Whole, Term, and Everything Else: An Introduction to Life Insurance

Sometimes, despite our best efforts, life doesn’t turn out the way we planned. If a catastrophic event occurs to you, your loved ones might be left with mounting expenses, medical costs, and (if you’re a homeowner), a lingering mortgage.

Life insurance can relieve some of those financial burdens. It provides a safety net when you ultimately pass away. Purchasing a life insurance plan demonstrates a commitment to protecting your family’s financial well-being.

Payments from a life insurance plan can cover expenses like:

• Mortgage payments: Helping your family remain in their home.
• Debt repayment: Covering credit card balances, non-discharged student loans, or other debts.
• Final expenses: Funeral costs, medical bills, and legal fees.
• Income replacement: Providing a source of income for your dependents.
• Education costs: Helping to fund your children's education.

Navigating the life insurance market can be confusing. You might already have some coverage from your employer, but it may not be enough to cover all your family’s expenses. This post covers the basics of life insurance: types, coverages, riders, and best applications.

And here’s a primer on insurance based on a recent episode of the Welcome Home Podcast from the Minnesota Homeownership Center.

Common Life Insurance Types

At the broadest level, life insurance policies come in two primary forms: term and whole life. The main difference is when the policy ends:

• Term policies have a fixed length, usually 10, 20, or 30 years. Policyholders pay a yearly premium (either in one lump sum or spread out monthly) to retain coverage. Term policies protect the policyholder for the length of the term, as long as the premium is paid. If the policyholder dies during the term, the insurance company will pay out cash benefits to all listed beneficiaries.
  
  If the policyholder is still alive at the end of the term, they would no longer be covered. Some people become self-insured at this point, meaning their income no longer needs to be replaced to cover expenses at the time of death. If income is dependent upon by loved ones, they’d need to take out another policy to keep coverage–often at a higher cost than the previous policy. Generally, life insurance policy costs increase as people age, so purchasing longer-term plans is better when young and healthy.
  
  Financial experts typically recommend term policies because they are considerably cheaper than other types of policies, as the risk factor is lower for the insurer and do not include a savings component.
  
  
• Whole policies cover the policyholder for their entire life, as long as the premium is paid. However, because they are more likely to be paid out, whole plans are considerably more expensive than term plans.
  
  Whole life policies also have a savings component, called cash value. This is a tax-deferred investment account that grows over time, built up by a portion of each premium payment. The cash value grows as the insurer’s investments pay off and more premiums are paid.
  
  

Other Life Insurance Types

Term and whole life are the primary types of life insurance, but other variations might work in certain situations:

• Universal policies offer permanent coverage (similar to whole life plans) but offer some adaptability as life needs change. Premiums increase over time, which may require the policyholder to increase payments or adjust their benefit amounts. They’re typically less expensive than whole life plans, but still typically more expensive than term plans. Plus, the benefits aren’t guaranteed to be the same throughout.
  
  
• Variable policies also offer permanent coverage, but tie cash value to investment accounts. Policyholders can allocate their cash value to mutual fund-style accounts, which can grow if the funds perform well in the stock market. However, if the funds don’t perform well, the cash value decreases. Either way, variable policies require dedicated investment and monitoring from the policyholder. Premiums are usually higher than term policies because of the investment component.
  
• Limited payment whole policies offer permanent coverage with a term-based payment structure. For example, a limited whole plan may require premium payments for 20 years, but once the payments are complete, coverage extends for the rest of the policyholder’s life. Limited plans carry higher premiums and may incur tax penalties if overfunded.
  
  
• Final expense policies are limited to coverage for funeral, burial, and other end-of-life expenses. Coverages are capped, usually between $5,000-25,000, and these policies work best for seniors with pre-existing health conditions or for people who no longer feel the need to carry a larger policy to replace loss of income. 

Determining Coverage Amounts

Choosing a life insurance policy type is just the first step. The next question is determining how much coverage you’ll need. The goal is to provide enough coverage to meet current and future needs for your family.

Financial experts recommend taking out policies to cover 10-15 times your annual income.

• For example, if you earn $50,000 annually, seek a policy offering coverages between $500,000 and $750,000. Aim toward the higher end of that scale if you have large investments (like a mortgage) or want to account for inflation or higher standards of living.
  
  
• Use this calculator tool to get a more accurate assessment of what you need.

Keep in mind that you may already have an existing life insurance policy through your employer. Standard employer-sponsored policies offer coverage up to your annual salary, and you can increase those coverage amounts with additional pre-tax payroll deductions.

Adding Coverage Riders

Many life insurance policies offer riders, which are optional add-ons that help you customize your policy's coverage. These riders typically increase your policy premium, but they might help in specific scenarios. Some common policy riders include:

• Waiver of premium disability rider, which waives the policy premium if you become disabled and can’t work.

• Accidental death and dismemberment rider, which increases the policy benefit if your death is caused by a covered accident, or pays out a certain amount while you're still alive if you suffer a qualifying injury caused by an accident.

• Cost of living rider, which increases your policy's coverage over time to adjust with inflation (the premium would also increase).
  
  
• Return of premium rider, which refunds all or some of your premium payments at the end of a term, provided the death benefit hasn’t been paid out.

• Charitable benefit rider, which adds an extra percentage to your standard death benefit to be paid to the charity of your choice, at no additional premium.

• A child term rider, which provides extra coverage for a child in the event of their death. Child riders can help families cover funeral expenses, medical costs, and income gaps.

Each insurer offers different riders depending on policy type, so check with your insurance agent on applicable riders when shopping for a policy.

Protecting Your Loved Ones

By nature, life insurance is a delayed benefit. You hope to never need the benefit (unless you have a whole policy), but it can help keep your family financially secure. Financial coaches encourage people to purchase life insurance policies when they’re young and healthy, rather than waiting to pay higher premiums when older.

Whenever you choose to take out life insurance, you’re adding a financial safety net and securing your family’s well-being for years. If you want to learn more about life insurance policies, connect with some of our financial services partners for further guidance.