When I first got a life insurance policy at 28, I was confused about all the different types. In the end, I got a 10-year term life insurance policy for $1 million.
It was an affordable amount and wanted to closely match my new, massive $1.2 million liability. You see, I had just bought a single family home for $1.52 million in expensive San Francisco. The last thing I wanted to do was die and leave that liability on my girlfriend.
A life insurance policy is important if you plan to take on debt or have children. In retrospect, I should have taken out a 30-year term life insurance policy because I ended up blessed with two children, one in 2017 and another in 2019.
Now, getting a term life insurance policy at 42 with chronic snoring will cost me 5X more! Luckily I can convert my term life insurance policy into a permanent life insurance policy if I want to.
For the majority of people, a simple term policy will do. Term life can provide the most coverage for the least amount of money. Think about a term life insurance policy like renting an apartment. It does it's job, but nothing more. Once you stop paying rent, you're out.
Let's have a detailed look at all the different types of life insurance policies out there so you can make the best choice for you and your family.
The Different Types Of Life Insurance Policies
There many types of of life insurance policies, with Term Life and Permanent Life being the two major categories.
Permanent life, also known as whole life, has many sub-types of life insurance. They are:
- Universal Life (the most conservative)
- Variable Life
- Variable Universal Life
- Indexed Universal Life
- Simplified Whole Life Insurance
- Guaranteed Issue Life Insurance
Then there are some speciality situation life insurance policies for specific issues:
- Final Expense Life Insurance
- Mortgage Protection Life Insurance
- Key Person Insurance for business owners
Let's talk about the main types of life insurance now.
Term Life Insurance
Term life insurance is a life insurance contract that comes with an agreed upon coverage expiration date. Typical terms are 10 years, 20 years, and 30 years.
During the term, you agree to pay regular premiums, usually monthly, in exchange for the amount of coverage. If you die within the term of your policy, your beneficiaries will receive your coverage amount.
Further, the coverage amount your beneficiaries will receive is tax-free. Here are the main considerations when shopping for term life insurance:
- Term Length: 10, 20, 30 years are most common.
- Coverage Amount: $50,000 – $1,000,000 is most common.
- Beneficiary: Surviving children and spouse are most common.
- Medical Exam: Not needing a medical exam is most common because most life insurance policies $500,000 or less do not require one. But if you are very confident in your health, you may want to take a medical exam to reduce your rate.
Term life insurance is what I recommend for 80% of the population. It's affordable and does its job.
Permanent Life Insurance
For the other 20% of the population, I think permanent life insurance may be appropriate. With a permanent life — also known as whole life — policy, you’re entering an insurance contract that can last the rest of your life.
Whole life insurance is more expensive because your premiums go to covering your life and to building your cash value. Think about a whole lif insurance policy like paying an amortizing mortgage that goes to interest AND principal. It's more costly than just getting an interest-only mortgage.
For those of you who have a lifelong dependent such as a child with a disability and/or who plan to accumulate much more than the estate tax exemption amount, a whole life insurance policy is a tax efficient way to provide life insurance coverage and grow wealth.
Types Of Permanent Life Insurance
Although most people should get a simple term life insurance policy, the most amount of life insurance types comes from a permanent life insurance policy.
With a standard whole life policy, your cash value works like a savings account growing at a moderate interest rate. You can borrow against your cash value or cancel the policy and receive the cash minus surrender fees. Whole life insurance is definitely a retirement planning strategy that wealthier Americans exercise.
The cash value is the key different between a permanent life insurance policy and a term life insurance policy. It can be used and invested in different ways through these sub life insurance types:
- Universal Life: You can use your policy’s cash value to lower your premiums or increase your death benefit later in life.
- Variable Life: You can invest your policy’s cash value in mutual fund accounts to potentially earn a greater return on your cash value.
- Variable Universal Life: Combination of Universal and Variable life insurance. You can use the cash value to change the amount of your premiums or death benefit.
