Along with determining how much life insurance you need, the answer to which type of life insurance to get can depend on a variety of factors, such as your age, life stage and financial needs.
To start, let’s compare the two main types of life insurance policies, term and permanent life insurance.
- Term life insurance provides life insurance protection for a pre-defined number of years. Its main purpose is to provide a “death benefit” to beneficiaries if you pass away during the time of coverage. At the end of the term or if you elect to not pay premiums, coverage is discontinued.
- Permanent life insurance is designed to last throughout your life and provide a death benefit to beneficiaries upon your passing. There are four primary forms of permanent life insurance to consider – whole life, universal life, index universal life, and variable life. All three types of policies can include a cash value component that grows on a tax-deferred basis and can increase in value over time. Differences primarily come down to if and how earnings accumulate.
Given that you have a variety of options, it’s important to select a protection strategy that’s best suited to your individual needs and financial objectives. Let’s take a closer look at the details.
Term life insurance
What it is: A temporary form of life insurance coverage set for a period of years, usually no more than 30. You’ll typically pay a fixed premium each year. When the term ends, you can renew the insurance (although premiums may rise significantly as you get older), apply for a new policy or look to convert the term policy to a permanent life insurance policy prior to the end of coverage.
Who it’s for: If you’re looking for the most affordable premiums or if you want or need coverage for a specific amount of time. It’s also a good option if you’re a business owner and want to provide a life insurance benefit your employees.
What to consider: A term life insurance policy has no cash value; however, it’s a low-cost income replacement option, particularly for people ages 50 and younger.
Whole life insurance
What it is: A type of permanent life insurance that offers both a death benefit and cash value. The cash value is paid through dividends from the insurer.
Who it’s for: If you want to provide death benefit protection for your family and have the flexibility to access the cash value that accumulates inside the policy (either through direct withdrawals or loans). The cash value can be used for additional financial needs like college funding.
What to consider: Of the four forms of permanent life insurance, whole life is the most conservative but also the most reliable. You don’t have the ability to choose investments and your premiums are fixed. However, growth of cash value is guaranteed year-after-year and the death benefit is not subject to fluctuation. And keep in mind that loans and withdrawals may reduce the death benefit.
Universal life and Index Universal life insurance
What it is: Similar to whole life insurance, universal life also provides a death benefit to your beneficiaries when you die. You can choose to have a death benefit only, or you can also include a cash value component. The cash value in universal life is based on an interest rate determined by the insurer, while the cash value in index universal life is based on the underlying index selected, a cap, and participation rate.
Who it’s for: If your primary concern is to provide a death benefit and cash value is not a critical factor. It’s also a good option if you’re looking for the least expensive form of permanent life insurance.
What to consider: Universal life insurance premiums can be flexible, though the policy should be reviewed regularly to make sure it is performing as intended.
Variable life insurance
What it is: A type of permanent life insurance in which your premiums are invested in stock and bond market portfolios. This creates the potential to generate competitive returns that can dramatically impact the cash value accumulated in the account.
Who it’s for: If you’re looking to provide a death benefit and potentially contribute to your investment portfolio. You can also take partial withdrawals of the cash value or borrow against it. Increasing cash values can also be used as a way to partially offset premium payments.
What to consider: Variability in investment performance could alter the death benefit and cash value of the policy. A variable life insurance policy requires more hands-on oversight than other forms of life insurance because of the impact that investment performance has on the policy’s coverage features. Yet it also offers an opportunity to boost the cash value beyond what’s available in other types of permanent policies. You’ll want to assess your risk tolerance and investment time horizon to determine an appropriate investment strategy.
Permanent life insurance with a long-term care rider
What it is: Any of the permanent life insurance options with a long-term care (LTC) rider. This allows you to dip into the policy to pay for long-term care services, if needed.
Who it’s for: If you’re age 50 or older and interested in long-term care coverage.
What to consider: If you don’t end up using the LTC benefits, your beneficiaries will receive the full death benefit.
Choosing between term and permanent life insurance
Your first decision in selecting a life insurance policy is to determine whether a term policy or one of the permanent life insurance options is more appropriate for your situation. Here are some additional factors to consider.
Why term life insurance?
Term life insurance may be your best choice if your primary goal is to provide a source of income for your family that would be lost upon your death and you’re under the age of 50.
- When selecting your term, you’ll want to consider the length and amount of your outstanding debts, number and age of dependents, and any anticipated future expenses including end-of-life costs. For example, a 28-year-old parent with young children and a 30-year mortgage might opt for a term policy of 30 years. A 45-year-old parent with children in their teens and 10 years or less left on their mortgage may find a 10-year policy sufficient to cover their financial commitments.
- Term life insurance is generally less appealing after age 60. However, if you have a term policy and are diagnosed with a terminal illness, you may want to renew or convert your policy as you wouldn’t meet medical requirements to qualify for other life insurance coverage. Note that premiums will rise after the term ends.
- Term life insurance is also often used by business owners to protect their company in the case of a death of a key employee or executive that their business is particularly dependent on.
Why permanent life insurance?
Permanent life insurance is designed to meet more specific needs beyond income replacement. Additionally, since insurers are obligated to pay out death benefits to beneficiaries, these types of policies are significantly more expensive than term life policies.
Specific circumstances where permanent life insurance might be the best fit include:
- Providing liquidity for an estate. If estate taxes are a concern, permanent life insurance can be used to essentially replace the proceeds from the estate that would be lost to taxes and fulfill the financial expectations of your heirs.
- Funding the buyout of a business partner upon their death. Life insurance is often used as a key component of a buy-sell agreement between business partners.
- Meeting potential future costs for long-term care. As outlined above, an LTC rider allows a portion of the death benefit to fund long-term care needs.
- Financially supporting a disabled dependent upon your death.
In the end, determining the right approach to life insurance is best accomplished with a financial advisor. Since life insurance is just one aspect of a comprehensive financial plan, you want to make sure your purchase decision is aligned with your most important financial goals.
Learn more about the role life insurance can play in your financial plan.
