Types of Life Insurance

Term life insurance, which lasts a specific number of years, is suitable for most people.
Insurance, Life Insurance
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What type of life insurance is best for you? That depends on a variety of factors, including how long you want the policy to last, how much you want to pay for life insurance and whether you want to be able to withdraw money from the policy later.

Here’s a brief summary:

  • Term life insurance is suitable for most people. It lasts for a specific number of years. If you don’t die within the time frame specified in your policy, it expires with no payout.
  • Whole life insurance and other types of permanent life insurance policies, such as universal life, usually include a “cash value” account, which builds value over time. Eventually, you may have enough cash value to take a loan against the policy to use for large expenses, such as college.

» MORE: The differences between term and whole life insurance

Comparison of types of life insurance

FeatureTerm lifeWhole lifeUniversal life*
*Details regarding premium flexibility and death benefit flexibility vary for universal life policies.
Choices in policy length
Builds cash value
Premium payments may be flexible
Death benefit amount may be flexible
Most affordable way to buy life insurance
Cash value usually can be linked to investments

Term life insurance

How it works: You have to make only two decisions if you buy term life insurance: what amount you want and how long you want the coverage to last.

  • Pros: It’s easy to understand and is the cheapest way to buy life insurance.
  • Cons: You could outlive your policy. If you still need coverage when the policy expires, you’d need to buy another policy and will pay more based on your age and, possibly, health.

What type of life insurance is best for you depends on a variety of factors, including how long you want the policy to last and how much you want to pay.

Amounts: “Small” term life policies are available with under $50,000 in coverage, but policy amounts can go into the millions.

Term lengths: Term life is typically sold in lengths of five, 10, 15, 20, 25 or 30 years.

Locking in a rate: “Level premium” term life means you’re locking in a price for the length of the policy. Typically, you’ll pay a monthly or annual premium. “Annual renewable” term life is a one-year policy that renews every year for a higher price. This is for someone who wants to cover only short-term debts or who expects to buy life insurance through work soon.

» COMPARE: NerdWallet’s life insurance comparison tool

Whole life insurance

How it works: Whole life insurance doesn’t expire. It’s the closest thing to “set it and forget it” life insurance. As long as you pay the bill, you don’t have to think much about the policy. Your payments stay the same, you get a guaranteed rate of return on the “cash value” investment component of the policy, and the death benefit amount doesn’t change.

  • Pros: It covers you for your entire life. Everything in the policy is guaranteed, so there are no surprises.
  • Cons: It’s a very expensive way to buy life insurance.

Universal life insurance

 

GUARANTEED UNIVERSAL LIFE INSURANCE 

How it works: These policies promise a certain death benefit, and payments don’t change. There’s typically little or no cash value within the policy, and insurers demand on-time payments. Missing a payment could mean you forfeit the policy. And since there’s no cash value in the policy, you’d walk away with nothing if you forfeit. If you’re sometimes late with bills, this is not the product for you. In addition, consider that future financial or health problems could cause you to miss a payment.

  • Pros: It’s cheaper than whole life and other forms of universal life insurance. You can choose the age to which you want the death benefit guaranteed, such as 95 or 100.
  • Cons: You must make every payment on time or you could lose the guarantee and forfeit the policy, thereby losing all your previous payments. The policy may have little or no cash value.

INDEXED UNIVERSAL LIFE INSURANCE 

How it works: Indexed universal life insurance links the policy’s cash value component to a stock market index like the Standard & Poor’s 500. Your gains are determined by a formula, which is outlined in the policy.

  • Pros: You can access cash value, which grows over time. The cash value is linked to a stock market index, so if the stock market goes up, you get some upside, too. Within limits, your payments and death benefit amount are flexible.
  • Cons: Your cash value doesn’t take full advantage of stock market gains. Understand the policy’s fees and participation rates and the cap on your return before you buy.

