You’ve probably heard of life insurance before, but do you know the difference between term and permanent life insurance? What about whole life insurance or variable universal life insurance? Don’t worry if you don’t. Life insurance can sound complicated, but we’re here to make it easier to understand.
At its core, life insurance provides a death benefit that helps your beneficiaries (usually your family) financially if you die. But that’s just the start. Depending on the type of life insurance you get, your policy could also become an integral part of your financial plan while you’re alive — from helping you grow funds that you can access for any reason at any time, to weathering down markets in retirement and even being more tax efficient with your overall financial plan1.
Here, we explain the different types of life insurance and how each can help you reach various goals.
What are the types of life insurance?
Term life insurance
Term is one of the most basic types of life insurance. With term life insurance, you pay an insurance company a yearly premium (you could also opt to pay monthly) for a set amount of years — the term. The term could be a length of time, 20 years for example, or until you reach a certain age. If you die during the term, the insurance company will pay your family the death benefit. Once the term ends, you stop paying and the insurance ends, meaning no death benefit will be paid to your family.
Premiums for term insurance are typically less expensive than other types of life insurance for the same death benefit. That’s because term provides only life insurance and for a finite amount of time. In most cases, you get nothing more than peace of mind when you buy a term policy. This makes term insurance useful when you need a large death benefit to cover an obligation, say, a mortgage.
There are two main types of term life insurance: level and annually renewable. With level term, the amount you pay is the same for the entire term. Technically, you’ll pay more to start but less in later years than you would with a similar annually renewable policy. Level term is good when you want certainty and don’t think you’ll need to change your policy in the future (since you’re paying more to start, you may not want to change it later). With annually renewable term insurance, premiums adjust each year. While that can be inexpensive when you’re young, costs will rise as you get older.
One additional question you may want to ask when buying term life insurance is whether you can convert your policy to permanent insurance in the future. Many term life insurance policies offer the ability to convert to a permanent policy without having to take another health exam. But different policies have different rules, so it’s a good idea to ask how yours would work.
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Permanent life insurance
Unlike term, permanent life insurance never expires. So long as the policy stays in place it will pay a death benefit someday, even if you live to age 103 for example. That’s why permanent insurance tends to be more expensive than a term policy, even for the same death benefit. Permanent policies also offer more than just a death benefit. They accumulate cash value, which you can access at any time and for any reason throughout your life.1 Because everyone’s financial picture is a little different, there are several permanent life insurance policy types that can fulfill specific needs.
Whole life insurance is the most common type of permanent life insurance. Whole life insurance offers certainty. Your premiums will never change, and your cash value growth is guaranteed (it may grow at a higher rate, but never less than the guaranteed rate). That makes whole life insurance an incredibly stable part of your overall financial plan. In retirement, you can use the cash value of whole life insurance to weather down markets (since the cash value won’t decline). Withdrawing or borrowing against cash value can also help you be tax efficient, if managed properly, particularly in retirement.2
Universal life insurance is like whole life insurance in that it accumulates cash value and has a death benefit that won’t expire. But unlike whole life insurance, which has fixed premiums, universal life insurance allows you to adjust the premium you’ll pay for your policy in any given year. There’s also more flexibility to raise or lower your death benefit. While more customization is a great benefit, it’s important to work closely with a financial professional because paying too little can result in the policy lapsing (meaning you will lose your insurance).
Variable universal life insurance is like universal life insurance, but you can choose to invest your cash value in various sub-accounts that are often tied to the market. That means you could see more upside with your cash value than you would get with a whole life insurance policy. But as with any market-based investment, your cash value could also decline in value.
How to decide between the different types of life insurance
While there are many different types of life insurance, you don’t have to choose just one. Often, people mix the different types to meet different goals. For instance, new parents might buy a large term policy for the death benefit and a small whole life policy to lock in additional guarantees and financial flexibility they can't get with term. Over time they may convert some of their term to whole life to continue to grow the amount of whole life insurance they have. People who have more complex financial needs will often consider universal life insurance or variable universal life insurance.
A financial advisor can help understand your overall financial plan and show you how the different types of life insurance could help you reach your goals.
1Withdrawing or borrowing against your cash value will reduce the death benefit and may affect other aspects of your policy.
2Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon policy termination or the death of the insured. Repayment of loans from policy values (other than death proceeds) can potentially trigger a significant tax liability and there may be little or no cash value remaining in the policy to pay the tax. If loans equal or exceed the cash value, the policy will terminate if additional cash payments are not made. Policyowners should consult with their tax advisors about the potential impact of their policy loans.