Types of Life Insurance

Types of Term Life Insurance Policies

Term life insurance provides protection over a specified period of time, otherwise known as the term, which can last anywhere from 5 to 30 years. It is designed to meet temporary financial needs such as home mortgage payments or a child’s college tuition.

Term life insurance is great for those financial requirements that gradually shrink over time as they are paid off. For example, if you know that it will take you 20 years to complete your mortgage payments, taking out a term life insurance policy that covers you for those 20 years would be reasonable. Thus, if you were to pass away within that 20 year term, your family could collect the death benefit from the policy to continue paying the home mortgage without undergoing financial stress. The benefit paid out is usually free of federal income taxes.

Let’s talk about the various types of term life insurance:

Guaranteed level term life insurance

Guaranteed level term life is the most common of term policies. It is simple to understand and fits most people’s needs.

• You pay a level or set premium for a predetermined amount of time (this is the term period)
• These terms typically last 10 to 30 years
• At the end of the term, coverage under the policy can continue but with a very significant increase in premiums, thus many policyholders opt to end coverage after the term finishes
• If you die during the term set by the policy, and all of your premium payments have been made up to that point, the insurance company would pay the death benefit to the beneficiaries you specified in your policy
• Beneficiaries should not have to pay federal income tax on the benefit, but there are exceptions

Return of Premium term life insurance

If you are alive at the end of the term specified in the polic this policy refunds 100% of all the premiums you paid. Best of all, this refund is not subject to income tax.

Take for example Mr. B, who buys a policy with a death benefit of $2,000,000 with a 25-year term and makes a yearly premium payment of $2,000/year. If Mr. B is alive at the end of his 25-year term life insurance policy, he will receive a $50,000 refund from the insurance company ($2,000 x 25 years = $50,000).

Annually Renewable Term (ART) life insurance

This type of term life insurance starts of with very low premiums at the beginning of the policy, but premiums increase each year at various rates. As one gets older under an ART policy, the increase in premiums becomes greater every year.

For example, say Mr. B purchases an ART policy at age 30 that starts of with a premium of $500 for the first year. At age 31, the premium increases to $550. At age 32, the premium increases to $610, and so on and so forth. In later years, it can become incredibly expensive and not recommended if you intend to hold life insurance for long periods of time. A guaranteed level term policy is usually recommended over Annually Renewable Term policies.

Decreasing term life insurance

This type of policy decreases the death benefit at a predetermined rate over the term of the policy while maintaining level premiums throughout the term. It is the ideal structure for life insurance because as you age, in theory, you would need less and less insurance so your total premiums paid should be less.  However, decreasing term is becoming more rare and typically is not priced competitively. Under this policy, even though you would be paying the same premium every year, the benefit amount would decrease, meaning the cost per thousand dollars of coverage would go up each year.

We generally recommend that individuals seek coverage using a strategy we can help create using guaranteed level term life insurance.

Types of Permanent Life Insurance Policies

Permanent life insurance, while more expensive than term life insurance, has very important and substantial advantages over the latter, but the largest drawback is cost. Most of the time the cost outweighs the benefits.

• Assuming you purchased a guaranteed, no lapse policy and have made your yearly premium payments on-time, the life insurance company is basically guaranteed to pay the death benefit to your beneficiaries when you pass away
• Unlike term life insurance, you cannot outlive your policy
• The life insurance company cannot cancel your policy as long as you continue to pay your premiums in a timely manner
• Premiums can be locked-in at a rate and remain at that rate for life. The younger and healthier that you purchase your policy, the lower your premiums can be
• No need to renew a permanent life insurance policy unlike term life insurance
• Permanent life insurance policies can build cash value

Whole Life Insurance

By far, whole life insurance the most expensive type of life insurance out there. But with the high premiums comes with some great features:

• Level or set premiums for the entirety of the policy
• Premiums can be paid over a shorter period of time (10-20 years) and the policy will continue to guarantee lifetime coverage after the last payment is made
• Accumulates cash value (also known as cash surrender value) that grows at a specified interest rate and is tax-deferred, for a return of anywhere from 3% to 5%
• Cash value will never decrease in value, regardless of market performance
• Cash value can be redeemed if the policyholder decides to cancel the policy
• Cash value can also be borrowed against and put as a collateral for a loan
• Death benefits paid out to beneficiaries are usually tax-free

Universal Life Insurance

Universal life insurance also offers permanent coverage but with an added benefit of flexibility with premium payments in exchange for adjustment of death benefits. Because of this, universal life insurance is much cheaper than its whole life counterpart.

Therefore, policyholders can change how much premium to pay each year or even choose to not pay the premium at all. This could be useful if an unprecedented loss of a job occurred or a policyholder cannot afford the insurance premium. The death benefits usually will be adjusted to a lower value to reflect the fewer premium payments made into the policy. Conversely, a policyholder could choose to bump up the premium payments to increase the death benefit.

Universal life coverage also has cash value, but the cash value tends to be much less due to universal life coverage having lower premiums.

Survivorship or Second-to-Die Life Insurance

Survivorship, otherwise known as second-to-die, life insurance policies will cover two individuals, typically married couples. The death benefit is usually paid out to the beneficiaries when both individuals under the policy finally pass away.

In general, purchasing a survivorship life insurance policy is less expensive that having to purchase two separate permanent life insurance policies. These kinds of policies are particularly useful if you want to protect your estate or pay tax liabilities on behalf of your children. These policies have also been used to set up a trust fund to support offspring.

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