Life Insurance 101: Types of Life Insurance Explained

Types of Life Insurance

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When many people think of life insurance, they usually think of one basic type: term.

It's the most popular and the most often purchased, but; in the life insurance menu of options it's not the only choice. Far from it, actually.

There are actually many different types of insurance policies to choose from. Here's a Life Insurance 101 look at some of the basic types of life insurance policies explained.

Different Types of Life Insurance

There are generally four types of policies to look for and different considerations with each one.

1. Term Life Insurance: This kind of policy will maintain a certain premium for a distinct time period, after which you can opt to continue coverage with a premium that increases annually. You might decide that you want life insurance for 15 years with guarantees that your premiums will remain fixed. If you have a fixed budget, this might be especially useful. This is the cheapest kind of life insurance because it's based on a fixed time period, but know that it doesn't generate any cash value. Another variation of term life is return of premium insurance
2.  Universal Life Insurance: More expensive because these products offer a cash value and are tax free. Also, you have the option of borrowing against the policy. Universal Life Insurance is more flexible in that you can adjust the premiums paid per month, useful if your income varies over time. You just have to ensure that you pay enough to keep the policy valid and in effect. There may be a death benefit option that can either increase or reduce the death benefit as needed.
3. Whole Life Insurance: Lifetime protection that offers a guarantee on the death benefit and guaranteed cash value for a guaranteed premium (also tax free).  This is often one of the most expensive kind of life insurance, but may pay dividends (refunds of unneeded premium) that can be used in a variety of ways.
4. Equity Index Life Insurance: Equity Index Universal Life Insurance is a form of whole life insurance which includes an investment portion where your earnings are tied to a market index.  Cost is higher than whole life, but there is 'potential' to have more over long-term since it does have some tie to the stock market.

Understanding the 'Cash Value'

When an insurance policy contains a guaranteed cash value for a guaranteed premium, it means that the premium is larger at the beginning of the policy than it would be in a term policy so that the additional premium can be invested in a 'separate account' controlled by either the insurer or the policy holder in order to grow the cash value.

Whatever gains are earned can be used in a few different ways: to increase the death benefit, to borrow against for some later use or to keep the policy in effect so that you can stop paying monthly premiums. If you have a cash value policy, it's best to hold it until death or retirement so you can allow for probable gains.

A Closer Look at the Tax Benefits of Life Insurance

These tax benefits within a universal life insurance policy are similar to 401ks and IRAs. Annual earnings on the investment part of the policy don't get taxed, and any taxable gains when cashing out on a policy can be reduced by the amount of insurance protection the plan provides. Furthermore, in the case of death, the policy holder's gains usually aren't taxed.

Such policies can offer a range of investment options, including stocks, bonds, balanced mutual funds, international mutual funds and money market accounts. When deciding to invest, work with an advisor just as you would a financial advisor, and always invest just as much as you foresee needing, neither more nor less.

If you're still in the exploratory stage, there are many free tools available online, including Genworth Financial's Budget Calculator, that can help you as you look into life insurance options.