Death comes like a thief in the night—abrupt, inconvenient and with immediate and long-term consequences for those affected.
The family left behind is already dealing with heartbreak. And if they were supported by the income of the deceased, they could also soon be struggling to pay the bills.
A life insurance policy can relieve this kind of financial uncertainty and distress. It gives the family the financial means to carry on despite the loss of a loved one’s income. As with other types of insurance, life insurance provides financial recompense when an emergency happens. The payment is made to the beneficiaries (predetermined by the policyholder).
For most people, that’s as far as their understanding of life insurance will go. But it’s important to know about the different types of life insurance, the benefits of each type, and the considerations that must be made when taking out a policy.
Distinguishing between term life insurance and permanent life insurance often gives insurance buyers trouble. To simplify the issue, you can think of term life insurance like renting a house and permanent life insurance like buying a house.
Renting a house and term life insurance both give you something for your money during a specific, finite time period. The end of the period presents a choice for the house renter to continue the lease or to walk away. The money he or she has paid towards rent doesn’t improve the value of the house. Likewise, the premiums paid for term life insurance don’t improve the cash value of the policy. The policyholder can, at the end, extend the policy or walk away.
With term life insurance, if you outlive the policy you don’t get anything for the money you’ve paid. It’s a relatively inexpensive form of life insurance (compared to permanent life insurance). You can buy as much coverage as you need to cover a specific time period (your kids’ college years, for example).
Term life comes in several flavors:
- Level Term—Premiums and benefit amounts don’t change for the duration of the policy.
- Annual Renewable Term—The benefit amount doesn’t change, but the premiums you pay may go up when the contract is renewed each year.
- Decreasing Term—The premiums don’t change for the duration of the policy, but the benefit amount decreases each year.
Permanent life insurance, meanwhile, is more like buying a home. It has an investment component that might be in bonds, money markets, or stocks. You can borrow against the policy when it has accrued enough value (just as a homeowner can borrow against the value of his house).
Three types of whole life insurance are traditional/whole life, universal and variable policies.
- Whole Life (aka Traditional) — The premium and death benefit are generally fixed, there is a cash value component, and the policy insures someone until they die.
- Universal — Combines the low-cost protection of term life with the savings aspect of whole life. Benefits, premiums, and investment aspects can be changed as the policyholder’s needs change. It differs from whole life in that it allows the cash value of investments to be adjusted according to a variable rate.
- Variable — Allows tax-deferred investments through the life of the policy. Smart investing could grow the value of the policy; bad investments could make your premiums go up.