If you judge by the ads you see on TV for “Grab a Quote” or “Cheap Insurance R Us,” the only differences between life insurance policies for a given individual are the amount of coverage, the cost, and how long you want the policy to last.
So why not just pick the cheapest policy and be done with it?
The companies selling insurance based on price desperately want you to think life insurance is a commodity—that the only difference between their insurance and someone else’s insurance is price—and theirs is cheapest.
That’s what they want you to think!
Life Insurance Is Not a Commodity
Someone who’s never driven a car might think automobiles are commodities. After all, they all have the same basic task, which is to get you over the river and through the woods.
But you know better! You’ve had enough experience to know the difference between the “Ultimate Driving Machine” (BMW), and “The Power to Surprise” (Kia). You know which one is worth more, and you probably have some idea which one you would pick, if given the choice.
The purpose of this article is to give you enough experience to know the difference between the two main types of life insurance policies, and to help you have some idea which one you would pick, if given the choice.
The Two Main Types of Life Insurance Policies
It all boils down to one simple question: Do you want life insurance only for a relatively short term (term insurance) or do you want life insurance for the long term (permanent insurance)?
But that one simple question glosses over some pretty important considerations:
- What reasons would there be to own a life insurance policy, other than for the awkwardly-named “death benefit”? (You might be surprised.)
- Do you know for sure when your need for life insurance will end? (You might be surprised again.)
- Is the cheapest kind of life insurance (term) really the cheapest? (Yep, you might be surprised yet again.)
Let’s take those three questions one at a time and get the surprises over with.
Three Important Questions You Must Answer When Choosing a Life Insurance Policy
Question 1: Why own life insurance, other than for the death benefit?
Traditional term life insurance policies offer only a death benefit. But a permanent life insurance policy gives you more than a death benefit legacy. A permanent life insurance policy also includes living benefits.
What’s that all about?
A term policy’s death benefit is just for those people and organizations you care about. It benefits them, after you die. Your only involvement with the policy is to keep paying those darn premiums—which go up, by the way, every time you renew the policy for another term.
On the other hand, a permanent policy’s living benefits are for you. Now. While you’re still around to enjoy them. Sure, you’ll leave a legacy—a benefit for those you care about. But wouldn’t it be nice if you didn’t have to keep paying those darn premiums? What if your insurance policy started paying you?
That’s something worth thinking about.
Question 2: When will your need for life insurance end?
To answer that, you’ll need to decide if you are a short-term planner or a long-term planner.
Short Term: You can buy life insurance that will end in less than 24 hours. They used to sell it at the airport. It was called trip insurance. It was designed to pay a death benefit only if you died in an accident on a particular flight (or bus trip, train ride, or whatever). The coverage ended the moment you were safely deposited at your destination.
That’s really short-term planning!
You can also buy policies—term policies—that will last for just one year, five years, 20 years, and so forth, if you’re a short-but-not-that-short-term planner.
Long Term: Someone who plans long-term might say, “Well, at first I thought my spouse wouldn’t need any extra money if I could just wait to die until after the kids start school 10 years from now. But I’m looking ahead now, to when we’re 60 or 70 or even 80. …
“What if I die first? Would it be a good idea to plan for an income for my spouse in case that happens? Goodness knows, we can’t count on our investments. They may shrivel up before we do!”
And someone who understands the living benefits of permanent life insurance likely never wants to give them up! When would you ever say, “Well, I guess I don’t need any more tax-free retirement income!”
Question 3: Is term insurance really the cheapest?
Some folks claim it is. But term insurance looks cheaper only if you’re nearsighted.
You see, the price of a term insurance policy is guaranteed to go up every time you renew it for another term. But if you pick the right kind of permanent life insurance (we’re talking about whole life insurance here), the price is guaranteed never to go up. (In fact, cost might actually go down.)
So, you will probably think term insurance is cheaper if you’re looking at just the next few years. But if you’re not nearsighted—if you’re looking 10, 20, 30 years into the future, you realize that a permanent policy can be much less expensive overall. And that’s even before you begin enjoying the living benefits.
Term Life Insurance
The most basic type of life insurance is term insurance with no riders. (The purpose of life insurance riders is to give the policy benefits that aren’t included in the basic version.)
Term insurance is also the least expensive—at least in the short run—because it pays out only if the policyholder’s death occurs during the “term” of the policy. Renewing a term policy at the end of the term is more expensive—sometimes several hundred percent more expensive. That’s why it may only be less expensive in the short run.
But term insurance is ideal for covering short-term needs. Term insurance is sometimes called “pure” life insurance, because the only the thing the insurance company offers is a death benefit—if the insured dies during the term.
Permanent Life Insurance
The three most common types of permanent life insurance are whole life, universal life, and variable life. Insurance companies may offer various hybrid policies, such as universal whole life, variable whole life, and variable universal life.
But for now, we’ll stick to the basics: whole life, universal life, and variable life.
All permanent life insurance policies have two things in common:
- They’re designed to provide coverage for your entire life. In other words, permanent coverage. Hence the name. As long as the premium gets paid, the coverage lasts until the bitter end—your bitter end.
- In addition to a death benefit—a legacy—these policies offer living benefits, which are all related to cash value—the internal buildup of money within the policy that you have access to, as the policy owner.
The differences among whole life, universal life, and variable life involve:
- How the growth of the cash value is calculated.
- What guarantees the company offers.
Whole life policies accumulate cash value based on a formula predetermined by the insurance company. Once the policy is issued, the formula is guaranteed not to change. Thus, the cash value of a whole life policy will grow at a predictable and guaranteed rate, unless the policy owner does something to change it, such as surrendering the policy, withdrawing part of the cash value, or, in some cases, borrowing against it.
Regular universal life policies accumulate cash value based on current interest rates. The operative word is “current.” What was current when the policy was issued may not be current several years later. Thus, there are no guarantees, absent the purchase (for a price) of a special “rider” that provides some nominal guarantees.
Indexed universal life policies, also known as equity indexed universal life policies, accumulate cash value based on the performance of the stock (equities) market (or some portion of it), as measured by a particular index such as the S&P 500 Index. (Please review 7 Reasons to Be Wary of Indexed Universal Life Insurance.)
Variable life policies promise you the possibility of accumulating cash value based on allocating a portion of your premium dollars to various instruments and investment funds within the insurance company’s portfolio such as stocks, bonds, equity funds, money market funds and bond funds. Because of investment risks, variable policies are considered securities contracts and are regulated under the federal securities laws.
Could my life insurance premiums go up?
Our article How Whole Life Insurance Works answers this question in detail. To summarize:
- Term insurance premiums go up with every new term.
- Universal insurance premiums can go up if cash value drops due to low interest rates.
- Variable insurance premiums can go up if cash value drops due to poor investment performance.
- Whole life insurance premiums are guaranteed to remain level forever.
Check out this article for a fair and unbiased comparison of universal life insurance versus whole life insurance, written by an executive at a top life insurance company that sells both whole life insurance and universal life insurance—this is someone who has no vested interest in either one.
To find out more about the advantages of supercharged dividend-paying whole policies, grab your free copy of our Special Report, Five Simple Steps to Bypass Wall Street, Beat the Banks at their Own Game, and Take Control of Your Financial Future.