Figuring out what kind of life insurance policies fit your needs best can be overwhelming at times, especially with the number of different kinds of policies that exist. Talking to a life insurance agent, who’s paid by commission, probably isn’t going to help either. To help you with this, I’m going to be writing a series on understanding the different kinds of life insurance products that exist and how they work.
Let’s start out with the basics. There are two main types of life insurance: temporary (or term) and permanent.
Term Life Insurance
The most common type of term life insurance is group term, which is often provided by employers. If you have life insurance through work and you’re not sure what kind you have, it’s more than likely going to be group term. Group term is an inexpensive type of policy, provides decent coverage, and is available to everyone in the work place. The catch is that you must remain with that employer in order to be covered by that plan. This means that changing jobs, getting laid off, or retiring will all cause your coverage to cease.
Term insurance is also something that you can purchase on your own outside of work. The coverage lasts for a predetermined amount of time, so it could be for ten years, twenty years, until you’re age sixty-five, etc. Term is typically used for things like protecting college expenses, ensuring that a mortgage is covered, and making sure that short term debt is paid off. In the short run, this kind of policy is very cheap to buy because it’s only going to be there for a limited amount of time. In the long run, it can become very expensive. If you’re twenty-five years old and are in good health, you would be able to get a large amount of term insurance for a pretty low price. Let’s say for example that you got a thirty year contract for $500,000 in coverage for $50 a month. The policy payments are based on the age at issue, so for the next thirty years, you’ll be paying the same $50 a month like you did when you were twenty-five, all the way until you hit fifty-five. When insurance contract expires at fifty-five years old, it’s going to be a lot more expensive to renew it because it’s going to be based on your new age. The same $500,000 in coverage could run you upwards of $500 a month. And that’s also assuming that you can renew it, as you may not be insurable anymore. Having a heart attack, a stroke, or cancer can cause your insurance rates to hike up significantly or it might make you ineligible all together. In addition to that once the contract expires, the coverage is gone. You could die the day after your insurance ends and the life insurance company won’t have to pay your beneficiaries a dime. If nothing happens to you during your period of coverage, all the money that was paid into the insurance won’t be returned to you.
Permanent Life Insurance
The other type of life insurance is permanent insurance. These policies are referred to as permanent insurance because they will stay with you forever, until you die, provided that you keep them in force. There are three main types of permanent life insurance: whole, universal, and variable life. There are also combinations of those three, but we’ll get into that another time. Permanent insurance is commonly used for income replacement, in case the primary income earner passes away, and for final expenses. Examples of final expenses are funeral expenses, medical bills, attorney fees, estate and probate taxes, etc. In the short run, permanent insurance is a lot more expensive than term insurance. In the long run however, permanent is a much cheaper alternative than term. Generally with permanent insurance, the rate that you pay when you get the policy is going to be the rate that you pay for the rest of your life. If you got permanent policy when you’re twenty-five, you’re going to be paying that same premium over the entire policy, even if you live to be 100. Permanent policies also build up cash value, which is your equity in the policy that you can redeem should you no longer want the policy. Additionally, you lock in your insurability because with permanent insurance, you’ll never have to renew it, so you don’t have to worry about health problems affecting your insurability.
Getting term insurance is similar to renting an apartment. Every month that you live in an apartment, you pay rent. From time to time, the landlord is going to increase the rent. Suppose you live in that apartment for thirty years. After thirty years of paying rent if you decide to move out, you won’t have anything to show for the past thirty years of payments. However, you at least had some place to live during that time.
Purchasing permanent insurance is like buying a home. The cost upfront is a lot higher than renting an apartment: you have to make a down payment, pay the real estate agent, and maybe even pay home owner association fees. On top of that you still have to make your monthly mortgage payments which tend to be more expensive than rental payments. But as you make your monthly payments, you build up equity and after thirty years of payments, you now own your home.
The differences in these two kinds of insurance are huge and it would be beneficial to know what kind you have. If you’re thinking about getting life insurance, make sure you get all the details first so you know what you’re buying. There are pros and cons to each type of insurance; most people use a combination of temporary and permanent life insurance to meet their needs. Each person’s situation is different so how much of each kind of coverage that you need depends on you.
Next life insurance post: Why Life Insurance is an Important Part of Your Financial Plan
All works here are my own and are considered works in progress and may be subject to change at any time. The opinions expressed here are mine only unless otherwise noted. I am not being paid by a third party to endorse a product of any sort. These writings are written for my own references. I do not claim to be a professional of any kind so follow any information you find here at your own risk. The facts that I post on here are things that I believe to be true, but may not necessarily be so. This is the internet; do your own fact checking and take everything with a grain of salt.