What type of life insurance is best for you? That depends on a variety of factors, includinghow 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:
Term life insurance
- Pros:It’s easy to understand and is the cheapest way to buy life insurance.
- Cons: You could outlive your policy. If you still need coverage, you’d need to buy another policy and will pay more based on your age and, possibly, health.
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
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- Pros:It covers you for your entire life. Everything in the policy is guaranteed, so there are no surprises.
- Cons:It’s a very expensive way to buy life insurance.
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.Universal life insurance
- Pros:It’s cheaper than whole life and other forms of universal life insurance. You can choose the age to which you want the death benefit guaranteed, such as 95 or 100.
- Cons: Every payment must be made on time or you could lose the guarantee and forfeit the policy, thereby losing all your previous payments. The policy may have little or no cash value.
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 (IUL)
- Pros: You can access cash value, which grows over time. The cash value is linked to a stock market index, so if the stock market goes up, you get some upside, too. Within limits, your payments and death benefit amount are flexible.
- Cons: Your cash value doesn’t take full advantage of stock market gains. You should understand the policy’s fees, participation rates and the ceiling on your return (called a cap) before you buy.
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.Variable universal life insurance (VUL) and variable life insurance (VL)
- Pros:There’s achance for a large potential gain in cash value if your investment choices do well. A policy owner can take partial withdrawals from cash value or loans against it.
- Cons:It requires you to be hands-on in managing your policy. The cashvalue changes every day based on the market. Lots of fees and administrative charges are deducted from your payment before anything goes to cash value.
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.Comparison of types of life insuranceFeatureTerm lifeWhole lifeUniversal life**Details vary for universal life policies regarding premium flexibility and death benefit flexibility.Choices in policy length✓Builds cash value
✓✓Premium payments may be flexible✓Death benefit amount may be flexible✓Most affordable way to buy life insurance✓Cash value can usually be linked to investments✓
Types of underwriting for life insurance policies
You may hear some other wordsthat 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.
- Fully underwritten life insurance: A life insurance medical exam is often required. The application will also generally include many questions about your health, your family’s health history, your lifestyle (such as hobbies like skydiving), and your plans for travel outside the United States. This “full underwriting” allows the insurance company to most accurately price the policy based on your life expectancy. If you are healthy — or even if you have a couple health issues — this will generally be the cheapest way to buy life insurance.
- Simplified issue life insurance: No life insurance medical exam is required, but you will be asked a few health questions and you could be turned down based on your answers.
- Guaranteed issue life insurance: There’s no medical exam and no questions asked. You can’t be turned down. This is the most expensive way to buy life insurance, and you might find only low coverage amounts available, such as $50,000 or $100,000. In addition, if you die within the first few years of having the policy, your beneficiaries may receive only a partial death benefit or a check for the premiums you paid. People often buy these policies when they’ve been turned down elsewhere but they want to cover final expenses, such as funeral costs.
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 dismembermentpolicies 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:
- First-to-die: Pays out upon the death of the first person, whichever one it is. The surviving spouse would typically be the beneficiary. The policy would then expire; it doesn’t continue to cover the second person.
- Second-to-die: Pays out when both people have died. A policy like this is typically used when heirs (such as children) will need money to pay estate or inheritance taxes, so that they don’t have to sell off assets.
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