Sometimes life comes at you fast with the unexpected. Accidents, illnesses, or unexpected events happen to the healthiest and youngest of us and can change our plans of living a long life with those we love. The best thing we can do to ensure our families are taken care of is to leave them with enough money—via a life insurance policy—to cover the funeral or other expenses that may crop up in our absence so that they can grieve with peace of mind.
What We'll Cover
Read on to learn what to expect when choosing a life insurance policy, personal factors that might affect your choice, and how to choose the right policy for you and your family.
What to Consider Before Choosing Life Insurance
As with any other big purchase, it is essential to look at all the factors that will influence your decision, including price and what is available to you.
When it comes to life insurance, there are five things that are important to keep in mind before you purchase any policy.
The younger you are, the less expensive a life insurance policy will be, no matter the type of life insurance you choose. Younger people are less likely to pass away and do not tend to have the failing health that comes with age, so life insurance companies do not have to pay out as often. This factor comes into play very significantly when it comes to term insurance (more about this later).
As you get older, purchasing a policy not only becomes more expensive, but you may not be able to purchase certain types of insurance. If you are young, take advantage of these low-cost policies as you get more bang for your buck, and you can have peace of mind knowing that your family is taken care of should something happen to you.
Many insurance companies do not even offer term life insurance to people 60 or over because the likelihood of them having to pay out and pay sooner (or at all) has risen significantly. If you fall into this age bracket and still want life insurance, you will have to choose a permanent life insurance policy.
The good news here is that while the premiums of permanent life insurance policies tend to be significantly more expensive, they may be worth the investment because you will be able to save money in addition to earning a death benefit. Also, the premiums are more flexible, and there are several types of these policies to choose from.
Because men, on average, live significantly shorter than women, insurance companies have to pay out death benefits more frequently. This makes buying an insurance policy more expensive for men.
Most life insurance companies require you to have a physical before telling you what policy options are available and giving you price options.
If you have had serious health issues (for example, a heart attack or cancer) or any habits that are bad for your health (such as smoking), you will not have as many policy options available to you. The options that are available to you will have much higher premiums because there is a higher likelihood the insurance company will have to pay out sooner.
Think through what you can afford. If you are young and just getting started in a career, you may not be able to afford permanent life insurance. In that case, term life insurance (which covers you for a set amount of time) would be the best and most affordable option.
If you are older and have an established career and savings, you may be able to spend more on life insurance that lasts for the rest of your life instead of expiring after a certain point.
Maybe you have young children who will not be independent for 10-20 years, and you want to make sure they are taken care of—house paid off, debts taken care of, funeral costs covered—if something happens to you. If that’s the case, then the ideal life insurance would be term life insurance.
On the other hand, you may be older but have a child or spouse who requires much medical care and will need someone to look after them once you are gone. If that is the case, a form of permanent life insurance may be right for you.
Types of Life Insurance
Before you choose a life insurance policy, it is important to know what types of options there are so you can choose the type that will best work for you. There are many different life insurance plans, but they all fall under two basic options: Term life insurance and permanent life insurance.
Term Life Insurance
Term life insurance is a life insurance policy in which the user pays a premium (usually monthly) for a specified period for a specific amount of money to be paid to their beneficiaries should they die.
If the person has regularly paid their premiums and they pass away during the period (or term), the insurance company will then send the sum of money either in a lump sum or monthly payments to their beneficiaries.
If the insured dies outside this period, their beneficiaries will receive no payment unless the policy was renewed. While many insurance companies give the option to renew the policy, keep in mind that the premium will likely increase because you are now older and are more susceptible and likely to become ill.
The premium or fee is determined by factors such as how much money the insured wants to be paid out in the event of their death and their age, health, and gender. The younger and healthier the insured is, the less their premium will be as it is less of a risk that they will die, and the insurance company will have to pay.
Term Life Insurance Policy Options
Within term life insurance, there are three policy options to choose from, each with pros and cons: level term or level-premium, yearly renewable term, and decreasing term.
Level Term or Level-Premium Term Life Insurance Policy
This is the classic term policy that comes to mind when people hear someone say, “term life insurance.” With this policy, there is a set amount of time—usually between 10 to 30 years—to pay a fixed premium. If you die during that agreed-upon period, the insurance company pays out the amount of money initially agreed upon, known as the “death benefit.”
This type of plan is great for a young and healthy person without much debt or who has young kids that they want to be sure are cared for if they die unexpectedly, whether by an accident or illness. Not only will your loved ones be able to pay for funeral expenses, but it will ensure that living expenses, such as rent, mortgage, health insurance, and food, are taken care of while your family works through the aftermath of their loss.
The downsides to this type of policy are that if you die outside the policy period, your beneficiaries will not be paid. You will have to renew the policy if they want continued coverage, and the premiums will increase. The renewed premium will be more expensive due to your increase in age and any health problems that may have come along with it.