Participation rate: The policy will dictate how much your cash value “participates” in any gains. For example, if your participation rate is 80% and the S&P 500 goes up 10%, you get an 8% return. If the index goes down, you won’t lose cash value; you’ll just get zero rate of return. Some policies offer a small guaranteed interest rate in case the market goes down.

Cap on gains: Your gains in cash value will also be limited by your cap, which is the maximum you’ll get no matter how high the market goes. For example, a cap might be 10%. If the index goes up 20% and your cap is 10%, you’ll get only 10%. And remember, only a portion of your payments are going into the cash value component to begin with.

Flexible premiums and death benefit: There are additional moving parts to keep track of, such as your payments and death benefit. Within limits, you can decrease your premiums or skip a payment, as long as your cash value covers the insurance costs. You need to keep track of this. If you’re skipping payments and you don’t have enough cash value to cover the costs, your policy could lapse. Some policies let you adjust your death benefit, too, as your family’s needs change.

VARIABLE UNIVERSAL LIFE INSURANCE AND VARIABLE LIFE INSURANCE 

How they work: With variable universal life and variable life insurance, you tie your cash value to investment accounts, such as bonds or money market and equity accounts. There can be high risk to the investment account value based on the market, but if you do have cash value, you can take partial withdrawals or loans against it.

  • Pros: There’s a chance for a large gain in cash value if your investment choices do well. You can take partial withdrawals from the cash value or loans against it.
  • Cons: It requires you to be hands-on in managing your policy. The cash value changes every day based on the market. Lots of fees and administrative charges are deducted from your payment before anything goes to cash value.

Flexible premiums and death benefit: You can also vary your premium payments, within certain minimums and maximums, and vary the death benefit. The “policy illustrations” shown to potential customers can be complex and optimistic. If you’re considering a policy like this, a fee-only financial advisor — one who doesn’t earn commissions based on policy sales — can help you sort it out.

Underwriting for types of life insurance policies

If you hear the word “underwritten,” it refers to how a life insurance company will decide how much of a risk you are. The underwriting determines how much you’ll pay.

Fully underwritten life insurance: If you’re healthy or have just one or two health issues, this generally will be the cheapest life insurance type.

The insurance company often will require a medical exam. The application also will generally include many questions about your health; your family’s health history; your lifestyle, such as hobbies like skydiving; and your plans for travel outside the United States.

This full underwriting lets the insurance company price the policy most accurately based on your life expectancy.

If you hear the word ‘underwritten,’ it refers to how a life insurance company will decide how much of a risk you are. The underwriting determines how much you’ll pay.

Simplified issue life insurance: You won’t have to take a medical exam. You’ll be asked a few health questions, and you could be turned down based on your answers.

Guaranteed issue life insurance: There are no medical exams and no questions asked. You can’t be turned down. This is the most expensive way to buy life insurance, and you might find only low coverage amounts available, such as $50,000 or $100,000.

In addition, if you die within the first few years of having the policy, your beneficiaries may receive only a partial death benefit or a check for the premiums you paid. People often buy this type of life insurance when they’ve been turned down elsewhere but they want to cover final expenses, such as funeral costs.

Other life insurance types for specific situations

Mortgage life insuranceCovers the current balance of your mortgage and pays out to the lender, not your family, if you die.
Credit life insurancePays only the balance of a specific loan, like a home equity loan. Your bank might offer to sell you a credit life insurance policy when you take out a loan. If you die, it pays off the lender, not your family.
Accidental death and dismemberment Pays a death benefit only if you die in an accident, such as a car crash. Accidental death and dismemberment insurance also has payouts for loss of limbs, sight and hearing, and other problems.
Joint life insuranceThis type of life insurance insures two lives, usually those of spouses, under one policy:

First-to-die: Pays out upon the death of the first person, whichever one it is. The surviving spouse typically would be the beneficiary. The policy would then expire; it doesn’t continue to cover the second person.

Second-to-die: Pays out when both people have died. A policy like this typically is used when heirs, such as children, will need money to pay estate or inheritance taxes, so that they don’t have to sell off assets.