Understanding the Different Types of Life Insurance

Thinking (and reading) about life insurance sometimes feels like courting death. You don't want to talk about it because you feel as though you're inviting it. After all, the purpose of life insurance is to provide for others after your passing. But not thinking about life insurance is a mistake; it is important for all adults to understand how it works and how to choose a policy.

There are three basic types of life insurance, according to Financial Web: Whole, or permanent, life; flexible life; and term life. Within these three categories are several other subtypes of life insurance, and within those subtypes are myriad clauses and provisions that make every policy unique. Wading the waters can be daunting at first, particularly if you don't have a background in finance.

Term Life Insurance

Young people often choose term life insurance because it is cheaper than the other options. This type of life insurance is limited in scope to the period for which the policy is purchased (e.g., 20 years). When the policy expires, there is no cash value to collect.

It is the purest form of death benefit because the policy is not used for anything else. If the insured passes away during the term of the policy, the beneficiary receives the value. If not, the policy is no longer valid after the term ends.

The basic philosophy behind term life insurance is to cover one's dependents until other sources of income are sufficient to cover burial costs and other expenses. For example, a 45-year-old might purchase a 20-year term life insurance policy so that, if he dies before he retires, his spouse and children won't have to worry about money. He figures that once he retires, his benefits will take the place of his policy.

Permanent Life Insurance

Permanent life insurance is different from term life because the policy is active as long as the insured (or whoever purchased the policy) continues to pay the premium. In other words, there is no expiration date, and the policy itself builds a kind of equity. You can cash out or borrow from a permanent policy at any time, subject to taxes and other fees imposed by the underwriter.

Also called whole life insurance, this type of policy is more of an investment than term life. The insurance company is responsible for managing the account, meaning they make investment choices that cannot be changed by the insured. If the insured passes away while the policy is still in effect, the death benefit as well as any additional equity is paid out to the beneficiary.

Flexible Life Insurance

Flexible life insurance is a variation of permanent life, featuring many of the same benefits. The insured individual (or whoever controls the account) has flexibility in choosing investments and making other decisions.

When you purchase a flexible life insurance policy, you can decide how much money you want allocated to the savings and insurance components. If you are getting a high rate of return in savings, for example, you might want to allocate more money there. Premiums change as market conditions change, however, so the policy is less stable than whole life.

Variable and universal policies are common subtypes of flexible life insurance. It is important to talk to an investment or insurance adviser to determine which type of policy is best for you. If you are worried about your policy lapsing if the premiums go up, you might want to negotiate a reinstatement clause that allows you to re-activate the policy within a specific period of time.

The different types of life insurance can be confusing, and you might have to change strategies as you get older and your financial position changes. This is why many people purchase term life insurance early in life, then switch to permanent or flexible life insurance later on.

Source:
Financial Web, Types of Life Insurance Policies