Whether you need life insurance or not is generally a relatively simple decision to make. But there are many life insurance types, and deciding which one will serve you best can be more complicated. Here's a handy introduction to the five main types of life insurance: term, whole, universal, variable, and variable universal.
Why life insurance?
Let's start, though, with a quick review of why you might need life insurance in the first place. Obviously, you might need it if you have young kids and a spouse and want to provide for them in case you die and aren't around to do so yourself. But life insurance is also valuable if you have any other people who depend on you financially -- or might in the future -- such as parents or nieces or nephews or a disabled loved one. For that reason, single or childless people shouldn't quickly assume that they don't need life insurance.
You might also get life insurance that can pay off a mortgage should you die, or that can keep your business running for a while once you're gone or that can pay any estate taxes or funeral expenses that materialize upon your death. (Of course, for some of these reasons, you might just accumulate money in a separate fund, bypassing insurance.)
It's worth noting that come tax time, the payout ("death benefit") is received tax-free by the beneficiary, as death benefits in general are, for all types of life insurance. An exception would be if you owned a life insurance policy on yourself, with proceeds becoming part of your estate. If so, then they might be subject to an estate tax.
With that out of the way, it's time to jump into the types of insurance. Note that each of them is sometimes referred to by a different name, so focus on the description of each. Whole life insurance, for example, may be called ordinary life insurance, and universal life insurance might be called adjustable life insurance.
Term life insurance
Term life policies are often chosen by insurance consumers because they can make the most sense. As its name suggests, a term life insurance policy remains in force for a specified term -- often 10 to 30 years. Thus, it won't necessarily cover your entire life -- but by age 60 or 80, you may not really need it anymore, with your children grown and your retirement nest egg established.
Term life insurance also tends to be simpler and significantly less expensive than other life insurance types. In part, that's because it offers a death benefit should you die during the policy's lifetime, and little else. Term life policies generally offer the most insurance coverage for your buck, because the policies aren't offering you many other features.
Premiums for term life policies are often fixed at first, for a certain period, and then they start rising. There are many variations of term policies, though. For example, you might be able to opt for fixed premiums, in exchange for a death benefit that decreases as you age. Many policies let you renew for additional years, usually at a higher cost, and some let you convert the policy into a whole life insurance policy.
Considering that the Society of Actuaries has estimated that 39% of whole-life policies are terminated within the first 10 years, getting a term policy is an even more appealing option.
Whole life insurance
Another widely used kind of life insurance is the whole life policy. It's designed to last for your entire life and usually features a lot of certainty: You'll have fixed premiums and a specified death benefit. And along with that, you'll accumulate a cash value account that serves as an "investment" component to the policy. The longer the policy is in force, the more money accumulates in the cash account -- on a tax-deferred basis and according to a schedule. If you stop paying premiums before you die (or before age 95 or 100, when many policies let you stop paying), you'll lose out on the death benefit, but you can claim the cash value.
In addition, many whole life policies will pay you dividends that will effectively reduce the cost of your premiums. Some policies will let you use the cash that has accumulated in your account to pay your premiums, too.
The next three life insurance types are variations of whole life insurance.
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Universal life insurance
Universal life insurance also involves a cash-value account growing over time, but it does so in a different way, based on prevailing interest rates (and typically guaranteed to not fall below a particular point). It's also very flexible, permitting the policy holder to adjust, over time, the premiums, cash accumulation, or term of the policy. If you find you need or want more coverage later in life, for example, you can get it. Or if you want to pay less for less coverage, you can opt for that, too.
Variable life insurance
With variable life insurance, the policy has two parts -- one is a general account intended to cover the insurer's obligations and the other an investment account, where the policy holder gets more choices regarding how money in the account is invested -- for example, perhaps being able to invest through one or more stock mutual funds, bond mutual funds, or money market funds, or a combination of them. This increases the upside of the account, but also adds more variability to the cash account and also the death benefit.
Variable universal life insurance
Variable universal life insurance is a combination of universal life and variable life, permitting adjustments in the premiums, death benefit, and investment options. The death benefit may fluctuate in value depending on the performance of the underlying investments -- though insurers will typically have a floor below which it can't fall. These policy holders bear more risk, in return for a chance at higher returns.
It's worth noting that with the insurance policies that have investment components, you might consider passing that component up and simply investing your own money in funds or other investments you choose yourself. That can be a less expensive way to invest, giving you ultimate control and flexibility, and it can permit the dollars you do allocate to insurance to buy you more insurance.
Whichever of the life insurance types that you select, be sure to choose a strong, highly rated insurer. If you're quoted a great price by a company you've never heard of that ends up going out of business in a decade, you'll be wishing you'd gone with a top-rated outfit instead.
