There are dozens of different kinds of insurance policies out there to consider. But out of all of them, there are really only about four every person should make sure they have. These four kinds are health, auto, disability and life insurance. Of these four, life insurance is probably the most controversial and potentially confusing. If you’re one of the many people who would like more information regarding life insurance, keep reading as we cover the basics per this article.
What is Life Insurance?
While there are several different kinds of life insurance, each of which can differ significantly from the others, they have a basic function in common. Life insurance is a contract whereby the insurance company agrees to pay out a sum of money to the appointed beneficiary when the customer passes away. Usually this insurance is billed just like other kinds, on a monthly basis via premiums. There are types where the insured simply pays a lump sum all at once as well. However, like so many other forms of insurance, there are different kinds of life insurance worth noting. Let’s go through some of the more common forms now.
Whole Life Insurance
This type of life insurance most closely models the definition provided. You pay a company a regular premium and, in exchange, they are contracted to pay out a sum to whomever you named as beneficiary in your contract. Usually, these premiums are kept at a constant rate, which you agree to upon signing. In exchange, the insurance company guarantees a certain return based on a low interest rate to be paid out when you pass away. One of the benefits of a life insurance policy is this amount is tax deferred. Another benefit is that these insurance policies can often function much like a savings account (these are known as a participating whole life policy). Until you withdraw above the cash amount you have put in, this money will also be tax deferred.
Universal Life Insurance
This type of insurance is very similar to whole life insurance. The main difference, however, is its flexibility. This means that everything from the premiums to the cash values to the protection involved can be adjusted during the term of the policy. A policyholder, for example, may decide they wish for less payout and thus a smaller premium. With a universal life insurance policy, the customer’s cash grows at an interest rate regularly set by the insurance company. Generally any changes are based on market performance. Fortunately, most universal life insurance policies guarantee returns that won’t drop below a certain level.
Variable Life Insurance
This is another kind of insurance that is very similar to whole life. Variable life insurance looks to add an emphasis on growth, however, more comparable to traditional investments. To accomplish this, variable life insurance accounts have two separate halves. One part of the policy is geared toward what’s known as the general account. This account acts like a whole life insurance policy. However, the second part works more like a traditional investment. This component is known as the separate account. Money in that account goes to investing in the insurance company’s portfolio.
The policy is known as “variable” given its vulnerability to fluctuation.
Term Life Insurance
One of the most common kinds of life insurance is known as term life insurance. Like whole life, you pay in and the insurance company agrees to pay out when you pass away. However, the payout is a specific amount agreed on at the time you sign the contract. You’ll never overpay this amount, however, as you’re only agreeing to pay, and therefore to be insured, for a certain amount of time. This amount, also known as a term, is how the insurance policy earned its name.
Term policies are favored when only a limited amount of time is needed for coverage. The maximum term is usually 30 years. So many people may take out a term life insurance policy when they know that in, say, ten years they will be doing better financially and capable of funding a permanent policy. As term policy providers know exactly when the policy will come to an end and how much will be paid out (provided the insured doesn’t pass away), premiums for these policies are generally for more affordable. At the beginning of the term, they also provide a better cost-benefit ratio. This all changes, however, the older a person gets as the end grows nearer.
Whole life insurance from here may seem unnecessary as, by definition, you’ll never see the money and the worst-case scenario is guaranteed to happen, there’s much more to it than that. Life insurance policies will provide your loved ones with the funds they need to handle pressing matters when you pass away (e.g. funeral costs, medical costs, etc.). If you spend enough time learning about them or working with a financial advisor they can also provide valuable investment opportunities for you in the here and now.