Yearly Renewable Term Life Insurance Policy
With this type of policy, there is no set amount of time you have to pay premiums. Instead, you renew it year to year without having to give proof that you are healthy or “insurable.” This policy can be expensive as the premiums will also increase year to year and with age.
However, if you have received a diagnosis of a short-term terminal illness, this is a way to get life insurance, so your family will be taken care of after you are gone. This may be impossible otherwise, as many insurance companies want proof that you are healthy before they insure you.
Decreasing Term Life Insurance Policy
With this specific policy, you will pay a fixed premium for a specified amount of time, but your death benefit will decrease as time goes on.
This type of insurance is a great option if you want personal loans and debts such as mortgages, car loans, and business loans (which also decrease over time) to be paid off after you are gone, so your family does not have to worry about them or worry about losing their home. While the amount you receive decreases over time, the premiums are more affordable than level term or level-premium term life insurance.
Permanent Life Insurance
As with term life insurance, permanent life insurance has several options to choose from. But, before exploring the different types of permanent life insurance, it is important to focus on the benefit that most permanent policies have that term life insurance policies do not—cash value.
In addition to a death benefit, almost all types of permanent life insurance policies help you build a savings account known as cash value. As long as you consistently pay your premiums, this account will keep being paid into, with interest included.
There are several instances in which this account could be helpful to you, including:
Withdraw Money Quickly
In medical or any other number of emergencies in which you need money quickly. You can withdraw from your cash value account instead of taking it from your bank account. One plus to using your life insurance’s cash value account to pay off these expenses is that unless you take more from the account than you have paid in premiums, it is tax-free.
The downside is that if you have not paid back the money you took from your cash value account and you die unexpectedly, then the death benefit given to your beneficiaries will be reduced.
Use the Money as a Loan
Perhaps you want to start a business, pay off your car, pay off some of your mortgage, or put a down payment on a home. Depending on how long you have had the insurance policy and how much in premiums you have paid into it, there may be a lot of money you can put toward paying off expenses or starting a business.
The best part is that it is a tax-free loan, meaning you will only have to put back in the amount that you took out and nothing more.
The downside, once again, is that any loans that are not paid back before you die will be subtracted from your death benefit.
Close the Account Anytime
If you can no longer afford the premiums, you can close the account and receive back the equity—the amount that is in your cash-value account and its interest—in return.
The downside to this is that the insurer has the right to subtract the cost of any premium payments you may have missed or any loans you took out from the cash value account that you haven’t paid back.
You can use the cash value to help pay premiums. Maybe you have unexpectedly lost your job or had other unexpected expenses come up and need a little help paying your premium. In that case, you can take money from your cash value account to help pay your premium.
It is important to not rely on this feature too frequently, however, for two reasons:
- Different insurance companies have different rules concerning how and when you can do this, and you do not want to be taken off guard by any unexpected penalties.
- If you deplete your entire cash-value account, it will cause your policy to lapse, leaving you without insurance.
Permanent Life Insurance Policy Options
The two main types of permanent life insurance are whole life insurance and universal life insurance. Under the umbrella of universal life insurance are three subtypes: guaranteed universal life insurance, indexed universal life insurance, and variable universal life insurance.
Whole Life Insurance
Whole life insurance is the most popular choice of permanent life insurance. With whole life insurance, the user pays a fixed premium based on age, gender, and health. If you choose whole life insurance, you do not need to renew your policy as you would if you have term life insurance.
You can cancel your policy at any time, but as long as you pay your premiums, it does not matter if you die in one year or a hundred years later; your beneficiaries will receive your death benefit in the amount specified.
There are several benefits to whole life insurance:
- The premium remains the same no matter how long you have it. That means if you, for example, buy a whole life insurance policy at the age of 20 with no health issues, your premium rates will stay the same if you keep paying into the policy even if you live to 100 or have significant health declines or illnesses.
- You do not have to worry about renewing your policy. There is no need to keep track of dates or worry about what happens if you die unexpectedly the day after your policy expires. Whole life insurance lasts the duration of your life as long as you pay your premiums.
- You can save money in a cash value account as long as you pay your premiums.
Despite these benefits, there are also a few disadvantages worth considering with whole life insurance:
- Whole life premiums are much more expensive than term life premiums—somewhere between five and fifteen times as much. This is because the insurance company has to consider possible health declines due to age or emergencies (more likely to occur over extended periods). Because they will likely be covering you for a much longer period, the up-front cost is more.
- You may no longer need whole life insurance and could still be spending a lot for it without realizing it. This can be easy to do if you have an automatic payment system set up.
Who Should Get Whole Life Insurance?
