Life Insurance
There are two types of Life Insurance: Term Life and Permanent Life
What is term life insurance?
Term life insurance offers protection for a set period of time. This period is called a term. The term can be for one year, or anywhere from five to 30 years or longer. You choose the length of the term. Term life policies pay a lump sum, called a death benefit, to your beneficiaries if you die during the policy’s term. The policy ends at the end of the term, unless you pay to extend it.
Term policies aren’t meant to provide coverage for your entire life. Most people who buy term life policies want coverage for only a time, such as while they’re raising a family or have children in college.
Premiums will stay the same for the entire term. They’ll go up if you renew at the end of the term. This is because your new premium will be based on your age when you renew, not when you originally bought the policy. To help avoid higher premiums later, consider buying a policy with a longer term.
Most companies offer term life insurance only up to a certain age, usually 70 or 80.
Key features of term life policies
The two most common features of term life policies are convertibility and renewability. They make it easier to get a different type of policy or keep the one you have.
Convertibility lets you exchange your term policy for a permanent life policy without having to take a medical exam or answer questions about your health. This can be helpful if your health gets worse after you buy a term policy. Converting a policy will raise your premiums. Companies usually allow you to convert term life policies only for a time, typically until you turn 65.
Renewability lets you extend your policy for additional terms, regardless of your health and without having to take a medical exam.
What is permanent life insurance?
Permanent life insurance lets you build savings over time. You can withdraw from, invest, or borrow against this savings. You can also use it to pay premiums.
A portion of each of your premiums is put into an account, known as the cash value. The cash value grows at either a fixed or variable interest rate. Some policies tie the growth to indexes, such as the S&P 500, or to sub-accounts you choose. The sub-accounts are invested in stocks, bonds, or both. Your cash value could go up or down, depending on the performance of your sub-accounts.
It takes a policy several years to build a cash value. You might have to pay a surrender fee if you withdraw the money early. And if you withdraw more money than you paid in premiums, you’ll probably have to pay taxes on it. If you withdraw the entire cash value, the company might cancel your policy. If that happens, the coverage will end, and it could affect your taxes.
Premiums for permanent life insurance are higher than for term life. That’s because of the savings feature and because you’re buying coverage for a longer period. But if you buy a permanent life policy when you’re young and keep it, your premiums will likely be lower than for a term life policy you buy when you’re middle-aged or older. That’s because premiums are based on your age when you buy the policy.
Types of permanent life insurance
The two most common types of permanent life insurance are whole-life insurance and universal life insurance.
Whole-life insurance stays in effect for your entire life unless you cash the policy in or stop paying premiums. Some whole-life policies might pay a dividend each year. You can get the dividend in cash, add it to your policy’s cash value, or use it to pay premiums. Dividends aren’t guaranteed. Your dividend could be lower than the company’s projection. Before you buy a policy, ask the company for a history of its projected dividends versus paid dividends.
Universal life insurance stays in effect until the maturity date, which is usually age 95 or 100, as long as you have $1 or more in cash value. At the maturity date, coverage ends and you get the cash value.
Universal life insurance is more flexible than whole life. You can change the amount of your premiums and death benefit. But any changes you make could affect how long your coverage lasts. If your premiums are lower than the cost of insurance, the difference is taken from the cash value. If the cash value reaches zero, your policy could lapse.
The company will send you a report each year showing your cash value and how long the policy might last. The estimate is based on the cash value amount, the cost of insurance, and other factors. Review it carefully. You might need to pay more in premiums to keep the policy in effect until the maturity date.
Most universal life policies earn a guaranteed minimum interest rate on the cash value. Variable universal life policies depend on the performance of the sub-accounts you choose. Agents who sell variable life insurance in Texas must have a federal securities license and a state insurance license.
Some universal life policies have a no-lapse guarantee. If your premium payments aren’t enough to cover the cost of insurance, the no-lapse guarantee keeps the policy in effect. You must pay your premiums on time for the guarantee to apply.
For another explanation of how universal life insurance works, watch our video about universal life policies.
Comparing the major types of life insurance
| Term Life | Whole Life | Universal Life | |
|---|---|---|---|
| Premiums | Low at first but may go up each time you renew the policy. Premiums are based on your age when you buy or renew your policy. | Higher than term life at first, but usually don’t go up. Premiums are based on your age when you buy the policy. | Flexible. Premiums are based on your age when you buy the policy. Most policies let you change your premium payments, but it will affect your death benefit, cash value, or both. |
| How long policy lasts | The period you choose, usually one year, five to 30 years, or longer. | Your entire life if you keep the policy. | Depends. The policy stays in effect until the maturity date, usually at age 95 or 100, as long as you have a cash value. |
| What the policy pays | Death benefits only. | Death benefits, plus a possible cash value you can withdraw from, invest, or borrow against. | Death benefits, plus a possible cash value you can withdraw from, invest, or borrow against. |
| Advantages | Good option if you want coverage for a specific period, such as when you’re raising a family. You can convert to a permanent life policy or renew without having to take a medical exam. | Premiums, death benefits, and cash values are guaranteed. | Flexible. You can change the death benefit and premiums. |
| Disadvantages | Premiums will go up each time you renew. Doesn’t allow you to build savings. | Might be expensive to cover a short- term need. Usually little to no cash value in the first few years. Not flexible enough to make changes when needed. | Might be expensive to cover a short- term need. The payment isn’t guaranteed. Low interest rates can affect cash value, which might increase your premiums. |
Other types of life insurance
These types of life insurance provide only specific coverages:
- Credit life pays the balance of a loan if you die before the loan is paid off. Banks and other lenders may require you to buy a credit life policy as a condition of a loan.
If you already have life insurance, you might not need credit life. Instead, you can assign some of the death benefits to the lender to pay the loan balance.
- Prepaid funeral insurance pays your funeral expenses. An advantage of this insurance is that it locks in funeral costs at current prices. Funeral insurance can be expensive compared to other types of life insurance. The amount you pay in premiums might end up being more than what the policy pays when you die. And many policies won’t pay the full cost of the funeral if you die before paying a required amount. A regular life insurance policy or savings might be a better way to pay for a funeral.
Customizing your policy
You can usually add features or other coverages to your policy so it better suits your needs. You do this by buying policy riders. Some of the most common riders are:
- Additional term insurance adds term life coverage to a permanent life policy. For instance, if you need $500,000 worth of total coverage, you could buy a $100,000 whole-life policy with a $400,000 term life rider. As you make more money, you could convert the term life rider into a universal life policy or buy an additional whole-life policy.
- Guaranteed insurability lets you buy additional coverage regardless of your age or health. The company may still use these factors to decide on your premium. You usually must buy the additional coverage by a specified date or life event, such as when you retire or before you turn 50.
- Accidental death provides an additional payment if you die because of an accident. For instance, if you have a policy with a $500,000 death benefit and a $500,000 accidental death rider, your beneficiary would get $1 million if you die because of an accident. There are some restrictions.
- Disability waiver of premium covers the premium if you meet the policy’s definition of disabled. This rider is usually only available to people younger than 60.
- Accelerated death benefit option prepays some or all of the death benefit while you’re still living. You must have a terminal illness, specified disease, or long-term care illness. People often buy this rider to help pay long-term care expenses in case they need them later.
- Spousal rider provides term life insurance for your spouse. Basically, this rider combines two policies into one.
- Children’s rider provides term life insurance for your children. Most companies require the child to be at least 14 days old. Coverage typically lasts until the child turns 21 or 25.