Common Life Insurance Questions
There are two major types of life insurance—term and whole life. Whole life is sometimes called permanent life insurance, and it encompasses several subcategories, including traditional whole life, universal life, variable life and variable universal life. In 2018, 4.0 million individual life insurance policies bought were term and about 5.9 million were whole life, according to the American Council of Life Insurers.
Term Insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.
There are two basic types of term life insurance policies: level term and decreasing term.
- Level term means that the death benefit stays the same throughout the duration of the policy.
- Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term.
In 2003, virtually all (97 percent) of the term life insurance bought was level term.
Whole life or permanent insurance pays a death benefit whenever you die—even if you live to 100! There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life, and there are variations within each type.
In the case of traditional whole life, both the death benefit and the premium are designed to stay the same (level) throughout the life of the policy. The cost per $1,000 of benefit increases as the insured person ages, and it obviously gets very high when the insured lives to 80 and beyond. The insurance company could charge a premium that increases each year, but that would make it very hard for most people to afford life insurance at advanced ages. So the company keeps the premium level by charging a premium that, in the early years, is higher than what’s needed to pay claims, investing that money, and then using it to supplement the level premium to help pay the cost of life insurance for older people.
By law, when these “overpayments” reach a certain amount, they must be available to the policyholder as a cash value if he or she decides not to continue with the original plan. The cash value is an alternative, not an additional, benefit under the policy.
In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product—universal life insurance and variable universal life insurance.
The most useful way to answer the question of whether you, specifically, need life insurance is with another question:
Would your death financially impact the people in your life?
If the answer is yes, then you should consider life insurance.
Life insurance is a contract between you and an insurance company, where you pay insurance premiums in exchange for the insurer’s commitment to pay a “death benefit” to specific people or organizations if you die while the policy is in effect.
The people who receive this death benefit — which could be your spouse or children, for example — can use the money to cover their financial needs, whether that’s paying household expenses or covering debts.
If you die unexpectedly, and your death would leave important people in your life on the hook for debt, or unable to pay their bills, or saddled with expensive costs, life insurance can make sense for you.
Let’s review the scenarios where your death would most likely negatively affect other people financially:
- Someone would inherit your debt. Your debts don’t simply disappear when you die. Co-signers on a loan, joint owners or account holders, spouses in community property states such as California and Texas, and people tasked with settling your estate’s debt who didn’t comply with probate laws are all possibly on the hook to pay your debts.
- Your spouse or partner relies on your income.If you’re building a life with a partner, and that partner counts on your earnings to pay things like household expenses, the loss of your income could be devastating for them.
- Your children depend on your income.Your minor children, unable to provide for themselves, would almost certainly be put at a major disadvantage if your income disappeared. The same is true if they will rely on you to help cover college costs or provide support for a disability.
- Your heirs would owe estate taxes.If your estate is large enough, your heirs could be subject to an estate tax upon your death. In 2021, the federal estate tax kicks in if you leave behind assets totaling more than $11.7 million.
- Your funeral would be a financial burden.According to the National Funeral Directors Association, the median cost of a funeral with viewing and burial is $7,640. Depending on your wishes for your funeral, it could cost more. Life insurance can be a way for you to pay your own way, so to speak, keeping the burden off of those tasked with executing your funeral wishes.
- Your business, and the people it employs, might otherwise fail.If you own a business, your business partners and/or employees also depend on you. Life insurance can provide assistance to these people after you’re gone.
Other examples of financial burdens that you might leave behind include student loan debt (if the loan is from a private company and someone, such as a parent, is a co-signer), the costs of elder care that your family incurs while caring for you and the mortgage on a jointly held property.