Read about these life insurance types before you buy any life insurance policy. It’s your quick guide to life insurance basics and what due diligence to do before plunking down your hard-earned money. But beware… life insurance policies cost more the older you are. Call it a procrastination tax. So invest a few minutes into your life insurance policy contingency plan by reading this today.
Disclosure: Our editorial content contains affiliates from which we receive a small payment to support the site at no additional cost to you. These marketing partners do not influence our opinion of their products. They do not review, approve or endorse our editorial content. All opinions remain our own.
You definitely want to know about these life insurance types before talking with a life insurance agent or plunking down your hard-earned money.
That’s because salespeople can manufacture endless reasons for you to buy life insurance. So it’s in your best interests to spend a little time educating yourself about the pros and cons of the life insurance types as well as other life insurance basics, so you understand the smartest uses for life insurance policies, and find the type of policy that’s right for you. That’ll put you squarely in control of your purchase – not the sales person.
That said, the primary purpose of life insurance is to care for and provide for your loved ones in case of your premature death. Life is uncertain. It’s a priceless gift of love to make sure your spouse and children will be cared for with a life insurance policy in the unlikely event of your early passing.
Basic Life Insurance Types
There are only two basic life insurance types. The rest are just hybrids… which are often confusing and should be avoided on that basis.
1. Term life insurance policies.
Term life insurance, as its name suggests, insures your life for a certain term or period of time. Let’s say you buy a 20-year term policy on your 30th birthday. It will offer a flat premium which will expire when you turn 50. Some life insurance companies will continue to insure you after your 20 years. But your premiums will go up (perhaps drastically) to keep the term life insurance policy in place.
That’s not to say it’s an automatic mistake to keep the coverage in place. A lot depends on your debt load and other factors. (Keep reading…) Plus, it may beat starting over with a new policy, especially if you have any health issues.
Term life insurance premiums are lower than whole life insurance policies, since you might only carry it until you’re 55 or 60, not till you’re 90. Typically, term life insurance policies have no cash value. It’s just a straight death benefit for those who need your care and financial help.
2. Whole life insurance policies.
Whole life insurance policies cover you for your entire life as long as you continue to make your premium payments… suggested by the term “whole” life. It is sometimes called permanent life insurance. Whole life insurance is guaranteed to stay in place until the day you die, as long as you keep paying the premiums. A death benefit is paid to your heirs when you die. Most of the time it’s non-taxable.
Whole life policies may also have a cash value that you can access via “loans” while you’re still alive. (And will be one of the agent’s key selling points.) Cash value whole life insurance policies have significantly higher premiums than term life insurance. And correspondingly, the salesperson gets a much higher commission when you buy it. That’s part of the reason your cash value is very low for the first couple years. Because even if you pay thousands into a policy, their commission comes out before you start gaining cash value.
Which Life Insurance Type Is Right for You?
Think of life insurance as a parachute. If you don’t have it when you need it, you won’t get a second chance.
Premiums for annual renewable type term policies can rise every year. After the term ends, you may be able to continue with an annual renewable premium. Depending on the life insurance company and policy, you might have to prove insurability again.
How Much Will You Pay for Life Insurance? Depends on Many Factors
For both life insurance types, age is a major component for how high your premium rate is – and possibly whether you can even qualify to buy insurance.
Every birthday puts you closer to your life expectancy. That means your rates will rise for every year you delay buying life insurance, assuming the same amount of coverage. Also, for the sake of insurance you are deemed a year older half way between last year’s birthday and this year’s birthday. In other words, if it’s been more than six months since your 30th birthday, your insurance age is 31.
But other insurability factors also come into play.
- Your health
- Whether you’ve ever smoked
- How much you drink alcohol
- Your parents’ health, age at death and what they died of
- Your siblings’ health, age of death and what they died of
- Whether you participate in any dangerous hobbies/activities – hang gliding, mountain climbing, international travel…
- Your height and weight
- Your occupation (especially if it’s hazardous)
Insurance companies don’t necessarily take your word for your answers either. They’ll likely run their own medical tests before they accept you. Including blood tests that might suggest diseases such as heart disease, cancer, or liver disease.
Life Insurance Policies Are Sold, Not Bought
Agents and brokers get commissions – often very fat ones – for selling policies. This is not without reason, as most people are completely unmotivated to buy insurance without a certain amount of sales pressure. There’s an old saying: Life insurance is sold, not bought.
High front-end commissions are customary because it takes significant time to explain the policy (especially for whole life insurance policies) and complete the application process. And the commission is far greater for “permanent,” or whole life insurance policies. Thus, it’s easy to see why most sales presentations skew toward whole life insurance policies, not term insurance. An agent may even ask if you want permanent life insurance or temporary life insurance. Temporary insurance is term insurance.
Steer Clear from These Life Insurance Types
Never buy an insurance product you do not understand. There are many hybrids of whole life insurance, such as universal or variable life, and they can be quite confusing. Life insurance agents can make these policies sound like a great way to have your cake and eat it too.
Some of the laws about what they can guarantee have tightened in recent years. But beware…
Older folks wanting to leave an inheritance for several children have been duped into buying these types of plans – not realizing that if they can’t keep making large payments to cover any investment losses, they’ll lose the policy. Sadly, these types of policies were common during the bull market of the early 2000s. Then people lost their policies during the 2008-2009 recession when they couldn’t afford to cover huge investment losses.