- Indexed Universal Life: Like Variable Life, you can connect your cash value to a stock index and use the money to change the amount of your premiums or death benefit.
In retrospect, now that our wealth is on pace to exceed the historical estate tax exemption amounts for two people thanks to a bull market, I should have taken out a Variable Life or Indexed Universal Life insurance policy. These type of life insurance policies would have helped us build wealth even greater wealth.
Let's go through each permanent life insurance policy in a little more detail.
Universal life lets you change the relationship between your policy’s death benefit and cash value. When you have enough cash value built up, you could even stop paying premiums by using your cash value to keep the policy active. You will need a lot of time to accumulate enough cash value if you plan to go this route.
With universal life, you get to keep permanent life insurance and pay a lower cost for the coverage later in life.
Universal life insurance is good for adults with lifelong dependents. You're busy and stressed enough trying to make money to take care of your family, the last thing you want to do is worry about not having life insurance for life. Universal life is the simplest of permanent life insurance policies.
Below is a benefit growth chart example of a universal life insurance policy, the most common type of permanent life insurance policy. The death benefit is for $500,000 and the monthly premium is $830. But as you can se from the chart, after 21 years, the cash value grows to $237,452 from zero and the total death benefit equals $500,000 + $237,452 = $737,452.
Variable life is great because you get to invest your cash value to hopefully grow by a greater amount over time. We just wen through a huge 10-year bull market from 2009-2019. Investing the cash value in the S&P 500 mutual fund.
However, just like how your employer decided what funds you can invest in in your 401(k), your insurance company will provide a list of mutual funds in which you can invest your cash. You don't have carte blanche freedom.
Of course, if you invest your money at the top of the market, your cash value will likely lose money.
Variable Universal Life
Variable universal life insurance combines elements of variable life and universal life policies.
Like universal life, you can eventually change the relationship between your cash value and your death benefit, lowering premiums, or increasing your death benefit.
Like variable life, you can invest the money in insurance company-directed mutual funds.
Depending on the cost and your funds, a variable universal life insurance policy could be the best of both worlds.
Indexed Universal Life
With indexed universal, you can connect your cash value to a stock index such as the S&P 500. The money can grow at the same rate as the stock index.
As with variable universal, the insurance company can cap your growth at a specific percentage during a hot streak in the markets. And, when your cash value grows enough, you can use it to subsidize your premiums.
Given most actively-run money managers cannot outperform the indices they benchmark to, as an investor, you are wise to invest in a passively run index instead. Check out this chart showing the high percentage of actively-run mutual funds underperforming their indices over a 10-year period. High fees and human nature definitely drag on performance.
Main Ways To Apply For Life Insurance
The best way to get competitive life insurance quotes is to check online with PolicyGenius, the #1 life insurance marketplace where qualified lenders compete for your business.
Once you've applied online to know what's out there, here are the three general ways the life insurance application process proceeds.
Medically Underwritten Life Insurance
Medically underwritten life insurance almost always requires you to take a medical exam. The exam will calculate your body-mass index, get your blood pressure, your height, your weight, and take blood and urine samples to test your overall health.
Most people, including myself, hate getting a medically underwritten life insurance policy because most people hate needles.
For those who don't want to get a medical exam, you have many options as well. Also, if you get under a $1 million policy, chances are higher you won't need to do a medical exam.
However, if you are in great health and just got your physical with bloodwork, you may want to get another free medical exam to prove to the life insurance companies you are indeed in great health to get a lower premium.
Simplified Issue Life Insurance
Simplified issue life insurance is what we all want. A simplified issue life insurance lets you skip the dreaded medical exam with needles.
Instead of collecting your urine and poking you with a needle, the life insurer will ask a variety of questions about your health and your family’s health history. They will also check your medical profile to see what type of issues you've had. They will also check your driving record, so be aware!
Given there is no medical exam, expect to pay more for simplified issue life insurance, and expect lower coverage amounts. Life insurers are taking a higher risk on insuring you, therefore, they must charge higher premiums.
