Types of Life Insurance Plans and How to Decide Which One Is Right for You

Life insurance is essential to financial planning for anyone with a family that depends on them. The choices can be bewildering, but one of four basic types of life insurance will likely fit you and your family. Each type offers additional features to tailor the product based on your unique needs.

Some key factors in choosing a life insurance policy are how long you want the coverage to last, whether you want a policy with a cash value you can access, and how you want its value and benefits to grow during your lifetime.

Types of Life Insurance Plans

There are several types of life insurance, each designed for different financial circumstances and needs. The types are term, whole life, universal life, variable universal life, and final expense insurance.

Term Life Insurance

Term life insurance covers you for a specific period, such as until age 72. This insurance type will provide your beneficiary a payout after you expire until the age specified in the insurance contract.

Term life insurance is generally cheaper than other plans because it may not cover you for the rest of your life. Payouts are generally tax-free, and premiums and benefits are fixed for the entire term. There are different term life insurance plans for you to choose from:

• Fixed term: The coverage amount and premiums are fixed. This plan is good for someone who can afford the premiums and wants a specific amount of coverage for the term.
• Simplified issue term: No medical exam is required, and the death benefit is generally smaller. This plan is good for someone who might not pass an exam or only needs a smaller coverage amount.
• Decreasing term: Coverage amounts and premiums decrease over time, making this plan good for someone who will not need as much coverage later on.
• Short-term: Generally, this is one-year coverage. This plan is good for someone transitioning between jobs or plans.

Whole Life Insurance

Whole life insurance pays a fixed benefit regardless of the age you pass away. You pay a fixed premium, which is higher than term life insurance plan premiums because it covers you for the rest of your life.

A percentage of each premium payment is used to build up your policy’s cash value, which grows tax-deferred at a fixed interest rate over your life.

You can draw or borrow from this cash value after a specific amount of money is contributed to the policy.

Universal Life Insurance

Universal life insurance, like whole life insurance, is permanent as long as you make your payments. The key difference is that you can adjust your benefits and premiums as your financial circumstances change. You can even skip monthly premiums if your cash value will cover it.

This offers something a whole-life policy doesn’t—a chance to pay premiums only up to the point where your cash value can cover them for the rest of your life, freeing up the money you were using to pay them. You’re paid interest on your cash value, but the rate is not fixed.

Universal life is a good choice if you’re comfortable with the amount of money your beneficiary will inherit when you pass on, if you believe you won’t need to access the cash value, or if you want the option to skip monthly payments occasionally to use the money for something else.

Variable Universal Life Insurance

Variable life insurance comes with a fixed death benefit, but it has a variable cash value. The cash value varies because it is based on the performance of the investments (generally mutual funds) that you choose.

You may be required to maintain a minimum balance in the account, and investment fees may be charged against your account.

The issue with variable life insurance policies is that there is a risk of loss. If the markets drop when you’re ready to withdraw from the cash value, you might lose a significant amount of money.

Some variable policies might give your beneficiary the face value plus your policy’s cash value when you pass away. If the market drops before your beneficiary receives this death benefit, it could be much less than expected because the cash value would fall with the market value of the funds your money was invested in.

Final Expense Insurance

As the name implies, final expense insurance is a whole life policy that pays a smaller death benefit to cover final expenses such as funeral costs, final medical bills, and outstanding debts. This policy can also accrue a cash value.

Other Variations of Life Insurance

In addition to the general types of life insurance policies, there are variations of them you could consider.

Indexed Universal Life Insurance

A variation of universal life insurance policies, an indexed universal policy, has the same characteristics of variable premiums and the option to choose to have the cash value pay them. However, the cash value grows and shrinks with an underlying investment index such as the S&P 500.

This presents a bit more risk than the universal life policy because it relies on index investing, and there is always the risk of loss.

Supplemental Life Insurance

Supplemental life insurance is additional coverage for group policies provided by your employer. If you have life insurance through work, you might have the option to add more term or whole life coverage.

Survivorship Life Insurance

Survivorship life insurance is a joint insurance policy that pays a death benefit when two insured people pass away. Deaths don’t need to occur at the same time, but the payout only occurs after both parties pass.