Again we say, if you don’t understand the product completely, it’s not the right product for you… no matter what the salesperson tells you. Remember that the salesperson will receive a large commission of about 50% of your initial payment. This amount decreases your cash value immediately until your payments catch up and recover that commission cost.
This doesn’t make them evil people. But it is one of the realities of buying insurance, with the exception of term life insurance.
3 Really Sane Uses for Life Insurance Policies
Since insurance agents can engineer so many uses for life insurance – and can sound pretty compelling – you should know your personal reasons for buying life insurance before contacting any agent. Otherwise you risk buying a life insurance policy that you don’t need or can’t afford.
Here are the three best reasons to buy life insurance policies — and who they are right for:
1. Replace lost income due to a breadwinner’s (or full-time mom’s) premature death.
Term insurance is best for young families trying to provide a “financial parachute” for their families in the even of an untimely death.
Don’t think this can’t happen to you. I know stay-at-home moms who suddenly lost their husband, the primary breadwinner. And I mean suddenly. One was a Marine who went out on a routine training mission and never came back, leaving her with four children to raise. Another man went to work and was killed in an industrial accident, leaving her with three preschool children. Stuff happens. Every primary breadwinner needs some term insurance to cover his family’s needs.
A strong case can also be made for buying a life insurance policy for a full-time stay-at-home mom. If you had to pay for the services she performs out of love, it could cost a small fortune. Nannies don’t come cheap. Think about all the child care, meal prep, chauffeuring, laundry, cleaning, homework supervision, planning and more… If you had to hire those tasks out, you’ll incur some serious out-of-pocket costs.
2. Provide liquid assets for your estate so heirs don’t have to sell assets like real estate or a family business to pay estate taxes. This is often the intent behind buying whole life insurance policies.
Or alternatively, to provide cash to equalize a distribution between multiple children.
3. Serve as an investment, letting you build funds for college, retirement or other objectives, or simply to increase the value of your estate. This is only advisable for those who have already maxed out all their retirement plans, 529 plans, etc. and still have extra cash to utilize here.
These life insurance policies, called “income for life” and other variations, are whole life insurance policies with certain caps and structure. They are appropriate for high-income earners who’ve maxed out their qualified investment accounts, as these accounts let you squirrel away money tax-free – when structured correctly. These life insurance policies must be structured properly to work.
If you’re in a high tax bracket and want to stash extra cash into a cash value policy for retirement or a death benefit, this might be an option to consider.
How Much Life Insurance Do You Need?
Here’s another thing you should decide before meeting with a salesperson… how much coverage do you need?
Life Insurance Should be Based on Two Things – Who You Love and Who You Owe
How much coverage you need depends on what you want it to do for you. But don’t expect too much. Insurance should maintain, not raise, your family’s standard of living. To estimate your life insurance need, estimate your family’s annual living expenses including debts. Subtract other sources of funds that would be available to your family if you die prematurely – like Social Security, savings, other assets, your spouse’s income.
The difference between money needed and money available is your life insurance need.
Depending on how far into the future you need this money to carry your family, the insurance need can be quite high. If you’re in your early 30’s with a few young kids, you might be looking at $1,000,000 to $3,000,000 of coverage to cover living expenses for 20 or 30 years, any debts, college for each child, plus money to pay off the mortgage. Much depends on your lifestyle and circumstances. Everyone’s situation and lifestyle is different, so you need to figure out what’s right for you.
You might decide to scale back and buy “less” insurance than you think you need. Maybe your kids will have to work more to fund their own education or won’t go to college… you get the idea.
Don’t underestimate the life insurance needs of a stay-at-home mom either, just because she may not be drawing an income. If you had to replace her many tasks in the home – child care, chauffeur, cook, housecleaner, yard attendant – it would require considerable resources. These are discussions you should have before you talk with any agent. Or even before you get an online quote.
Do Before Buying Any Life Insurance Policy…
Today you can buy life insurance without ever sitting down with a life insurance agent. You can’t beat that for convenience. Or for keeping your confidential matters to yourself. It’s also easier to compare quotes side-by-side.
You still need to do your due diligence. Don’t skip these steps. They’re key to getting exactly what you want and need, not a “piece of worthless junk.”
- Compare quotes from at least three life insurance companies.
- Check each life insurance company’s financial ratings before you buy. Use A.M. Best, Standard and Poor’s, Fitch Ratings, and Moody’s Investor Services. It only takes a few minutes.
After all, what good is a life insurance policy if the company went belly-up a few years before you need to make a claim? All your premiums went down the drain and you have to start over… perhaps with a health condition by then. This is critical, whether you buy online or through an agent!
- Run your own numbers and make sure you can afford the payments long term. It may be better to buy a “lesser” policy and be able to stay current on payments than to lose the entire policy because you can’t make the payments. You could always add another policy in a couple years if your health is still decent, to increase your total death benefit.
- Research any exclusions a policy will have. One hot question this year is whether death from Coronavirus is covered. Also, many policies exclude suicide during the first two years of the policy.
Buying whole life insurance is definitely more complex than buying term. As a former insurance sales person, I definitely recommend sitting down with an agent if you need a whole life insurance policy, so you understand what you’re buying. As with any financial products, never buy a life insurance policy you don’t understand. Make the agent go over it repeatedly, till you understand it.
Otherwise, buy term now for protection, and add whole life for other reasons later.