Some policies allow you to adjust your death benefit, too, as your family’s needs change.
With variable universal life and variable life insurance, you tie your cash value to investment accounts, such as bonds or money market and equity accounts. There can be high risk to the investment account value based on the market, but if you do have cash value, you can take partial withdrawals or loans against it. You can also vary your premium payments, within certain minimums and maximums, and vary the death benefit. The “policy illustrations” shown to potential customers can be complex and optimistic, but if you’re considering a policy like this, a fee-only financial advisor (who doesn’t earn commissions based on policy sales) can help you sort it out.
You may hear some other words that sound like additional types of life insurance, but they’re really about how the policy is “underwritten,” meaning how the life insurance companies will determine how much of a “risk” you are.
There are also types of life insurance meant for specific situations:
Mortgage life insurance: Covers specifically the current balance of your mortgage and pays out to the lender, not your family, if you die.
Credit life insurance: Covers only the balance of a specific loan, like a home equity loan. Your bank might offer to sell you a credit life insurance policy when you take out a loan. If you die it pays off the lender, not your family.
Accidental death and dismemberment (AD&D): Pays a death benefit only if you die accidentally, such as in a car crash. Accidental death and dismemberment policies also offer insurance payouts for loss of limbs, sight and hearing, and other problems.
Joint life insurance: This type of permanent life insurance insures two lives (usually spouses) under one policy and comes in two forms:
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