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While all life insurance policies serve the same general purpose – providing funds to your family in case of your death – not all types of coverage are equally ideal for you and your family’s long-term financial future.
Like the IRS, life insurance companies can make it difficult to understand all the fine print, terms, and conditions. Sales representatives, agents, brokers, and financial planners can also make things worse by marketing certain policies because of the huge commissions they earn after each sale.
When it comes down to it, there are only two main, overarching types of life insurance you need to worry about: term and permanent life insurance.
Once you learn about the pros and cons of each, you can pick a specific kind (i.e. return of premium, level term, survivorship, no exam, guaranteed issue, etc.) within that category.
Term vs Whole vs Universal Life Insurance
Term Life Insurance
The point of term life insurance is to cover a person for a set amount of time.
The policyholder pays a fixed premium during the term period, which can be from 5 to 30 years, and if the insured person does not pass away while the policy is in force, the contract expires without a payout.
Otherwise, the insurance company will pay out the death benefit to your beneficiaries.
Term life insurance quotes are generally cheaper for younger applicants, as per the risk model of the companies.
Premiums
In regards to premiums, traditional term life insurance is the cheapest because it is temporary and issued through a strict underwriting process. The company uses actuary tables to calculate your mortality risk and rates based on your age, current health, family medical history, occupation, and other factors.
At the risk of sounding morbid, each year you live is a year closer to death, and because of this simple fact, your life insurance quotes will never be cheaper than when you were young and healthy.
Pros and Cons of Term Life
Although term life insurance rates are initially the cheapest form of coverage, term life expires after a specific period of time and must be renewed or replaced.
Renewal rates are usually substantially higher than rates for the initial policy. Term life does not accrue a cash value and if you become ill or elderly during the initial term, you may not be able to obtain a new policy.
Whole Life Insurance
Unlike term life, whole life insurance policies remain in effect for your lifetime, assuming you continue to make premium payments. Whole life insurance, which is a type of permanent coverage, also has an investment component known as cash value.
Think of it as a forced savings account whereby a portion of your premiums is diverted into this investment account. This is one of the reasons whole life rates are generally 5 to 10 times higher than term rates.
Premiums
Whole life premiums are averaged over the life expectancy of the insured individual, which maybe 50 years or more.
Once the policy is issued, the rate remains fixed for the policyholder’s lifetime and the policy can only be canceled for non-payment of premiums.
Even if the insured person becomes uninsurable due to poor health or age, a whole life policy remains in force.
Additionally, if premiums become a financial burden whole life policyholders can sell their insurance to a third-party for a lump sum payout through a process called a life settlement.”
Cash Value
As we mentioned, part of the premiums of whole life is diverted into a savings feature. Some of the best-rated life insurance companies pay a guaranteed rate of interest of about 4% on the cash value. Given the low-interest-rate environment, that’s definitely better than a checking or savings account, even a high yield one.
You can then choose to fully withdraw the cash value from the policy, effectively canceling the policy, or you can use the money as collateral for a low-interest loan.
Pros and Cons of Whole Life
Unfortunately, whole insurance has a fixed death benefit which cannot be changed as financial obligations change over a lifetime. This means that you may or may not have enough life insurance to meet your needs, while at other times, you may be overpaying for more life insurance than necessary.
Moreover, initial whole life insurance rates are higher than those of term or universal, making it less affordable for most American households on a budget.
Overall, unless you are a high net worth individual seeking tax-advantaged investments or estate planning strategies to minimize estate taxes for your heirs, life insurance isn’t a good investment. It is an overpriced life insurance policy with a low yield compared to other investment opportunities.
Universal Life Insurance
Universal life insurance is another form of permanent life insurance that has a minimum and maximum premium payment, offering a bit of flexibility to policyholders. Unlike fixed whole life premiums, if the cost of administering a universal life policy increases, the minimum payments increase.
Your contribution also determines the amount of money that is diverted into the investment account.
