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Wednesday, October 21, 2020

What is life insurance? Here are the most popular types

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As the COVID-19 crisis continues to rattle households across America, it has led many people to consider their own mortality — and plan for it accordingly. 

Life insurance can be a vital tool for taking care of the important people in your life. But how do you know if you need it and which type should you get? Here’s a primer.

Read more: What is a robo-advisor? How Wealthfront, Betterment and others manage your money

What is life insurance?

A life insurance policy provides a payment to your beneficiaries after you die. Like other insurance policies, you pay a premium — monthly or annually — for different thresholds of coverage. There are three main types of life insurance.

Term life insurance

This type of policy covers you for a set number of years — 10- and 20-year policies are common, though some go even longer. You make monthly payments — known as the premium — for the duration of the term. If you don’t pass away during the term, the policy expires and there’s no payout to your beneficiaries.  

Pros: This is typically the least expensive type of life insurance. You choose the payout amount and the coverage period. Your monthly or annual premium remains fixed for the duration of the policy.

Cons: You could outlive your policy. This means that you’d be paying for a policy for a set amount of time but your beneficiaries aren’t guaranteed any money if it expires before you pass away. After the term expires, you could purchase a new policy — but it gets more expensive as you get older.

Whole life insurance

This type of insurance covers you until you die. Known as whole life or permanent life insurance, this kind of policy guarantees that your beneficiaries will receive a payment.

Pros: The term never runs out, which means if you die 10 years from now or 30, your family receives the policy payout. Your premium payments remain fixed for the life of the policy.

Cons: It’s more expensive than term life insurance. You can’t adjust your premium payments or coverage amount.

Universal life insurance

Another variant of permanent life insurance, a universal policy is more flexible than a whole life insurance policy. For instance, if you lose your job, you can reduce your monthly premium (though your coverage amount will also decrease).

Some universal life insurance has a cash value tied to it. Indexed universal life insurance, for example, is tied to a stock market index. This allows you to cash in on your earnings over time. Variable universal life insurance is also tied to investment accounts that let you withdraw from the cash value.

Pros: Greater flexibility, including a premium amount that can be adjusted. You’re covered for life. Some accounts let you cash in on earnings.

Cons: More expensive than other types of insurance.

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How is the cost of life insurance determined?

There are multiple factors that influence how much you’ll pay in premiums for life insurance. They include your health, age and the type of coverage you choose.

Term: Whole or permanent life insurance costs more than term. And, generally, the longer the policy term, the higher the premium.  For instance, the annual premium for a 10-year will be less expensive than a 30-year policy.

Coverage amount: The higher your policy payout amount, the higher the premium. For instance, a $250,000 policy will have a lower premium than a $1 million policy.

Age: The older you are when you buy life insurance, the higher the cost. 

Health: Most insurance policies require you to take a medical exam, submit your health records and share your family health history. A pre-existing medical condition, like heart disease or diabetes, could increase your premium. Smokers also tend to pay higher premiums compared to those who don’t smoke.

Gender: Because women typically live longer, they often pay lower premiums than men.

When weighing the different types of life insurance, consider what you want your policy to cover. Depending on the amount, your beneficiaries will be able to pay off a mortgage, cover children’s college expenses, and offset funeral expenses and household needs. 

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