Some might choose to use this as an inheritance or as part of an estate plan.

How to Choose the Right Life Insurance Plan

Assessing Your Needs

According to Western & Southern Financial Group, a life insurance needs analysis can help you decide your needs. This is a financial assessment of your income and expenses to learn how much coverage you need and the type of plan you should purchase.

Here are some steps that can help you analyze your current and future financial concerns and help you with choosing a plan:

• Add Up Your Current Expenses: Total your debts, such as auto loans, mortgage, credit cards, recurring bills, and daily living expenses, such as groceries and gas.
• Assess Your Family’s Future Income and Expenses: Estimate the income you expect your family to be able to generate realistically and the expenses they are likely to have. For example, a child’s educational costs could be a big factor here.
• Examine Your Assets: Figure out what you and your family have that they can sell, start, or dip into for funds. This could include Social Security benefits, investments, retirement accounts, luxury items, or any other assets.
• Decide on the Type of Insurance: The primary concern when choosing a plan is cost. Term life insurance is generally less expensive and has no cash value that can be used. Permanent life insurance has a cash value that can be used but is more expensive.
• Determine How Much Coverage Is Needed: You’ll need to decide how long your family will need support. This could be 10 or more years, so the longer you think they’ll need the help, the more you’ll need to request.

Factors to Consider

The most important things to consider when assessing your life insurance needs are your current health, age, and general life expectancy. The insurance company will include this in its assessment to get an idea of the risk it is taking by insuring you. Your payments will reflect how long, based on averages, you’re expected to live and pay premiums.

Should some of the life insurance death benefit be invested? An analysis of the returns various investment options bring could suggest additional income for your family. Income funds, bonds, and certificates of deposit can all add to their income.

An annuity might also be beneficial for your family. Many insurance companies offer life insurance annuities, in which the death benefit from a life insurance policy is paid out as an annuity. Depending on the annuity chosen, the income could last for many years or the life of your main beneficiary.

Evaluating Cash Value Options

When you’re considering whether you want a policy with a cash value, it’s important to know the types that offer a cash value and their differences. There are generally four types with cash value:

• Whole Life Insurance: This type lasts your entire life, as long as premiums are paid. Its cash value grows tax-deferred, and the premiums can be borrowed against, withdrawn, or even used to pay the plan’s premiums.
• Universal Life Insurance: The cash value is similar to that of whole life insurance, but you can vary the premiums depending on your ability to pay them. Of course, lowering your payments will lead to a lower cash value.
• Variable Life Insurance: You choose investments to put your money in, allowing it to grow (and shrink) with market conditions. Similar to whole and universal life policies, you can borrow and withdraw from this policy’s cash value or use it to pay premiums.
• Indexed Life Insurance: This policy holds portions of premiums paid in an account, which pays interest based on the performance of an equity index such as the S&P 500. This allows your cash value to grow following the index. These policies generally come with minimum interest rate guarantees, so you still earn interest if the index isn’t performing well. You can access your cash value in the same ways as whole, universal, and life.

Customizing Coverage with Riders

Life insurance plans can be supplemented with additions, called riders, that can help you customize your plan for you and your family. Your premiums will increase as you add riders, but they can provide coverage you might not otherwise have.

You can choose from many riders, but here are some of the most common:

• Accidental Death & Dismemberment (AD&D): If you die or lose a limb in a covered accident, your benefit can increase or pay out a certain amount while you’re alive.
• Critical and Chronic Illness: Gives you access to your death benefit if you’re diagnosed with covered conditions
• Long-Term Care: Provides money for long-term care if you’re no longer able to care for yourself as you age
• Cost of Living: Gradually increases your death benefit to account for inflation and increases in the cost of living
• Child and Spouse: Pay a death benefit to help with expenses in case something happens to a spouse or child

The Bottom Line

Life insurance is an important part of financial planning—and in today’s world, it can be risky for a family’s primary earner not to have coverage. There are several plans to choose from, and everyone’s circumstances require different considerations. Unless you know exactly what you need to prepare for your family’s future, it’s best to seek the advice of a financial advisor or a life insurance agent.