Starting a family means creating a shared life based on your goals and values. If something happens to you, your partner may not be able to hold everything together alone. The burden can be especially heavy if you have children.
Life insurance can provide you with confidence that if the worst happens, the people who depend on you will be financially protected. The right life insurance policycan help your family maintain its financial obligations, like mortgage payments. It can also help your family spend money on something you value, like enrolling your children in private school.
That said, life insurance is complex. Too many people put off buying insurance because it can be intimidating to find and select a plan that fits their situation. A financial professional, the Insurance Information Institute (III), or your state’s “Department of Financial Services” or similar department can help you clarify your options.
Here are some of the most common policy types you might encounter.
There are many different types of life insurance. Each comes with a number of factors to consider—these vary based on how each insurance product is designed. Examples include things like how long coverage lasts (whether for a specific length of time or your whole life) and how you pay your premiums (for example, whether your premiums stay the same or decrease over time).
Here’s what you need to know.
Most of the time, when you’re researching different types of life insurance, you’ll be presented with two main options: term life insurance and whole life insurance. What many people don’t realize is that these are more like general categories and there’s still a lot of variation to consider.
Term life insurance is one of the most popular types of life insurance. It offers death benefit protection for a specific time period, such as 10, 15, or 20 years. Because it only pays out in the event of the insured’s death, term life insurance is also a very affordable way to obtain coverage.
You pay a premium during a specific length of time (the term). If you die during the term, your beneficiary receives a death benefit. If you don’t, the term ends and you get no cash value or other payout from the policy.
A 20-year term is popular because many families use term life insurance as protection while their kids are growing up. Term life is typically used to replace the income you would have contributed toward housing, education or lifestyle activities like extracurricular sports for the kids.
If this sounds like a fit for your family, check out term life insurance through Fabric.
This is an overarching name for life insurance that lasts your entire life (instead of expiring, as term life insurance does).
With a permanent life insurance policy, you can’t outlive your insurance protection. Even if you live to a ripe old age, the insurer will pay a death benefit to your beneficiaries (as long as you’re up-to-date on premium payments and there are no outstanding policy loans). Because these policies last your whole life, they often have higher premiums.
With this kind of policy, part of the premium accumulates as a cash value associated with a policy account. It’s tax-deferred, which means—as in some other accounts like a traditional IRA—that the interest growth you accumulate isn’t taxed annually. This can help the total amount compound and grow faster.
As a result, this type of insurance is sometimes used as a form of savings. Note, though, that there must always be a primary need for the death benefit—meaning you wouldn’t just buy a policy for saving purposes. In many cases, people use the cash value to pay their monthly premiums. This can provide some short-term liquidity because it means you wouldn’t need to pay your premiums during those months.
Other times, people use the cash value as a source of liquidity if they need cash down the line. This can take the form of a policy loan or withdrawal. Most of the time, you can borrow up to the “basis” tax free (that’s the value of the premiums you’ve paid).
If your cash value has increased past the basis, these gains will ultimately be subject to federal estate taxes and any other applicable taxes if the policy is surrendered.
And, of course, policy loans and withdrawals will reduce the available cash value and death benefit of your life insurance policy. If you take a lot of loans or withdrawals, this may even cause the policy to lapse. Withdrawals in excess of premiums paid will be subject to ordinary income tax.
While cash accumulation features can be helpful in many circumstances, permanent life insurance isn’t necessarily the best way for you to grow a nest egg. Depending on your goals, your retirement and other savings might be better served by investing in stocks, bonds, mutual funds and similar investments.
Whole life insurance is one of the most common permanent life insurance options. It offers consistent premium payments and a guaranteed interest rate on your cash value.
Since this is a type of permanent life insurance, you can expect the monthly premiums to be higher than a term policy with similar coverage. Keep in mind, though, that if you continue to buy term life insurance over time—for example, your term expires so you buy a new term policy down the road, when you’re older and face higher rates—starting with whole life might make sense.
A 30-year-old, non-smoking man in excellent health in California might get a quote of $460+ per month for $500,000 coverage on a whole life policy (according to a quote we got from State Farm), and only around $24 monthly for 20-year term life. Of course, your personal situation and policy needs will determine your own rates. Just know that if you decide to purchase a whole life insurance policy, that does mean you’ll need to have the financial resources to pay the premiums.
Universal life is another type of permanent life insurance. Universal life insurance provides more flexibility than whole life; it may allow you to adjust the death benefit without opening a new policy (subject to the terms of the contract). You can potentially increase your death benefit down the road, too, if you pass medical and any other requirements.
