A recent study indicates that a record number of American consumers (39%) plan to purchase life insurance within the next year1. This figure is even higher among Gen Z adults (44%) and millennials (50%)1,3. Many of these consumers are approaching life events, marriage, starting careers, and having children—events that are making them consider life insurance because beneficiaries are now depending on them.
In this post, we will explain what life insurance is, and the different types of individual policies available. Please note that for this post, we are only focusing on individual life insurance policies, not group life insurance policies often offered through work.
What is Life Insurance?
Life insurance is a contract between an individual (the policyholder) and an insurance company, where the policyholder pays regular premiums, and in return, the insurance company provides financial protection to the beneficiaries named in the policy upon the death of the insured. It serves various purposes, including providing financial security, covering debts, replacing lost income, and leaving a legacy. There are different types of life insurance, each designed to meet various needs. These are the most common types:
- Term Life Insurance: Term life insurance provides coverage for a specific period, typically ranging from 5 to 30 years. Its primary purpose is to offer a temporary and affordable solution for individuals who want coverage during a specific period of their life. If the insured dies within the policy term, the death benefit is paid out to the beneficiaries. If the term expires and the policyholder is still alive, there is no payout, and the coverage ends. This type of insurance is suitable to replace income used to pay financial responsibilities like mortgage payments, education expenses, etc. Term life insurance is generally the most inexpensive type of life insurance to buy.
- Whole Life Insurance: Whole life insurance, also known as permanent life insurance, provides coverage for the entire lifetime of the insured, assuming the premiums are paid. It combines a death benefit with a savings or investment component known as the cash value. A portion of the premiums goes towards the death benefit, while the rest accumulates in the cash value account, which grows over time. Policyholders can often access the cash value through loans or withdrawals, and some policies even offer dividends. The primary purposes of whole life insurance are providing lifelong coverage, building cash value, and leaving a legacy for beneficiaries. On an annual basis, whole life insurance tends to be much more expensive than term life insurance.
- Universal Life Insurance: Universal life insurance is another type of permanent life insurance that offers more flexibility than whole life policies. Policyholders can adjust the premium payments and the death benefit within certain limits. The premiums paid are divided into the cost of insurance, administrative fees, and the cash value account, which earns interest based on the market performance of a specific investment vehicle chosen by the insurance company. Universal life insurance can serve as a means of lifelong protection, investment opportunity, and an estate planning tool.
- Variable Life Insurance: Variable life insurance is a form of permanent life insurance that allows policyholders to invest the cash value in various investment options, such as stocks, bonds, or mutual funds. The cash value and death benefit of the policy fluctuate based on the performance of the chosen investments. Variable life insurance offers potential for higher returns, but it also comes with higher risk due to the exposure to market fluctuations. This type of insurance is suitable for individuals who are comfortable with investment risk and want to combine life insurance with potential investment growth.
- Indexed Universal Life Insurance: Indexed universal life insurance is a hybrid of traditional universal life and variable life insurance. The cash value growth is tied to the performance of a specific market index, such as the S&P 500. It offers the potential for higher returns than traditional universal life insurance, but with less risk than variable life insurance since it often comes with a minimum guaranteed interest rate. Indexed universal life insurance is popular among individuals seeking a balance between risk and potential growth. Index Universal Life Insurance is more complicated that universal life polices, and often has caps on returns, participation limits, and complex fee structures2.
Most life insurance applications will require a medical exam as the insured’s health record is one of the most important parts of determining life insurance premiums. People who are healthy, or younger, present less risk to the insurance company so they get preferential rates.
It is also important to read the fine print and know what different policies cover. The main purpose of life insurance is to provide for beneficiaries upon death, so understanding what is covered and what is not covered (i.e., if the death occurs during a high-risk hobby such as sky diving) is imperative.
Each type of life insurance serves distinct purposes, and the right choice depends on specific financial goals, risk tolerance, and coverage needs. If you have questions regarding what type of life insurance is right for you, please call us. As part of your wealth management plan, we will work with you and an insurance professional to make sure you have an appropriate policy in place.
- https://www.limra.com/en/newsroom/news-releases/2023/new-study-shows-interest-in-life-insurance-at-all-time-high-in-2023/
- https://www.nerdwallet.com/article/insurance/how-does-life-insurance-work
- https://www.beresfordresearch.com/age-range-by-generation/ (Millennial – born between 1981 and 1996, Gen Z – 1997-2012)