While whole life insurance is far more expensive and more of a commitment than term life insurance, it can be worth the extra expense if you fall into any of these categories:
- You need help paying off estate taxes (especially beneficial for large estates).
- You are the parent of a disabled child who will need quality care once you are gone.
- You are the parent of an ill child and need a way to help pay medical expenses.
- You want to buy or sell your portion in a company (that is majority-owned by five or fewer people) quickly.
Universal or Adjustable Life Insurance
Universal life insurance is a form of permanent insurance. It is similar to whole life insurance in that if you have it, you can build up cash value. It differs from whole life insurance in that premiums and death benefits can be adjusted.
Generally speaking, it is much less costly than whole life insurance—especially up-front. However, if you plan to keep this type of policy for a long time, expect premiums to get more expensive with time.
Depending on whether you have enough saved in cash value, you may be able to skip a payment here or there—something that may prove beneficial if you have unexpected expenses and cannot afford a premium a certain month.
Be careful doing this, however, and try not to make a habit or rely on it. As mentioned earlier, if your cash value gets too low (often due to the interest taken from the value accrued), it can cause your policy to lapse entirely.
Guaranteed Universal Life Insurance
Guaranteed universal life insurance or GUL is different from most other permanent life insurance policies in that it is the only one that does not have the option to build cash value.
On the other hand, it has many benefits that certain other permanent policies do not, such as:
- It has coverage for life insurance at more affordable premiums than whole life insurance.
- Flexibility with death benefits. You can have a guaranteed death benefit amount, or if something happens and you need either more or less, there is the option to change it.
- Refund on premiums. If you want to switch policies or get rid of life insurance altogether, most companies will refund anywhere to 50-100% of what you have already paid in premiums.
GUL is a good option for you if you want the lower rates of term life insurance but without worrying about having to renew a policy or having to worry about the time in between renewing policies and leaving it up to chance that nothing will happen.
While there is not the option to have extra money saved up with this account to help with any emergencies while you are alive, you can be sure that your family will receive money to help them take care of unexpected expenses if you die suddenly.
Indexed Universal Life Insurance
Indexed universal life insurance is unique among permanent life insurance policies in that the interest rate applied to your cash value is decided by market indexes (for example, Nasdaq).
There is a minimum interest rate that is decided upon by you and your insurer to make sure that you do not lose money. Even if the interest in indexes falls low, yours will not. Additionally, this interest rate also has the potential to rise with the market, meaning that there is more room to grow your cash value more than any other type of insurance.
The downsides to UIL are that it is complicated. Indexes are subject to great change over time, which means that your interest on cash value is also subject to change. The insurance company may put a cap on the interest rate, meaning that even if an index rises greatly, your cash value may not rise with it.
This type of insurance would be great for those who like and are willing to take risks. Along with other types of permanent life insurance, you will have peace of mind knowing that your beneficiaries will receive a set death benefit. There is potential to make enough from your cash value account to pay off estate taxes or have an inheritance for your beneficiaries that won’t be taxed or that any dependents with long-term needs will be cared for.
Variable Universal Life Insurance
Variable universal life insurance is unique among universal life insurances in that it has a savings component, where you can build up cash value. However, you can also separate this cash value into multiple accounts to invest in the market.
The insurer will separate any money from these accounts to cover administrative fees, and the other accounts known as sub-accounts are invested in the market.
Unlike most other universal life insurance policies and especially IUL, the investment and the risks associated with it fall solely on you, the insured. This can work in your favor in that if the market is doing well, you can add a lot to your cash value. However, if the market is doing poorly, you may end up losing money in two ways:
- Your return of interest could drop as low as 0%, causing you to lose money from your cash value.
- If your cash value drops below a certain point, you may have to start paying higher premiums or else risk your life insurance lapsing entirely.
Once again, this type of insurance policy has the potential to either lose a lot, leaving you or your family without anything if you lose too much. On the other hand, it can gain a lot and ensure that your family is well provided for if something happens to you.
It is up to you to decide if the risk is worth it or if maybe you should choose a simpler and more steady policy and invest elsewhere.
If you have a large estate, a child with an illness or special needs who will need long-term care, a permanent insurance policy is the way to go. There are several options to choose from, including whole life insurance or universal life insurance. Almost all of these insurance policies provide not just a death benefit but cash value, which can help pay off several things, from unexpected medical expenses and loans while you are alive to estate taxes when you die.
If you are young and healthy but do not have a lot of extra money to invest in the more complicated policies, but want to make sure your family is taken care of and not saddled with debt if something happens to you, then term life insurance is the best option for you.
Thinking about life after you are gone and making sure your loved ones are provided for and protected against unexpected expenses can seem like a daunting task. However, by looking at your specific situation and deciding what is most important to you and your family, you can narrow down your options to the ideal policy for you.
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