Additionally, you may be able to lower your premium payments or stop them altogether by paying from the cash value account. The tradeoff here is that you may need to make higher premium payments down the road if the cash value drops to zero, or else the policy may lapse.
If you want the option of some flexibility and you think permanent life insurance is your best fit, universal life may give you room to adjust as you go.
The “variable” factor of this type of policy is the rate of growth of the cash value. Instead of earning interest at a guaranteed minimum rate (as you would with a whole life policy), variable life insurance invests part of your premium in a select set of mutual fund sub-accounts.
There’s more potential for growth, but also more risk, because your money is subject to market risk. You may also have the option to allocate a portion of the funds to a fixed account not subject to market fluctuations, to incorporate a layer of protection from market declines.
Let’s say a variable policy grows, on average, in keeping with the historic stock market average of about 10 percent. In that case, the cash value could accumulate much more than a whole life insurance policy with a lower (albeit guaranteed) growth rate.
The problem is that the market can vary widely. If you die in a year when the stock market is in a slump, you may end up leaving the cash value in worse shape than if you’d stuck with smaller, more reliable growth.
As the name suggests, this option combines features from variable life and universal life insurance policies. This kind of policy lets you adjust the death benefit and premiums (like universal life insurance), and also gives you the growth opportunities that come with investing in market funds (like variable life insurance).
The main downside is that your death benefit as well as cash value can decrease if your investments don’t perform well. Some policies may guarantee that the death benefit won’t fall below a certain minimum, but there are market risks that can negatively impact your policy benefits.
You might also pay higher fees to cover management expenses for the sub-accounts, compared to if you set up a mutual fund investment outside of a life insurance policy.
This policy has more flexibility than some options, but it’s also more complicated.
If you’re over 50, or even in your 40s with some health problems, buying life insurance can get tougher. Depending on your age and health, it can sometimes be difficult to find an insurer to sign you on for a policy at all.
With a simplified issue policy, you skip the typical medical exam and fill out a detailed questionnaire instead. The premiums tend to be higher and the coverage options might be lower than you’d get with a term life insurance policy, but this can sometimes be a good option for seniors or people with moderate health risks.
If qualifying for life insurance is a serious hurdle, guaranteed issue takes things a step further than simplified issue. Almost no one gets declined for this kind of policy, so it’s helpful as a last-ditch resort. Because they are guaranteed issue, these policies tend to be more expensive for the same amount of coverage, compared to non-guaranteed policies.
In addition, guaranteed issue policies typically have graded benefits, which means that the payout would be reduced if you pass away during the first two years of coverage.
Guaranteed issue life insurance benefits are likely to cap around the amount your family will need to cover funeral costs and associated expenses. It’s not a great option for people hoping a death benefit will provide for dependents or constitute a large inheritance after their death.
If you qualify for another type of life insurance policy, you’d likely get better value by doing that. But if you aren’t getting approved elsewhere, simplified and guaranteed issue policies can be useful to ensure you have at least some degree of coverage.
This is essentially another name for a term life insurance policy that’s been scaled to pay for a funeral.
Policies generally provide up to about $20,000 as the benefit. Despite the name of the policy, beneficiaries can use the payout for whatever they want, not just funeral-related expenses. This can be a good option for families that would struggle to cover final expenses on their own.
If you already have a term life insurance policy or another policy you like, you may not need extra coverage to handle final expenses.
To be clear: These are different from insurance policies sold through funeral homes. If you buy a life insurance policy through a funeral home, it will likely be designed to pay for specific, planned services. Funeral-home-specific policies often have many strings attached about how your beneficiaries can use the death benefit.
Shopping around for coverage? Factor final expense costs into your total needs (along with mortgage, debts, bills, etc.) and check with a financial professional for find the coverage amount that will protect your family’s finances.
You’ve read through a long list of different types of life insurance already. But wait (as they say), there’s more!
Most policies offer variations on how you can structure premium payments. Some helpful terms include:
Level term life insurance: The face value of the policy stays the same throughout the duration of the policy term. That’s why it’s called “level term” life insurance. Essentially, if you die during the term, the payout amount is the same no matter how much time is left on the policy.
Increasing or decreasing term life insurance: The death benefit increases or decreases during the policy term. For example, maybe your decreasing term life insurance policy would pay out $750,000 at the beginning of your term, but $250,000 at the end. A decreasing term may make sense if you were seeking to cover your mortgage, for example, as it’d take less to pay it off over time.
