What Kind of Life Insurance Should I Choose?

Q: I know purchasing life insurance is the responsible thing to do, but the choices are overwhelming. How can I determine which kind of life insurance is right for me?

A: There are many kinds of life insurance, but the broad range of choices shouldn’t keep you from getting sufficient coverage. Here’s what you need to know about the most commonly purchased types of life insurance.

1. Term insurance

This is the most basic form of life insurance, and often the least expensive option for those under the age of 50. Term policies are drawn up for a certain amount of years, usually ranging from 1 to 10 years. They are renewable at the term’s end, but as the policyholder ages, the premiums will increase with each renewal.

There are several variations of term insurance, each with the same basic idea.

One is a level term policy, in which the annual premium will be locked at a set amount for up to 40 years, depending on the insured’s age.

Another common variation, the declining balance term policy, is often used as a mortgage insurance. It’s set up to match the amortization schedule of the insured’s mortgage principal. The premium remains constant over the term of the policy, but the face value, or the policy’s original death payout, will decline throughout the term. Once the entire mortgage balance is paid up, the policy expires as the insurance is no longer necessary.

A third takeoff of term insurance is a return of premium term policy. This policy offers to repay all of your premium payments if you outlive your insurance’s term. By purchasing this kind of insurance, your premiums are guaranteed to stay in your family – either as benefits to your dependents or as money back in your own pocket.

One major caveat of term insurance is that the policies have no cash value; they are pure insurance. Benefits are only paid if the policyholder passes on during the policy’s term. At the term’s end, the policy will expire and no benefits will be paid in case of death unless the term is renewed.

If you are considering term insurance, be sure to purchase a policy that is renewable up to an age when you think you will no longer need insurance. It’s also smart to find one that can be converted into a permanent policy without requiring a medical exam.

2. Whole life insurance

Another popular choice, whole life insurance offers protection coupled with a cash value component. You can lock in your premium payments at a level rate as long as you are consistent with your payments. A portion of your premium goes toward increasing your policy’s cash value. As your cash value grows, you can borrow money against it, up to 90% of the policy’s entire cash value, completely tax-free.

Bear in mind, though, that borrowing against your life insurance should only be done as a last resort as outstanding loans accrue interest, reduce the policy’s death benefit and increase the odds that the policy will lapse.

3. Universal life insurance

Universal life policies offer increased flexibility for policy holders. Premiums can go up or down, or even be deferred within certain limits. Cash values can be accessed and withdrawn, though this directly decreases the death benefit. Face values can be modified as well.

Universal life policy is the preferred choice for those who’d like lots of flexibility along with a guaranteed rate on cash value. Policy holders are afforded an annual statement clearly delineating the policy’s current cash value, total protection, cash value accumulation and a summary of all associated fees.

4. Variable life insurance

Variable life insurance promises fixed premiums and a slew of investment options for the financially savvy and the true risk-takers. The policyholder’s cash value will not lay dormant in the policy; instead, it will be invested in the insured’s choice of stock, bond or money market portfolio. Naturally, cash values and death benefits will fluctuate along with the investments’ performance.

Death benefits generally have a floor, so even if your stocks do terribly, your dependents won’t be left without any payouts. Conversely, cash values offer no guarantees; investing them means risking a significant loss, like any other investment.

These policies usually have higher fees than universal life insurance. On the bright side, though, any cash value accumulation is allowed to grow tax-free, as long as the funds remain in the policy.

5. Universal variable life insurance

In a convenient policy that combines the best features of universal and variable life insurance, this type of policy will offer investment options, along with the flexible premiums and the ability to modify face values that characterize universal insurance policies. Of course, this level of flexibility and volatility is not without risk.

Now that you have your options laid out clearly, you can easily choose the policy that best suits your needs and your personality.