Types of Life Insurance Policies and Riders

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The two primary categories of life insurance are term and permanent. Term policies only offer coverage for a fixed period of time. Permanent policies last as long as you pay the premiums.

Both term and permanent life insurance can be customized with riders, or add-ons to the policy.

The policies below can be referred to as "no medical exam," "simplified issue" or "guaranteed issue" (as opposed to "fully underwritten" policies). These terms all refer to the same products. It means the company is willing to charge more for a shorter underwriting process or without a medical exam. Underwriting can take several weeks. The exams tend to take less than an hour and can be scheduled at your home or work.

These features sound convenient. But unless you're concerned about being denied for health reasons, the high cost tends to outweigh the reduced hassle.

Term life insurance

A term life insurance policy covers a specified period of time. That means if you die during that time, the beneficiary will receive the payout. This is also known as the death benefit or face value of the policy.

Term policies are generally the least expensive life insurance. Term lengths can be as little as one year but are more commonly offered for 5, 10, 20, or 30 years.

Aside from the payout and term length, there are a few ways policies differ. It's important to understand them when choosing the best policy for your financial situation.

Level and decreasing term life insurance

Payments are generally the same for the term of the policy. But level and decreasing term policies are different. As the names imply, decreasing term policies pay a lower death benefit over time. Level term policies pay the same death benefit for the whole term.

For example, if you purchase a 20-year, $500,000 level term policy and die during those 20 years due to a covered event (and have paid all premiums) the beneficiary would receive a $500,000 payout.

However, if you purchase a decreasing term policy, the payout would depend on how long the coverage was in force. So if you die after 10 years, the payout may only be $250,000 (but the decrease in coverage each year isn't always the same).

To illustrate this example:

Level term death benefit
Decreasing term death benefit
Year 1$500,000$500,000
Year 5$500,000$350,000
Year 10$500,000$250,000
Year 15$500,000$150,000

This can be useful if you have a debt that will reduce over time, such as a mortgage, and your family couldn't cover payments without your income.

Convertible term life insurance

A convertible policy is a term life insurance policy you can convert to a permanent life insurance policy without the hassle of a new medical exam or underwriting process. If, for example, you receive a big promotion and raise five years after buying term coverage, you might want to convert it to permanent life insurance forthe tax benefits and dividends.

Choosing a convertible policy doesn't increase the cost.It simply gives you more options if your finances change. So we recommended asking for it. Just keep in mind that the conversion period doesn't last for the full term. You'll need to check when it ends.

Guaranteed universal life insurance

Guaranteed universal life insurance behaves like term life insurance but extends to a nearly permanent term. It offers coverage until age 90, 95, 100, 110 or 121. There's generally no cash value component, which you'd get with a permanent policy, so it's less expensive. But this policy essentially offers lifetime coverage with level premiums.

Are you considering permanent life insurance but wary of the complexity of the policy and not interested in the cash value or investment benefits? Then guaranteed universal life insurance is a less expensive way for you to get nearly lifelong coverage.

Renewable term life insurance

Short term life insurance policies (like one or five years) are often renewable. That means you can buy the same coverage again at the end of the term without a new application process.

This can be useful when you have a known obligation, such as your children's college tuition, but aren't sure how long you'll need to pay it. If your child stays in college for an additional year or two, you can simply renew your policy while they complete their education.

Having coverage every year without committing to a longer term may sound convenient. But if you know you'll probably want coverage for longer, you're likely to do better with a longer term policy. This is because every time you renew, you're basically buying a new policy that's priced by your current age, so the premiums will keep increasing.

Permanent life insurance

Permanent life insurance covers you for your entire life, as long as you pay the premiums. It's a category of insurance that includes several policies.

These policies all generally have a cash value component that's essentially the surrender value of the policy (if you give it up before its maturity or your death). It's the main reason permanent life insurance is more expensive than term. A policy's cash value is not added to the death benefit, but it can be:

  • Borrowed against for expenses (such as college tuition)
  • Used to pay premiums
  • Withdrawn in certain cases

If you die after having borrowed against the cash value of your policy, the amount of the loan will be taken from the death benefit.

Whole life insurance

The cash value of whole life insurance tends to grow at a guaranteed rate. Whole life also often pays annual dividends. Depending on your company, you may be able to pay the premiums for a set number of years, instead of paying every year the policy is in effect. But the annual premium would be higher.

For example, if you have a high income but low retirement savings, you could pay more each year for the first 20 years. That way, you'd make sure the policy is paid off and then build up your savings. The other option is to pay a lower premium for your entire life.

