If you are in the market for a life insurance policy, you might think that a lot of the terms surrounding this popular form of protection cover are self-explanatory. And that may be the case to some extent! Nonetheless, it is crucial to be well-informed on what distinguishes the different types of life insurance out there, and the implications for you and your loved ones.
The central principle behind life insurance is straightforward: it’s a product that pays out a tax- free lump sum to the family of the policyholder in the event of the latter’s death.
Such money could be invaluable for giving surviving relatives financial security during a distressing and difficult time – enabling them to pay for such essentials as mortgage payments, loans, funeral costs and daily living costs.
While any type of life insurance policy that you take out will entail you paying for monthly premiums, exactly how this cover works will depend on whether you purchased whole life insurance or term life insurance. So, what differentiates these two types of cover?
Whole life insurance lives up to its name
As the term ‘whole life insurance’ suggests, this type of cover – also sometimes referred to as ‘life assurance’ – will cover you for what remains of your life, provided that you continue paying for your premiums. This means that the exact time you eventually die doesn’t matter – as long as the policy is still in operation, your loved ones will be paid a lump sum by the insurer.
Unsurprisingly, whole life insurance tends to be a more expensive form of life insurance than the alternatives. However, this does guarantee that your loved ones will receive a pay-out, as long as the terms of the cover are satisfied.
Under the banner of whole life insurance, two types of cover are available: balanced cover and maximum cover. The former type involves both the costs of the premiums and the pay-out amount remaining the same for the duration of the policy.
As for maximum cover, taking out this form of life insurance would mean your insurer paying the money you pay them in premiums each month into an investment fund. The idea behind this is to try to achieve a sufficiently large return to cover the pay-out that your relatives would eventually receive when you die. You might even receive a bonus if the investment performs well – but if it doesn’t, you may be asked to fork out for higher premiums to cover the loss.
Term life insurance is time-limited – but many different options are available
Again, the basic meaning of ‘term life insurance’ might seem obvious; it’s based on a fixed ‘term’, or period of time (such as 20 years). This also helps to make term life insurance more affordable than whole life cover.
Term life insurance is available in three broad types: level term cover, decreasing term cover, and increasing term cover.
Level term cover, as its name implies, involves the pay-out amount staying the same throughout the life insurance policy. So, whether you die during the first year of cover or during the last year of cover, it makes no difference to the amount of money your family will receive.
This is as opposed to increasing term cover, whereby both your premiums and the pay-out amount would go up over time – worth considering, if you’re concerned about inflation over months and years gradually eroding the ‘real-world’ value of the pay-out amount.
Then, there is decreasing term cover – also sometimes referred to as ‘mortgage life insurance’. This type of life insurance policy is designed to assist in paying off large payments, such as a mortgage.
The idea with this type of cover is that as you gradually pay off your mortgage and thereby lower the outstanding balance, the pay-out amount of the life insurance policy will also fall over time.
In the event of you dying before the mortgage has been entirely paid off, your surviving loved ones would then be able to use the pay-out amount to cover the remaining balance.
Take the next steps to benefit from the ideal life cover
As the above makes clear, there are various needs and circumstances that a life insurance policy can be designed around – so you should be very careful to avoid accepting just any policy.