Annually renewable term: This term life insurance lets you renew each year up to a specified age, even if your health or other risks would get you rejected from a new policy. This type of term life insurance isn’t popular anymore, as more people tend to prefer a 20-year policy.
Continuous or level premium: A type of life insurance policy in which you pay premiums throughout the duration of the policy (i.e. up until your death).
Single premium: You pay a lump sum at the beginning, which grows tax-deferred to create the death benefit. This is an option for many whole life or variable life insurance policies. The upfront cost can make it cost-prohibitive for many families. That said, if you can afford it, you won’t risk the policy lapsing due to failure to pay premiums. You’ll also get a better jump-start on growing the cash value.
Limited pay: You pay premiums for a set amount of time, or to a specific age. After that, you’re done paying but get to keep the coverage. The pros and cons are similar to single premium. You’ll be guaranteed coverage once you’re done paying and you’ll get faster growth early on, but you’ll face much higher payments than with level premium.
Survivorship: A survivorship life insurance policy is a joint policy covering multiple people (often a couple). The death benefit pays out when the second person passes away. It’s rare for term insurance to offer this option, but as a form of permanent life insurance this can be helpful for families with special-needs dependents who require lifetime care.
Riders: Broadly speaking, these are policy add-ons. A long-term care rider, for example, could let you use part of the death benefit to cover hospice care, for example, instead of only making funds available once you’ve died.
The “best” type of life insurance policy is like the “best” house: The right fit is going to differ from person to person.
Many families opt for a term life insurance policy because it’s a way to gain affordable coverage for a set period of time.
While monthly premiums for permanent life insurance tend to be more expensive than those for term life insurance, permanent insurance might make sense if you’re looking for coverage that doesn’t end at a set time and has an interest-earning component that can potentially be accessed in the future.
In figuring out the best life insurance policy for your needs, collect all your important financial documents (assets, debt, etc.), and have a conversation with your partner. Discuss the lifestyle that fits your present and future needs, to help figure out how much coverage makes sense for you.
You might also meet with a financial professional to determine what coverage is right for your particular circumstances.
Consider the following factors in this decision:
How long people will be depending on you financially
Major financial commitments, like a mortgage or a business
Your age and health
Overall financial goals
Think about the financial worry areas if you lost your income, like how to pay your mortgage or put your kids through college. How much would it take to keep your current financial goals on track? From there you can figure out how much coverage makes sense and what type of policy best suits your needs.
Fortunately, you’re not locked into one life insurance policy forever, so you can make changes later if you realize that another type of policy would fit your life better.
If you choose this path, your best option (if available) may be to convert an existing policy from one type to another. That’s because canceling a policy means starting from scratch and getting a new one. That would include redoing medical exams, applications and other steps you took when you first applied.
Some people start with a term life insurance policy because of the lower premiums. Then they might convert it to a whole life insurance policy later on, once they have more income to pay higher premiums.
If you think you might want the option to convert your life insurance policy type, ask during the application process to make sure you’ll be able to do so down the line. (Term life insurance through Fabric, for example, can be converted to whole life.)
The specifics of conversion varies from product to product and insurance carrier to insurance carrier. So, make sure you understand how this option works and if it’s available before you make a purchasing decision.
Life insurance policies range from simple and inexpensive to much more complex, pricey policies. Every type of life insurance has its pros and cons.
No matter your situation, the best plan for you is to be well-informed so you can pick the course that offers what you really need.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
This article is designed to provide general information on the subjects covered and the views represented herein belong to the author and are not intended to be used in the making of any financial decisions.
Fabric Insurance Agency, LLC offers a mobile experience for people on-the-go who want an easy and fast way to purchase life insurance.
Hi, we're Fabric!
© 2019 Fabric Insurance Agency, LLC
Fabric Instant is an Accidental Death Insurance Policy (Form VL-ADH1 with state variations where applicable) and Fabric Premium is a Term Life Insurance Policy (Form ICC16-VLT and CMP 0501 with state variations where applicable). Policies are issued by Vantis Life Insurance Company. (Vantis Life), Windsor, CT (all states except NY), and by Vantis Life Insurance Company of New York, Brewster, NY (NY only). Coverage may not be available in all states. Issuance of coverage for Fabric Premium is subject to underwriting review and approval. Please see a copy of the policy for the full terms, conditions and exclusions. Policy obligations are the sole responsibility of Vantis Life.