Universal life insurance

Universal life insurance is similar to whole life insurance, but payments are more flexible (overpay when you have money on hand, pay less when you don't).

Cash value growth isn't always guaranteed, though, because it may be tied to an index or depend on the company's investments. In addition, you can increase or lower the policy's death benefit if your financial needs change.

So, for example, if you purchase enough coverage to cover one child's education and later decide to have a second child, you can up the face value. Just keep in mind that increasing the death benefit usually requires more underwriting, and lowering it may come with fees.

Variable life insurance

Variable life insurance is also similar to whole life insurance. But instead of having a guaranteed rate of growth, the cash value can be invested in subaccounts. These accounts behave somewhat like a mutual fund. Your money is invested in a specified portfolio, and the cash value changes by how well that portfolio performs.

If your investments do well and the cash value increases, you can use it to pay premiums or buy more coverage. However, it comes with the risks of investing, meaning you might lose value. And you don't have the full range of investment options you'd have with a brokerage account or retirement account.

The growth of your variable life insurance policy's cash value is tax deferred. So it might be good if you've maxed out your retirement account contributions, have sizable liquid assets (such as brokerage and savings accounts) and are looking for an investment that also offers coverage to your dependents if anything happens to you.

The policy is complex, there are added costs with permanent life insurance and you have the potential to lose your entire cash value. So it's not recommended if your main reason is to provide financial coverage in case you die.

Insurance riders

Life insurance riders allow you to tailor your life insurance policy with benefits that aren't available with standard coverage. Many riders increase the premiums, so you need to consider each based on your financial situation and what the policy offers. You want to make sure they pay off in terms of value.

The riders available change by company, so if you'd like to customize your coverage, check what's available before you buy a life insurance policy.

Waiver of premium rider

A waiver of premium rider offers the option to waive premiums until you're able to work again if you become disabled. It also applies if you are unable to work due to a covered illness or injury, such as:

  • Loss of a limb
  • Paralysis (full or partial)
  • Spinal trauma
  • Vision loss

The disability qualifications vary by company. This policy add-on can be very important, to make sure your policy doesn't lapse and your family is covered financially.

If, for example, you lose a leg and are unable to work for several months and accumulate hefty hospital bills, your normal living expenses and obligations (such as a mortgage) would still be there. You wouldn't lose coverage because of missed payments.

Terminal illness and critical illness riders

A terminal illness (aka accelerated death benefit) rider gives you the option of receiving some of your policy's payout immediately if you're diagnosed with a terminal illness.

The rider often comes at little to no cost, but that's because the terms may be very restricted: The percentage of the death benefit is usually less than 50%. What qualifies as a terminal illness depends on your policy. And the payout may be deducted, with interest, from the face value of your policy.

A critical illness rider is similar. It offers the option of an early payout if you're diagnosed with a chronic illness that requires intensive care for an extended period. For example, if you have a stroke and are unable to do daily tasks without assistance, you could take a portion of the death benefit early to pay for a caretaker.

There's no obligation to take the early payout. So if you're offered this rider at no cost, it's a good thing to have available. But if it does increase your premiums, evaluate the terms carefully.

Return of premium rider

A return of premium rider is specific to term life insurance. You pay more each year for coverage, but if you live past the full term, you get some or all of your money back.

However, it's usually more cost-effective to opt for a standard term life insurance policy and invest the money you saved in the stock market.

For example, imagine you can buy a standard 30-year term life insurance policy for $500 per year, or add on a return of premium rider for another $400 per year.

If you get the return of premium option, you'll get your entire $27,000 back.

But if you skip the rider and keep the amount you saved in a savings account at 5% interest, you'd end up with an additional $904 after 30 years. And if you invest the remaining funds in the stock market and receive a 10% return, you end up with an additional $45,377.

Plus, the money is available to you and your family any time, instead of locked up in the policy.

However, there is always risk associated with the stock market — returns are never guaranteed.

100% Return of Premium
No Return of Premium
Annual life insurance premium$900$500
Annual amount saved/invested$0$400
Total premiums paid (30 years)$27,000$15,000
Policy payout$27,000$0
Invested capital & returns, savings account: (5% ROI)$0$27,904
Invested capital & returns, stock market: (10% ROI)$0$72,377

*The premiums listed are for example only and do not reflect actual policy costs.

Child rider

It's difficult for parents to consider the death of a child. But it's important to understand that it can be very expensive to cover the associated costs, such as a funeral or paying off student loans.

For example, the average cost of a funeral is around $8,000, which many families can't afford. A child rider is generally available for term policies and offers limited coverage (usually less than $50,000) if your child dies. It's available for children under a specified age (generally 20 or 25).

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