Different Types of Life Insurance

Many people see life insurance as a great investment because it protects their loved ones financially after they die. Purchasing a life insurance policy has become much more common in recent years. And many of these policies were purchased to cover burial expenses, create inheritance, and replace the income of the deceased policyholder. 

While many people understand the importance of life insurance and how they can benefit from it, there may still be some confusion when it comes to choosing the right type of life insurance. 

We’ll explain the different types of life insurance in this guide. 

Basic Life Insurance Policy Features

According to annuity.org, close to 50% of Americans own life insurance as of 2022. Before we dive into the different types of life insurance policies and what they do, it’s important to understand the basic features of a policy: 

• Premium: The annual cost of the life insurance policy
• Term: The length of the time the policyholder is covered
• Beneficiary: The person or people chosen by the policyholder to receive the death benefit
• Death benefit: The amount paid to the beneficiary after the policyholder dies 
• Cash value: An investment component that builds throughout the policy term and allows the policyholder to withdraw or borrow against the policy
• Rider: An add-on that offers additional coverage, such as accidental death, which pays out an additional benefit to the beneficiary if an accident results in your death

Let’s get into the different types of life insurance and how each policy works.

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The Different Types of Life Insurance

Life insurance is divided into two different categories: term life and permanent life. 

Term life insurance is designed to cover you for a period of 1 year to 30 years. If you are alive at the end of your policy, it will expire unless you renew it for another term before the current term lapses.

Permanent insurance is designed to cover you your entire life, but it has a cash value feature that allows you to borrow against your policy while alive, reducing the payout amount when you die. 

Life insurance is even further separated into different types that fall under either term life or permanent life:

• Term life insurance
• Whole life insurance
• Variable life insurance
• Universal life insurance
• Simplified issue life insurance
• Indexed universal life insurance
• Group life insurance
• Guaranteed issue life insurance

We’ll further explain each of these types of life insurance options. 

Term Life Insurance

Term life insurance offers inexpensive but temporary coverage for periods of one, five, 10, 15, 20, 25, or 30 years. Coverage limits vary, but they can go as high as several million. Depending on the life insurance provider, you can purchase a term life insurance policy with a convertible term, which gives you the option to convert to a different type of life insurance before your term lapses. 

Here are the pros of term life insurance:

• Cheaper than other types of life insurance
• Renewable
• Guaranteed insurability for future life insurance policies 
• Convertible, depending on the life insurance provider
• Tax-free death benefit
• High coverage limits available 

Here are the cons of term life insurance: 

• Coverage is temporary
• No cash value 
• Terms options are limited by age
• Premium increases upon each renewal
• Required medical exam, depending on the life insurance provider

If term life insurance doesn’t seem like the best fit for your needs, there are other options to consider. 

Whole Life Insurance

Whole life insurance is a type of permanent life insurance that covers you until death rather than for a specific number of years. Premiums typically stay the same and do not increase, and the policy builds a cash value, which you can use while you are alive. However, withdrawing from or borrowing against your policy reduces the size of the payout for your beneficiary.  

Here are the pros of whole life insurance:

• Long-term coverage that lasts your entire life
• Guaranteed insurability for children
• Builds cash value
• Fixed premium
• May earn annual dividends, depending on the life insurance provider

Here are the cons of whole life insurance:

• More expensive than term life insurance
• An age restriction for policy purchases for individuals over a certain age
• Required medical exam, depending on the life insurance provider

Due to its cost, whole life insurance may not be ideal for someone with limited income. Depending on your circumstances, purchasing a term-life policy and converting it to whole life later down the line can save you money. 

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Variable Life Insurance

Variable life and variable universal life insurance are types of permanent life insurance offering cash value through various investment accounts, including stocks, bonds, and mutual funds. Similar to other permanent life insurance options, variable life and variable universal life insurance are more expensive than term life, but coverage lasts the policyholder’s entire life. 

Here are the pros of variable life insurance:

• Long-term coverage that lasts your entire life
• Cash value
• Potential to earn annual dividends
• Guaranteed insurability for children
• Fixed or adjustable premium, depending on the type of policy
• Adjustable death benefit, depending on the type of policy
• Minimum death benefit guaranteed
• The death benefit may include the cash value at the time of the policyholder’s death.
• The death benefit may include the face value and the premiums paid up to the policyholder’s death.