The cash value of universal life is invested in financial markets, resulting in greater volatility within the investment value of the policy. If the cash value of the policy reaches zero due to investment failures, the policy lapses. Universal life insurance rates usually rank somewhere in between term and whole.
Compare Life Insurance Online
Just like you would any product or service, it is best to research and compare carriers and policies. By comparing types of coverage, pros and cons, companies, and premiums, you increase your chances of finding the best, yet affordable policy to meet your needs.
This usually means buying a cheap term life insurance policy that offers you all the coverage you need, then taking the difference in premiums and investing. Max out your 401K, or if you don’t have access to one, open up a Vanguard or Fidelity account and invest in a passive index fund, such as an index fund that tracks the S&P 500.
In the long run, your term life policy will protect your family and offer you peace of mind. The premiums won’t be a burden on your budget. And, hopefully, you outlive your policy to enjoy the retirement savings you’ve built!
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First of all, everyone should note that if they are single and have no dependents, they don’t need life insurance! For the rest of us that are healthy and relatively young, I always promote term insurance, and then advise them to save/invest aggressively so that they won’t need life insurance by the time the terms are up. If you could stock up $2 million in your investments, I would think that your spouse and children could survive on that for quite some time. 🙂
As a former life insurance agent, I would tell anyone who doesn’t have boatloads of money to stay away from universal life. It’s just not sustainable for people who can’t load it up with cash. As for the buy term and invest the difference strategy, it’s great in theory but in practice, very few people have the discipline and motivation to do it.
I’m a proponent of whole life insurance for those who have maxed out their Roth IRA and reached their 401(k) match, and want to have some on-the-side guaranteed growth that isn’t directly tied to the stock market (and are OK with sticking with it for a long long time). For the rest, term is the best.
Term life is all that most people will ever need and the investment value of whole life does not justify the added cost. It’s already been said but unless you have dependents you do not need life insurance.
Thank you for this. Good, high-level description. Here’s my two cents for the “one-cent family” out there: First, with all due respect, the advisors above who say single people without dependents don’t need life insurance are just plain wrong. For a very select few, that is true. Do you have no debt, have made arrangements to donate your body to science, never plan on getting married or having dependents, and/or have no friends or relatives that you care about? Then you are in that category that don’t need life insurance. Everyone else will leave a mess behind that someone will have to clean up, and/or are punishing your future self who will ha e a spouse and/or dependents.
Next, term life should rarely need to be replaced or renewed. I bought my last term policy when my daughter was born to cover the period through her schooling. The purpose was to replace my income if I died during that crucial time. My savings and investments cover my needs after that. Also, the new term life also has living benefits you can access in the event of serious illness. A very important new feature in an era where we are good at keeping people alive but bad at curing them.
Lastly, some Indexed Unicersal Life products are not early as prone to the lapse fear outline above. They proved a safe place to save and grow funds over and above the cost of insurance without the risk of losing it, like a 401k.
Thanks for starting the discussion. A worthy one.
Agree with Tom in regards to advising singles not to take insurance. here’s a couple of reason’s why.
1. Premiums – choose level premium option when you are very young and your premiums remain at that level for the life of the policy. This makes long term cover incredibly affordable over your lifetime.
2. Underwriting requirements- insurance companies do not insure people who may look like a risk, hence they have underwriting procedures. When you are young it is far more likely that you will have no health issues and will be accepted without an issue. As term life is guaranteed renewable, if you do succumb to serious health issues later in life you already have your cover in place. Try getting insurance after surviving a heart attack.
One last point, I would steer clear of whole of life policies, they are expensive, they don’t deliver on their promises and they should have been phased out just prior to velociraptors becoming extinct.
I actually have a brother in law who owns his own insurance company so he keeps my insurance up to date every year or so. Though I still feel a lot people have no idea what things to cover and what things they can skip…
Term life is all that most people will ever need and the investment value of whole life does not justify the added cost. It’s already been said but unless you have dependents you do not need life insurance.
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