Life Insurance comes in many shapes and sizes. The type of policy that an individual should purchase depends on many factors such as: age when purchasing policy, medical history, use of tobacco, number of children and marital status. Choosing the right type of life insurance depends on individual circumstances and financial goals. Life insurance policies are designed to pay a death benefit when someone dies, but here are usually two basic categories of policies to meet your different needs—TERM and PERMANENT.
|Term Ins.||Permanent Insurance|
|Term Life||Whole Life||Universal Life (UL)||Indexed Universal Life (IUL)||Variable Universal Life (VUL)|
Fixed Premium with Guaranteed Cash Value
|UL-Relatively middle of the road, flexible
GUL- Scheduled Guaranteed premium
|Relatively Middle of the road
Flexible in design
|Relatively middle of the road
Flexible in design
|Death Benefit||Fixed for the duration of the level term period||Fixed- Guaranteed||UL-Variable, level, or return of premium
On GUL- Level
|Level, Variable, or return of premium.||Level, Variable or return of premium|
|Cash Value||None||Yes, cash value is guaranteed but dividends are not and subject to change year to year.||Yes, but depends on performance of the contract||Yes, but depends on performance of the contract||Yes, but depends on performance of the contract|
|Duration of coverage||Limited by the length of term purchased||Lifetime||UL- depends on policy performance GUL-Lifetime or specified||Depends on policy performance||Depends on policy performance|
Term Life Insurance
Term life is exactly what it sounds like. You purchase life insurance for a specific term, or set amount of time. You pay premiums for the entire length of the term and once the term is up, your death benefit is gone. Term life does not have a cash value component so your entire premium is simply used to keep the policy active. Once the term is up, you stop paying premiums and the policy expires. This is what makes term life one of the most inexpensive life insurance policies.
Advantages of Term Life Insurance
Term life policies are usually far less expensive than whole, universal, or variable life insurance. Term life also has a very specific coverage period—typically in terms of 10, 15, 20, 25, and 30 years. This allows you to only buy as much coverage as you need. For example, if you’re only concerned about life insurance while you have dependents at home or a mortgage to pay, you can plan out how long and how much coverage you need.
Disadvantages of Term Life
There is no cash value component of the policy. Your premiums strictly go towards the policy and do not earn interest or otherwise accumulate. And having a specific term can also be a drawback. If you purchase a 20-year term policy and after 20 years decide you’d like to extend your coverage, you may need to undergo proof of insurability and could be denied additional coverage or need to renew at a significantly higher premium.
Whole Life Insurance
As the name implies, whole life is meant to insure someone for their whole life. Like universal life, whole life has a cash-value component. In most cases, in a whole life policy the premium and death benefit are fixed.
Advantages of Whole Life
There are no surprises with whole life. You have a guaranteed premium, interest rate, and death benefit for the life of the policy. The cash value also grows tax-deferred and also typically allows for withdrawals and loans against the policy.
Disadvantages of Whole Life
Whole life is generally more expensive than both term and universal policies. This is largely due to the added guarantees that come with whole life. Also keep in mind that the policy is not flexible. If you determine you want more coverage or would like to increase or decrease your premium, which probably isn’t an option. Finally, the interest earned on the cash-value account may be less than you could obtain elsewhere.
Universal life insurance builds on term life and adds a cash component. Here, instead of just selecting a specific term and putting 100% of your premium towards the policy, part of your premium will actually go into a cash account in the policy. This cash account earns interest and accumulates tax-deferred.
Advantages of Universal Life
Universal life insurance provides additional flexibility. Because it has a cash component you could actually temporarily stop making premium payments as long as the cash value can cover the cost of insurance. In addition, you may also be able to increase or decrease the death benefit over time. Also, you can usually borrow against the policy in the form of a loan.
Disadvantages of Universal Life
Universal life is more expensive than term life. While some of that added cost will be going into the account in the form of building cash value, the rates you earn on that money may not be the best going rates. This is why many financial professionals recommend buying term and investing the difference. This allows you to still purchase a death benefit while having the flexibility to invest the difference anywhere you choose.
Indexed Universal Life Insurance
Indexed universal life insurance is a type of policy, which affords the policyholder the opportunity to invest the cash value in index options that follow the movement of an index, such as the Dow Jones Industrial Average
Advantages of Indexed Universal Life
Indexed Universal life insurance provides the potential of earning interest credit that is higher than traditional cash-value policies. The yearly returns are guaranteed not to be negative and the value of the contract will not decline because of a declining index. In addition, a policyholder may cancel his policy and get back the purchase amount. This type of insurance can offer lifetime insurance without having to make lifetime payments.
Disadvantages of Indexed Universal Life
Indexed Universal Life is more expensive then term life. Administrative costs are higher compared to other investments like mutual funds and may not reap as high of returns. This can be a disadvantage to consumers who think stocks offer better returns.
Variable Universal Life Insurance
Variable life insurance is very similar to universal life with one major difference. With this type of policy you aren’t earning a specific rate of interest in a cash-value fund, but instead you can invest this portion in a variety of different investments like mutual funds. So, you get much more control and can choose where to invest the cash-value portion.
Advantages of Variable Life
You are still guaranteed the minimum death benefit as long as you keep up with the minimum premium. You also have the flexibility to invest the cash-value portion in a variety of investment vehicles. If you make wise investment decisions you can take advantage of significant tax-deferred earnings on those investments.
Disadvantages of Variable Life
By investing part of your policy in possibly risky investments, if the market turns south and you lose a lot of money, you’re putting your policy in jeopardy. A significant drop in account value could force you to pay additional premiums just to keep the contract in force. In addition, the expenses associated with the investments in variable universal life may be significantly higher than you might pay elsewhere.