Updated on 09.16.14

Types of Life Insurance & How To Choose

Trent Hamm

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Andrea asks “What kind life insurance should you buy?”

The options available for life insurance are diverse and confusing. It’s certainly not helped by the fact that insurance salespeople are out there using sales pitches to convince people to buy their product, altering an important life decision into a carefully-crafted marketing brochure.

Life insurance choices
I’m going to describe several of the most common types of life insurance policies, followed by what I recommend among them.

Term Term life insurance policies offer a specified amount of life insurance protection for a specific fixed price. If you buy a term policy, you’ll typically buy a certain dollar amount of insurance over a certain number of years and for that you’ll pay a small amount each month, quarter, or year, depending on the policy. If the insured person dies in that time frame, you’re paid the insurance amount; otherwise, the contract simply ends at the end of the term.

Whole life Whole life insurance policies typically cost more than a term policy, but last for the entire life of the insured person. They often also build up a cash balance that can be borrowed against, but when you borrow against that balance, you reduce the death benefit by that much unless you pay back what you borrowed.To learn more, you can read the Simple Dollar’s article on Participating Policy Contracts, which are whole life policies that earn dividends.

Universal There are a lot of variations under universal life plans. Universal plans are most similar to whole life plans, but also regularly offer options that enable the insured to add the value of their cash balance to the face value of the insurance. The investment portion of a universal plan is often tied to outside investments, meaning that it doesn’t grow at a steady rate like whole life cash values do.

Accidental death Accidental death policies are much like term policies, but only pay out under much more narrow circumstances. Such policies are often very inexpensive, but their restrictions greatly reduce the likelihood that the beneficiary will receive a payout.

My preferred choice
My preference is almost always a term policy. The only exception to this is if you have had a universal or whole life policy for a very long time so that there’s a large cash value already built up inside of it, which can be a useful asset and is often growing at a nice rate at that point.

Typically, the early returns on non-term policies are low enough that they aren’t a good investment initially. They’re effectively the same as paying significantly more for a term policy. This trend does not begin to reverse itself for a while.

If you’re buying a policy for your child, I’d still recommend a small term policy. There are some advantages to buying a whole life or universal policy for children, such as the guarantee of lifetime coverage no matter what may come and the potential to grow a large cash value over a long period, but this relies on the long term health of the insurance company and the reliability of your children to always pay their premiums. If you have money to spare, a universal or whole life policy is acceptable for children.

For adults, I would stick with a term policy and use the saved money to eliminate debts or save for retirement. This will put your money to work much more effectively.

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  1. matt says:

    if you have a universal or whole life policy with a large cash value in it, why wouldn’t you just cash that out and buy a term policy which will probably cost you 1/4 of what you were paying a month?

  2. jim says:

    Don’t buy insurance for children. THeres much better ways to save money for kids like a 529, the chance of a child becoming uninsurable is remote and funeral costs aren’t that high.

  3. RJ says:

    Universal life have returns that are bond like around 3-5%. Some already consider them as an asset class and you can fit it in your overall portfolio as your other fixed income assets.

    My term insurance will end when I’m 65. The universal has coverage until my death, so its a bit of an upside.

  4. Roberta says:

    Reference #2 about funeral costs

    Depends on what you consider “aren’t that high”. Our son died unexpectedly last year and we had a very modest funeral, with no visitation, and turned down all of the fancy touches and world class options, and did not have to pay for a cemetery plot, and the funeral home still wanted $10,000 on the spot. Apparently so many people walked away from their bills after the funeral that many in the industry are no longer offering extended pay plans. We could swing it with no notice but lots of families could not. Teaching point for us was that we are now in the process of preplanning our own funerals as we did with our parents. You just don’t expect to bury a perfectly healthy child.

  5. Georgia says:

    I lost the life insurance on my husband when I retired. I could keep mine, but not his. Luckily I got a part time job for about 18 months. It paid well and I teased my husband that it was his burial policy. As it turned out, it was. I had saved $5k. The funeral cost me about $5,2k and SS took care of the extra.

    However, I live in a small town. I had a visitation at the funeral home, a cardboard coffin ($800) that would hold up to 665 #’s and was beautiful, and a service at the cemetery. My IL’s had bought the cemetery plots & that cost me nothing. I was able to not do a vault or liner, for which I was grateful – and not for monetary reasons.

    I have no other life insurance than my retirement amount ($15k). It is listed with both my children at 50%. They are to pay for my funeral, as close to my husband’s as possible) and they get the rest. Should work.

    I’ve had different types of life insurance at different times and always tried to do the best possible. I also have 2-3 $1k policies given to you by companies like cc’s. I keep track of whether they are still valid & keep a sheet for my kids to doublecheck it.

  6. socalgal says:

    Roberta & Georgia, I am very sorry for your loss. I do not think the average person realizes just how expensive funerals are and both of you are examples of why we should take the time to not only plan our funerals, but also set aside some money to pay for them.

  7. jim says:

    Yes $5-10k is a lot of money. Sorry wasn’t really meaning to be flip about that financial burden during peoples time of loss. But if you can’t afford to pay for a funeral out of pocket then you don’t have an adequate emergency fund. Saving up for an emergency fund should be a lot higher priority than paying for insurance on a child. The chances of a child dying are very low. If you don’t have an emergency fund then you’re a LOT more likely to have financial problems from a car failure, broken furnace, medical bill, loss of job, natural disaster, etc. Child insurance is a bad financial deal for the buyer. The risks are low and the cost is too high for the risks. And as Socalgal points out there are other ways to save costs on funerals.

  8. slccom says:

    You never know what life will bring you. For that reason, I strongly urge young people to get a good universal life policy. The premiums will be dirt cheap, you won’t have to worry about becoming uninsurable, and if your spouse or a child ends up with permanent disabilities, that insurance will be the difference between poverty and a decent life. Most universal life policies offer a feature where if you become terminally ill, you can collect early and use that money to make the end of your life better.

    Buying term life insurance involves a bunch of assumptions: that you will remain healthy, that your family members will remain healthy, and that you will have the opportunity all your life to build wealth. Every one of these assumptions, individually, is reasonable. Collectively, not so much.

    Buying a cheap life insurance policy on your child means that they will be able to have life insurance of their own no matter what happens to them. The cost of that assurance is very low, and the life insurance for them when they are adults and have their won family even if they are uninsurable is priceless. The chances of them dying are very small, but real. The chances of them becoming uninsurable are much greater, although still small. But if that does happen, the tiny cost will be the best investment you could have made.

    And no, I don’t sell insurance. I just look at what actually happens to people, and at a much longer timeframe than most people do.

  9. slccom says:

    #1 Matt, the reason to not cash out your universal life policy is because it is making money, and you may or may not be able to get or renew your term policy. If you got the universal policy young, it is almost certainly cheaper than the term policy, lasts your whole life, etc.

  10. Always go for double benefit plan which covers life as well as investment. Choose long term investment + insurance plan. It will always give you good returns.

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