Types of Life Insurance

There are many different types of life insurance. The one you choose depends on your needs and preferences. The main types are as follows:

  • Term insurance
  • Whole life insurance
  • Universal life insurance
  • Variable life insurance

Term Insurance

As the name implies, term insurance lasts for a specific period of time or a term. If you die during the term of the life insurance policy, the benefit of the policy is paid to the named beneficiary or to your estate. At the end of the specific period, the coverage is no longer in effect.

Advantages

  • It's a good way to provide assets for dependants in the case of the policyholder's death.
  • It’s designed to provide large amounts of relatively inexpensive coverage while you're younger and your need is higher.
  • Under a term policy, the younger you are, the lower the annual premium is.

Disadvantages

  • The cost generally increases as you get older to cover the increased risk brought about by increased age.
  • Some term policies are renewable; however, the issuer may have the right to refuse to renew the policy due to poor health.
  • Most term plans aren’t available for purchase after age 65.

Insurance provided through employee benefit plans is term insurance. When you leave the company, there may be a grace period to convert to an individual whole life policy without showing evidence of medical insurability. Premium rates on conversion are significantly higher than the group premium rates.

Some term policies may also be convertible to life plans. The death benefits guaranteed, under such a policy, may stay the same, increase or decrease during the term.

Whole Life Insurance

Whole life insurance, also called permanent insurance, provides lifelong protection upon the death of the policyholder, regardless of when he or she dies. This type of coverage creates or adds to an estate, providing cash to a surviving spouse/partner or other family members. It can also be used to pay income tax or make a charitable donation at death.

Whole life insurance has two or three components:

  • The death benefit or the insurance
  • The cash surrender value or the savings (the policy can be cashed in)
  • The annual policy dividend (on participating whole life plans)

The cash surrender value of a policy will depend on its face value and the length of time the policy has been in force. Because a whole life policy has a surrender value, it can be used as collateral for a loan. If you want the cash value, you have to either borrow it at current interest rates or surrender (cancel) the policy. Borrowing funds reduces the death benefit by the amount of the loan. Surrendering the policy means you no longer have the insurance coverage.

Whole Life Premiums

There are three things to keep in mind regarding premiums for whole life insurance. They are:

  1. Premiums for whole life insurance are set at a level premium, which is initially considerably higher than term insurance premiums. You are, in fact, overpaying on the policy to build up a reserve. This reserve is intended to cover the higher costs of being insured when you're older.
  2. The premiums may be payable for the entire lifetime of the insured or for a specified period of time (the size of the premium will vary accordingly).
  3. They can be lower to start with and increased at a certain age. This is called a “modified premium” or “graded premium” whole life policy. Such an arrangement allows a policyholder to purchase a higher amount of insurance than would otherwise be affordable based on current income. The expectation is that the high premiums will be more affordable in the future and/or the amount of insurance need may decline, allowing you to maintain the premium with reduced coverage.

Universal Life Insurance

Universal life insurance was originally marketed as a “buy term and invest the difference” product. This type of insurance combines an insurance product with a tax-sheltered investment account. The cost of insurance and the investment performance are reported separately. Cash withdrawals and policy loans can be made, which aren’t required to be repaid. The death benefit pays out tax-free.

Universal life insurance is commonly used by individuals seeking:

  • A tax-sheltered investment account to maximize the value of an estate
  • Planned charitable gifting
  • Tax-free retirement income by taking out a policy loan

Universal life is a complex product. Professional advice is needed to fully understand policy features, tax implications and costs.

The death benefit under a universal life insurance policy will vary depending on the size of the premium the policyholder elects to pay for a particular period. The policyholder must choose between a level cost of insurance or a yearly renewable term, with an increasing cost each year. Fees are levied against the investment account to cover administration costs. Be aware that fund management fees may be high in the investment account.

Variable Life Insurance

This type of coverage is similar to whole life insurance. However, premiums under variable life insurance policies are invested and the coverage and values under the policies will depend on the rate of return of such investments. Therefore, there is some risk involved with this type of coverage.