Simplified issue life insurance usually tops out around $350,000 to $500,000 — significantly lower than a medically underwritten policy. But given most Americans have less than a $500,000 net worth, $350,000 – $500,000 should be sufficient for most Americans.
Guaranteed Issue Life Insurance
Guaranteed issue life insurance is even easier than simplified life insurance. You just need to answer some basic questions because there are no health requirements.
As a percentage of coverage, the insurance premiums are high. But as an absolute dollar amount, the coverage amount and premiums are low.
For example, you can get a $20,000 guarantee issue life insurance policy at age 50 for $71 a month. Below are some sample quotes from Mutual of Omaha.
Special Situation Life Insurance
Now that we've talked about the main types of life insurance, here are lesser known life insurance policies you can get for more specific reasons.
Burial Life Insurance
The death benefit should be significant enough to pay your final expenses, which may include small debts or funeral expenses.
If you have a whole/permanent life insurance policy, you shouldn't need burial life insurance.
Mortgage Protection Life Insurance
Mortgage life insurance is a simplified life insurance policy that pays off your mortgage balance if you were to die. could pay off your house if you died with a mortgage balance.
Just note that a mortgage life policy would pay your lien holder and not your family if you died.
If you have a term life insurance policy that matches the duration of when you will pay off your loan, you won't need mortgage life insurance.
Key Person Insurance
If you run a business, there is at least one key person that is crucial to your business's success. If that person dies, your business could experience tremendous harm.
Now that I'm writing this, I realize I should look into key person insurance since I write 99% of the content on Financial Samurai as my wife takes care of our two kids full-time.
Life Insurance Riders
In addition to reason-specific life insurance sub-types, there are also life insurance riders you can add to help customize your insurance policy as life changes.
Here are the most common riders:
- Accelerated Death Benefit: Can pay part of your death benefit early if you’re diagnosed with a terminal illness or meet other requirements.
- Long-Term Care: Can pay part of your death benefit early if you need help paying for long-term health care.
- Accidental Death: Pays a higher death benefit if your death results from a qualifying accident.
- Child Term: Can extend part of your coverage to one or more of your children.
- Waiver of Premium: If you outlive your term policy, this rider could return your paid premiums.
Riders will aways cost extra. Check with your insurance provider to find out more.
Cost of Life Insurance Statistics
6x-10x: How much more permanent life insurance (like whole life insurance) costs vs. term life insurance
8%: Average percent increase in your insurance costs as you age, assuming your health stays the same. This is why you should get life insurance younger rather than later.
30%: The average cost difference between sequential health ratings (preferred vs standard, for example)
2x to 3x: How much rates for smokers cost vs. rates for nonsmokers (but a year after you quit smoking, most companies will offer you nonsmoker rates).
50%: The average difference between the least expensive and most expensive rate for the same person across insurance companies. This is why you should shop around for life insurance!
30%: Percent difference between premiums for men and women (with women paying nearly ⅓ less than men, on average).
Get Life Insurance To Protect Your Family
Life insurance is an act of kindness. Be kind to your family and loved ones by getting life insurance to cover your liabilities, take care of your parents, and ensure your kids have the financial resources to at least get a great education.
Hopefully this article has made it more clear about all the different types of life insurance policies out there. For the majority of you, getting a term life insurance policy is good enough. It's cheaper and gets the job done. I recommend getting a little larger death benefit and a little longer term duration than you need to be conservative.
My biggest mistake was not getting a 30-year term policy when I was 28. Now, my premiums are much higher because I'm older and have some health issues that are not looked favorably upon by life insurance carriers. Thankfully, we are financially independent and can self-insurance.
The most efficient way to get competitive life insurance quotes is to check online with PolicyGenius, the #1 life insurance marketplace where qualified lenders compete for your business. It's much easier to apply on PolicyGenius than go to each carrier one-by-one to get a quote. In adition, applying is free!
Good luck and stay safe!