Here are the cons of variable life insurance: 

• Expensive
• Cash value and death benefits may decrease due to daily market-impacting interest rates
• Fees 

With variable life and variable universal life insurance, the policyholder has the opportunity to increase the beneficiary’s payout, so this could be a good option for someone with a high income and investment knowledge. 

Guaranteed Universal Life Insurance

Guaranteed universal life insurance is a combination of term life insurance and permanent life insurance. This type of life insurance guarantees a death benefit up to a certain age and has fixed premiums, but payments must be received on time or the insurance provider may void or cancel the policy. The cash value can be earned through investments, but it is very small.

Here are the pros of guaranteed universal life insurance:

• Longer coverage options than traditional term life insurance
• Fixed premium
• Guaranteed death benefit
• Policyholder chooses the policy expiration age 
• Less expensive than whole life insurance

Here are the cons of guaranteed universal life insurance:

• Minimal cash value
• Strict payment requirements

Another type of universal life option is indexed universal life insurance. 

Indexed Universal Life Insurance

Indexed universal life insurance is a type of permanent life insurance, so it offers lifelong coverage for a fixed premium. Rather than the cash value being based on market interest rates, the cash value indexed universal life insurance earns is based on equity index accounts. Once the cash value builds, policyholders can enjoy a flexible premium. 

Here are the pros of indexed universal life insurance:

• Long-term coverage that lasts your entire life
• Builds cash value based on equity index
• Potential to increase the death benefit
• Adjustable death benefit, depending on the insurance provider
• Flexible premium, depending on cash value
• No age limit

Here are the cons of indexed universal life insurance:

• Cash value is limited due to a cap on gains
• Policy determines the participation rate or the cash value participation in gains
• Fees

This specific type of life insurance is a good option for someone comfortable with the cash value building over time. 

Types Of Life Insurance By Underwriting

Underwriting is the process of determining how much of a risk it would be for the insurance provider to insure you and how much you’ll pay for life insurance. 

Here are the three common types of underwriting: 

Fully Underwritten Life Insurance

Fully underwritten life insurance, which is often the cheapest, generally requires applicants to complete a health questionnaire that provides details regarding their medical history as well as a medical exam. With this information, insurance providers can estimate your life expectancy, which will factor into your premium. 

Simplified Issue Life Insurance

Simplified issue life insurance, often an option for those seeking instant approval, requires applicants to complete a health questionnaire, but a medical exam is not required. 

Guaranteed Issue Life Insurance

Guaranteed issue life insurance is limited to applicants who fall in a certain age range and does not require a medical exam or the completion of a health questionnaire. Coverage is guaranteed, but the death benefit is low and the premium is expensive. Benefits are also graded, meaning depending on when you die, the beneficiary doesn’t receive the full payout. 

During underwriting, the following information may be used by the life insurance provider to assess risk and calculate your life insurance premium: 

• Age 
• Gender
• Health
• Driving record
• Family medical history
• Credit score 
• Type of insurance policy
• Amount of coverage
• Occupation 
• Lifestyle
• Smoking status 

No two policyholders are alike, so everyone should expect to see different rates when shopping for life insurance. 

Other Types of Life Insurance

Here are additional life insurance options:

• Accidental death and dismemberment insurance: This pays out a benefit following the death of the policyholder if the death was due to an accident, such as a car accident, or if an accident results in the policyholder losing their limbs, sight, or hearing. 
• Credit life insurance: This pays off the remaining loan balance after you die.
• Group life insurance: This is free coverage offered by an employer during your time of employment. 
• Final expense insurance: This covers the policyholder’s funeral expenses as well as medical or legal expenses. 
• Joint life insurance: This coverage provides for two individuals, such as spouses, with two payouts: one after one policyholder dies and a second after both policyholders die.
• Mortgage life insurance: This pays off the remaining mortgage balance after you die. 

You can purchase more than one type of life insurance policy, so it’s an option to purchase a term life or whole life policy and an additional type of policy. 

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Choosing the Best Life Insurance Type for You 

Life insurance is purchased for a variety of reasons. If you know why you are purchasing a life insurance policy, you’ll be better equipped to select which type of life insurance is a good fit for your needs. 

