The idea of life insurance is simple: Protection for your loved ones should something happen to you. But for many people, figuring out what type of life insurance is appropriate can be complicated.
That’s because there are different types of life insurance, which offer a variety of features and available options. What’s appropriate for your own personal situation will depend on a range of factors. Major considerations typically include:
For some, these factors may be straightforward, so figuring out the right kind of policy may be fairly simple. For others, especially those with more complex financial situations, the task can become more involved. Indeed, many people find it useful to consult a financial professional about the choices.
But, in considering the life insurance question, there are some general points to consider for each of these major areas.
Life insurance is generally less expensive the younger you are. Therefore, the earlier in life you secure a policy, the less you'll spend overall for coverage.
For example, a 25-year-old, nonsmoking female in excellent health can get a $100,000 20-year term life insurance policy for $111 a year. But at 55 years old, that cost jumps to $336 a year. And that rate assumes you have not developed any health issues. (Related: Do you need life insurance in your 20s?)
The discount for youth can be particularly valuable when it comes to permanent life insurance which offers protection for your entire life — not just for a set number of years. The value increases over the long term, as permanent insurance offers attractive financial features like cash value with tax-deferred growth.
For instance, the 25-year-old above could get a $100,000 whole life policy by paying $767 a year up to age 100. The 55-year-old would pay $2,552 annually for the same policy. (A MassMutual financial professional can generate similar cost illustrations for you. Find one here or ask one to contact you here.)
Despite the price advantage, there is sometimes resistance to getting life insurance at an early age. People just starting out in careers often have less income and look to cut costs as a result. And the actual cost of insurance is often overestimated as well, by as much as three times its actual cost, according to industry research.1
Because term insurance is less expensive, it tends to be the starting point for many people, especially those in their younger years. Many term insurance policies have provisions that allow for conversion to permanent insurance at a later date, which can help with protection needs as people age and gain responsibilities. (Related: 4 times when term insurance may be the answer)
Some people opt for a combination of term insurance and permanent insurance to cover various protection goals as they age. (Related: How to ladder insurance)
As you reach middle age, life insurance may be more expensive, but the need for it will likely be greater, too. After all, family and financial obligations — a mortgage, college tuition, retirement security — tend to grow over time. Again, term insurance may be useful in some instances. But permanent insurance, like whole life insurance, may offer some financial features that could prove useful for goals beyond basic protection. (Related: Life insurance in your 40s)
In later years, there may be a need or desire for life insurance as well, if for nothing other than to cover final expenses or to help provide financial support for a surviving spouse. There, too, options are available. (Related: Options for insurance in your later years)
Different types of life insurance come at different prices. As mentioned earlier, those with tighter budgets tend to gravitate toward term life insurance, because it tends to be the least expensive.
That overlooks three income-oriented points.
First, as noted, is that people tend to overestimate the cost of life insurance. As a result, they make off-base assumptions about the impact life insurance — whatever the type — would have on their budget.
Second, there are a variety of premium and payment options available for permanent insurance. For example, a whole life policy can be based on paying up (meaning all the premiums have been paid) in as little as 10 large annual premiums or continuous smaller ones for life. Additionally, premiums can be paid on a different basis — one payment a year or 12 monthly payments over the year, for example. This can help with budget planning. (Related: Life insurance premium options: Which one is right for you?)
Third, many people only consider their present income, not their future income. That means they are only considering the life insurance question in terms of what they can afford today and not what they will need to protect down the road.
The chart below illustrates the cumulative income earned for people at various ages assuming they make $100,000 annually until age 65. It does not account for pay increases, inflation, taxes, the value of any other contributions, or the time value of money.
As the chart illustrates, future income can add up. Life insurance is a way of protecting the future income stream — not just today’s paycheck.
Many people look to employer-sponsored insurance plans tied to their income for coverage. But, for most people, that coverage is simply not enough to fully protect their future earning potential. Importantly, it is also generally not portable, meaning you may not be able to take your employer-sponsored coverage with you when you leave the company. That creates a challenge for those who must then purchase private insurance years later at a higher cost, and even more so for those who develop health conditions in the intervening years. (Related: Is group life insurance enough?)
Obviously, those with families see the need for life insurance to help ensure that their loved ones can meet their financial needs. Again, most young families look to lower-cost term insurance to provide that protection.
However, as family size and income grow, many look to various types of permanent insurance, like whole life insurance, to help build more significant protection as well as some financial flexibility. That’s because permanent insurance allows for lifetime protection and tax-deferred growth in cash value. Loans against the cash value can be taken during the policyowner’s lifetime to help with things like a house down payment or college tuition.2
One crucial point for families to remember is that it isn’t only the main breadwinner who should be protected. A stay-at-home parent may not be bringing in a paycheck, but their economic contributions are still valuable and significant. (Related: Stay-at-home parents and the need for life insurance)
If a family splits up, life insurance can be a factor as well. Divorce decrees sometimes require life insurance as part of the settlement. (Related: Life insurance and divorce)
Single people often don’t consider themselves important to the support and well-being of others. This can often be a false assumption once aging parents or personal debt obligations (such as a student loan for which their parents may have co-signed) are taken into account. (Related: Single? 3 reasons you still may need life insurance)
Different types of life insurance can also help with achieving various kinds of financial goals.
For instance, term policies, with their specific time-period coverage, can be used to provide protection for a designated obligation, like a mortgage.
As noted earlier, permanent insurance can allow for the growth of cash value. For that reason, some include various types of permanent insurance as part of a strategy to grow and diversify overall savings. (Related: Taking cash off the table: Life insurance, annuity alternatives)
Different types of permanent insurance grow cash value in different ways. Providers of whole life insurance typically guarantee a particular rate of growth in cash value, tax deferred, over time. Other types of permanent insurance — like variable universal life insurance — tie cash value growth to equity market performance. So you should factor in your tolerance for market risk when considering which type of life insurance may be appropriate for your goals.
As it accumulates, cash value can be intended for specific purposes.
In retirement, cash value funds can serve to supplement retirement income. This can be handy when there is reluctance to tap retirement investment accounts due to a market downturn. (Related: How life insurance can help you in your retirement)
Whole life insurance and some other types of permanent insurance offer tax advantages too, like tax-deferred growth as well as tax-deferred distributions. Also, all life insurance death benefit proceeds are generally tax free. (Related: 3 income tax advantages of life insurance)
Life insurance — be it a term policy or permanent coverage — can provide a substantial, tax-free benefit paid directly to your beneficiaries. Such proceeds also avoid the expenses and delays of probate and are not part of any public record. That can help provide your loved ones support or, at the very least, help with final expenses. (Related: Funeral costs and considerations)
But the benefits of life insurance can also extend to other assets you may want to pass along.
Indeed, life insurance proceeds have long been used to help heirs deal with costs and taxes that can apply to inherited property and assets. (Related: Estate planning and keeping a farm in the family)
And, should there be questions of who gets what, life insurance proceeds can be used to equalize an estate inheritance among heirs.
Additionally, life insurance proceeds can be designated to help with a specific situation — like providing for the care of a loved one with special needs — or to support a certain cause — such as a charity or school.
Between all these major factors — age, income, family status, financial goals, and legacy concerns — determining the appropriate kind of life insurance can be challenging. It can get even more complex when circumstances unique to an individual — children from a previous marriage or family business — are added in.
Many opt to consult a financial professional about their choices and possible strategies.
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1 LIMRA, “2020 Life Insurance Barometer Study,” April 2020.
2 Borrowing from cash value will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.