Crash Course for Choosing Life Insurance

For many people, buying life insurance can be a bit overwhelming.  There are many licensed brokers, a variety of policies and lots of finely printed words on pages and pages of paper. 

Keep this in mind as you sort through the jargon and plentiful options: there are only three main types of life insurance – term, whole and return of premium. Each major policy type is relatively easy to understand and products that are one of those three are combinations of multiple aspects of the three.

Term Life Insurance

Term life insurance is generally the simplest kind of life insurance to buy.  It is affordable, the coverage is flexible and term life insurance is going to be easier to get than whole life or return of premium insurance.  Term life insurance is a pure death benefit. It is intended to cover final expenses (consumer debt, kids’ education, etc.) and burial for the insured in the event of his/her death. 

Unlike whole life insurance, term life does not include a savings component.  For those who are disciplined savers, purchasing an inexpensive term life policy and investing separately may be a good option.  Term life insurance policies can generally be purchased for 1-year to 30-year terms. The low premiums characteristic of term life policies allow purchasers to buy high-value policies at a substantially lower rate than would be available with the other two types of life insurance.  If the insured outlives his/her policy, the policy expires and the insured would either have to forfeit coverage or renew the policy.  Renewal, however, will often require proof of insurability and the policy would likely be rewritten with new premiums.

Whole Life Insurance

Whole life insurance policies are purchased as an investment vehicle for the duration of the insured’s lifetime.  There is no expiration date, nor a set term or period wherein the insured would be required to re-establish insurability once the policy has been written. Whole life policies offer a savings component where a portion of the premium paid goes to a tax-deferred cash value account.  For that reason, whole life insurance policies are significantly higher in price than term life policies.  If you are considering whole life mainly for the investment component, be warned. Administrative fees will cause whole life insurance policies to be a costlier method of investing than simply investing on your own.

Whole life policies are guaranteed to pay out as long as the insured continues to make the scheduled payments of the premiums.  While whole life policies do not have a traditional 20 or 30-year term limit, most whole life policies are actually written with a built-in termination date, so that if the insured reaches a certain age – usually 100 years old – the policy will automatically be cashed out at face value.

You do have the option of   canceling a whole life policy and receiving the vested cash value.  Early in the life of your whole life policy, you will pay far more in premiums than what would be available in cash value. It will take around 15 years for the premiums paid and the cash value of the policy to equalize.

Return of Premium Life Insurance

ROP insurance is a comfortable compromise between term and whole life insurance policies.  Like term life insurance, ROP is purchased for a set period of time, usually no more than thirty years.  ROP insurance is easy to purchase, and while it is more expensive than term, ROP is significantly less expensive than whole life.  ROP is a death benefit policy. If the insured outlives the policy, all the premiums paid will be wholly refunded.  The primary difference between a whole life policy and ROP policy is that there is no return on your investment with an ROP policy (0% ROI), whereas whole life returns hover right above inflation.  In truth, a disciplined saver could do a better job of saving separately.

Universal Life Insurance

Universal life policies are permanent (i.e. lifelong) policies that offer the competitive pricing of term policies with the savings benefit of the whole life policy.  Universal life policies offer coverage from the insured’s current age up to 100 years of age.  As such, the policy premium is calculated as an average of the cost to insure you until your 100^th birthday.  With a universal life policy, you can trust that once you establish insurability, you won’t have to go through the process again for the entire duration of your policy (lifelong or to age 100).  With a universal life policy, there is a built-in savings component that offers a bit more flexibility that the whole life policy.  You have the option to make a minimum fixed premium payment – just the cost to insure you – or you can overpay to build cash value into your policy. The more you overpay, the faster you build cash value that is tax-deferred and interest-bearing.   You can use your policy’s cash value to cover the cost of minimum premiums down the road.