Life insurance can be used for the following: 

• Inheritance
• Funeral expenses
• Medical expenses
• Income replacement
• Debts
• Savings
• Probate
• Charity donation
• State and federal death taxes

Here are a few different scenarios to consider to help you when choosing between term life and whole life insurance. 

Consider term life insurance if:

• You only need life insurance for one to 30 years to cover or repay the financial obligations you have during that specified time period.
• You need an affordable policy with a high coverage limit. 
• You have various financial obligations that you want to be covered or repaid after you die, such as a mortgage, credit card debt, or your child’s college education. 
• You want to guarantee your insurability, but you can’t afford whole life insurance. 

Consider whole life insurance if:

• You prefer to pay a fixed premium for as long as you are covered.
• You want to guarantee insurability for your children. 
• You want to build cash value that you can borrow against or use to pay the premium. 

Even if you purchase a term life insurance policy today, you still have the option to purchase whole life insurance later. Depending on the insurance provider and your policy, you can convert your term life insurance policy into whole life or purchase a separate whole life policy and have additional coverage. 

Calculating Your Life Insurance Coverage Amount

How much life insurance coverage is enough? People choose different methods to calculate their life insurance coverage amount. And the method you choose really depends on how precise of an estimate you want. You can opt for something a bit more comprehensive that requires a thorough review of your finances or a more broad estimate using a few pieces of financial information. 

Here are a few different ways to calculate your life insurance coverage amount. 

Multiply Your Annual Income by 10

This method is ideal if you are married with no children. It ensures your beneficiary receives a payout equal to 10 years of your annual income. For example, if you make $65,000/year, you’ll multiply that by 10, and your coverage limit will be $650,000.  

Multiply Annual Income by 10 and Add $100,000 Per Child 

If you are married and/or have children, this method ensures your beneficiary receives a payout equal to 10 years of your annual income and your children receive $100,000 each, which will cover education expenses.  For example, if you make $65,000/year, you’ll multiply that by 10 and add $100,000/child, $750,000 if you have one child. 

DIME Formula

DIME, which stands for debt, income, mortgage, and education, accounts for the four common areas used to calculate an individual’s death benefit.  

When using this method, the following financial obligations are combined:

• Debts and funeral expenses
• Annual income multiplied by the total number of years to be replaced
• Mortgage balance
• Educational expenses for each child

The above-mentioned methods are best for quick estimates, so if you want a more precise calculation, you can use the method below. 

Financial obligations – existing assets = life insurance coverage amount

Common financial obligations covered by life insurance include the following:  

• Annual income multiplied by years of income to be replaced
• Funeral expenses
• College expenses
• Mortgage balance
• Any additional debts, such as credit cards, auto loans, personal loans
• Cost of services provided by a stay-at-home parent to be replaced, such as childcare 

Common existing assets may include savings, college savings, and additional life insurance policies.

Properly estimating the death benefit is important because the payout will be used to ensure your loved ones’ financial security after you die. 

Choosing a Life Insurance Provider

You may know what type of life insurance policy and how much coverage you want, but you still have to choose a life insurance provider. 

Here are a few things to consider when choosing a life insurance provider: 

• Life insurance products: As you shop around for a life insurance provider, confirm which providers offer the life insurance product and coverage amount you are interested in.
• Cost: Compare the cost between providers for a life insurance policy, as well as what additional benefits are included with the policy and how much they cost. 
• Discounts: If you have home or auto insurance with an insurance provider that also offers life insurance, you may be able to get a bundling discount if you purchase a life insurance policy. 
• Reviews: Look up reviews to see what current and past policyholders are saying about the life insurance provider, its products, and its customer service. 
• Financial stability: Review ratings and studies from independent agencies, including J.D. Power and Am.M. Best, to determine the provider’s financial stability and likelihood of the provider still being in business 10, 20, 30, or more years from now. 

If you need further assistance with choosing a life insurance provider, you can also speak to an agent from the providers you are interested in to get a better idea of its offerings and whether or not it would be a good fit for you. 

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Bottom Line: Life Insurance Protects Your Loved Ones

People often have their loved ones in mind when they decide to get life insurance. When you have dependents who rely on your income, your death can leave them struggling financially. Money can never replace a life, but at least with a life insurance policy, you can ensure your loved ones are financially taken care of when you’re gone.

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