Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money (the benefit) in exchange for a premium, upon the death of an insured person (often the policy holder). Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policy holder typically pays a premium, either regularly or as one lump sum. Other expenses, such as funeral expenses, can also be included in the benefits.
Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot, and civil commotion.
Term life insurance vs. Whole life insurance:
Term life insurance is the lower-cost option
Term life insurance is perhaps the purest way to protect your loved ones in the event that you die prematurely.
In a nutshell, when you buy a term life insurance policy, the period of protection is temporary (10, 20, and 30 years are most common). After the initial term runs out, policyholders have the option to renew, but by that point, the renewal rate is often prohibitively expensive.
Term life insurance policies don’t accumulate any cash value. Simply put, if you die while the policy is active, the policy’s beneficiaries collect the death benefit. If not, the policy expires, and the life insurer has no further obligation to you. For this reason, term life insurance is significantly cheaper than whole life insurance.
Whole life can offer lifelong protection but at a higher price
Whole life insurance is designed to protect you for your entire life. It’s a form of life insurance designed to not only pay out upon death but also to accumulate cash value, as an investment. Premiums are significantly higher like 10 to 15 times than term life policies, not only to compensate for the higher mortality risk in your later years, but because whole life policies accumulate cash value over time. Since whole life policies build cash value, they can be included in retirement planning one big advantage is the ability to borrow against the policy.
Which is best for you?
It depends on your personal situation and goals. If you prefer to keep your premiums low and invest the majority of your extra money. The idea is that by the time your term life policy runs out, your retirement accounts and other investments will be built up to the point where the death benefit is no longer necessary. Plus, your primary insurance goal is to protect your family during your working years.
On the other hand, if you want insurance that doesn’t expire, and the idea of building up cash equity is more appealing to you than simply “renting” a life insurance policy, whole life could be the best option for you.
The different types of life insurance are:
There are 4 major types of life insurance policies.
Term life insurance lasts for a set number of years before it expires. If you die before the term is up, a set amount of money, known as the death benefit, is paid to your designated beneficiary. Term life is considered the simplest, most accessible insurance policy. When you make your payments (known as your premium), you’re simply paying for the death benefit that goes to your beneficiaries in the event of your death. The death benefit can be paid out as a lump sum, a monthly payment, or an annuity. Most people elect to receive their death benefit as a lump sum.
Term life insurance policies are more affordable than other types of life insurance policies. They expire at the end of the term, which can last up to 30 years.
Whole life insurance is considered a permanent life insurance policy because if does not expire. It has a death benefit but also a cash value, which is a tax-deferred savings account that is included in the policy. The cash value accrues interest at a predetermined fixed rate. Each month, a certain portion of your premium will go into the cash value of the policy, which offers a guaranteed rate of return (The exact amount that goes into savings is determined by your individual policy). The policy’s cash value grows over time. Due to the fees and the extra feature, a whole life insurance policy can cost five to 15 times as much as a term life policy (for the same death benefit amount). Whole life lasts for as long as you pay the premiums. However, the cash value component can make whole life more complex than term life because you have to consider surrender fees, taxes, and interest as well as other stipulations. Still, it may be worth it if you need the cash value to cover things like endowments or estate plans, which might benefit from the greater options that a whole life policy provides.
Universal life insurance has a cash value, just like a whole life insurance policy. Your premiums go toward both the cash value and the death benefit. But there’s a twist: the policyholders of universal life policies can change the premium and death benefit amounts without getting a new policy. Basically, although you have a minimum premium to keep the policy in force, you can use the cash value to pay the premium. That means if you have enough money in the cash value, you can use that to skip premium payments entirely, letting the accrued interest do the work.
Variable life insurance is similar to whole life insurance in that they both have a cash value, but the functions of the cash values are quite different. With a whole life insurance policy, the cash value component is a savings account. That’s why, although the growth might be small compared to other investment options, there is a guaranteed minimum rate. It also includes dividend payments from the life insurance company. A variable life insurance cash value, though, is more akin to investing. The money paid into it goes into a series of mutual fund-like sub-accounts where you can get some decent growth, but you can also lose money depending on the market. The cash value is more or less placed in the stock market. While this makes variable life insurance policies a better investment option than whole life insurance policies – the potential for higher, tax-deferred growth makes it a “super-IRA” – you can only invest in the sub-accounts available through your policy. That means you don’t get to choose from the wide variety of mutual funds that are available on the open market.
While fees can be lower with a variable life insurance policy than a whole life policy, the product is riskier. Why? The same reason investing in stocks is risky: most people don’t know much about the stock market and don’t know enough to make changes in their investment. There’s too much management for the average person to do it effectively. All of this makes a variable life insurance policy both a limited investment option and a limited life insurance option. As an investment vehicle, variable life insurance policies provide tax-free money to beneficiaries during the time that the policyholder is alive. Once that person dies, however, that money is retained by the insurance company. Like other types of life insurance, a variable policy can help cover funeral and end-of-life expenses.
Simplified issue life insurance. A scaled back underwriting process that is simplified. Coverage amounts are lower than traditional fully underwritten policies. Simplified issue policies typically do not require a medical exam and have fewer application questions to answer. Many of these policies can be approved within several days.
Guaranteed issue life insurance. A life insurance policy that is guaranteed approval. Coverage amounts will be lower than traditional policies. Premiums will be considerably higher. Since there are no medical questions and everyone is approved, these policies will have a waiting period before benefits are paid out. If the insured dies during the initial waiting period, only premiums plus interest will be returned. Once the waiting period has been satisfied, the full death benefit will be paid out to the beneficiary.
Final expense insurance. Final expense insurance is a simplified issue policy. If you don’t pass the health questionnaire you’ll be placed in a guaranteed issue policy instead. It covers the cost of anything associated with your death, whether its medical costs, a funeral, or cremation. It’s usually only issued to people of a certain age and the policy is valid up to a certain age.