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Types of Life Insurance & How To Choose
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 of 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.
Types of life insurance
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.
Term life insurance is recommended
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.