Purchasing a life insurance policy can seem like an unfavorable, even morbid, task.
Death and dying are largely seen as taboo topics of discussion and are therefore avoided in most social situations. Sooner or later, though, everyone passes away. For primary income earners, especially those with dependents, it is important to plan for that inevitability. Life insurance provides one of the best ways to do this. No matter the type of policy, they all protect your dependents in case you die.
The proceeds from a life insurance payout, or a “death benefit” as it is called, can go towards funeral costs as well as expenses that you took care of in life: tuition payments, mortgage payments, car payments, and so on. This ensures that even if you’re not there to make these payments, your dependents will have enough money to cover them.
Types of Life Insurance
Term life and whole life are the most popular forms of life insurance, and each has its own unique features.
- Term life insurance is often offered at lower prices due to its set term length and is easier to conceptually understand.
- Whole life insurance tends to cost more, is more conceptually complex, but it accrues a cash value over time and is the most common form of permanent life insurance.
Permanent life insurance also comes in three different types: universal, variable, and variable universal.
- Universal life insurance tends to have lower premiums, like term life insurance, but it is a form of permanent coverage with an investment savings component, like whole life insurance. A portion of your premium is applied to the cost of the policy that provides the death benefit, while the other portion is invested so you can use it as investment savings. The term “universal” denotes the flexibility of this type of policy. It means that the policy holder can adjust the death benefit and the premiums if they so choose. However, universal life insurance depends on market stability to work, which therefore makes it more risky.
- Variable life insurance provides lifelong coverage in addition to a cash value account. Every time you make a premium payment, a portion of that goes to the cost of insurance and insurer’s fees—the money that functionally keeps the death benefit in place—and the other portion is applied to the policy’s cash value, which can be invested in certain securities. This type of insurance is referred to as “variable” because the owner can invest in separate accounts whose values vary. However, variable life insurance policies don’t always have a guaranteed rate of return and the cash value investment may have a cap on the maximum rate of return. This adds a level of risk that not everyone might be comfortable with.
- Variable universal life insurance is one of the most flexible types of permanent life insurance policies. Like the others, it accrues a cash value, but the owner has flexibility in how much premium to pay in a given month, which is where it gets the term “universal.” By comparison, with traditional whole life insurance, you’re locked into a set premium that you must pay monthly or else your policy will lapse.
Whole Life Insurance
Whole life insurance differs from term life insurance because it is a permanent form of life insurance. The policy is guaranteed to remain valid until the insured dies or the policy reaches its maturity date—in the past, this has typically been when the insured reaches 100 years of age, but recent policies have moved the age of maturation to 120.
This means that your dependents (or you, if you live past 100 or 120) are guaranteed to get money from the insurer.
Whole life insurance also has a cash value component, which is another key difference compared to term life insurance. A portion of your premium payments goes to a cash account, where the invested money has a guaranteed rate of return and grows tax-deferred.
Term Life Insurance
Term life insurance covers you and protects your dependents for a set period of time—a term—such as 10, 20, or 30 years. This means that in the case that you die during your set term, the insurer will pay out a death benefit to your dependents. Because of this, and the fact that they do not accrue any cash value over time, these policies are significantly cheaper. As with whole life insurance, this death benefit (the cash value beneficiaries receive) is also exempt from income tax, making life insurance a particularly attractive way to protect your dependents.
Term life insurance can be thought of as the life insurance equivalent of renting housing instead of buying it. When renting an apartment, you pay a monthly rent for the duration of your lease…but that doesn’t mean you’ve gained any ownership over that property when you move out. Similarly, with term life insurance, you pay a monthly premium for the duration of your term, but when that term is up—assuming you’re still alive—you no longer have that insurance and that money is gone.
Who Should Choose Each Type of Insurance
|Whole Life||Term Life|
|Those who want a more predictable and stable insurance policy||Those who need help providing for a family’s potential loss of income in the case of death of a primary earner|
|Those who want permanent coverage||Those who want coverage for short-term debts|
|Those who want the ability to withdraw most or all of what they put into it tax free (assuming you follow the strict rules about doing so)||Those needing additional insurance protection during child-raising years|
|People able to afford the higher premiums||People unable to afford higher premiums of whole life insurance|
|People who want to use it as a way to simultaneously save money and receive life insurance||Younger people, as term life insurance is relatively cheap for healthy individuals under 50 years old (though, even after 50, term life insurance is still much cheaper than whole life)|
Choosing Between Term and Whole Life Insurance
Choosing a life insurance policy is a personal decision that should be taken seriously. Though each policy type covers your dependents in the case of your death, term life and whole life have significant differences. Especially when considering purchasing whole life insurance, it’s helpful to consult an independent financial planner before making a decision.
Though independent financial planners are your best bet for personalized advice, internet research is a great start. Websites like Insurify can help you compare life insurance quotes so you can find the best policy for you.