How Does Life Insurance Work? Everything You Need to Know
Did you know that consumers, especially the younger generations, almost always overestimate the cost of life insurance?
Almost half of Millennials think that life insurance costs five times more than it actually does!
Are you holding back from purchasing a life insurance policy because you think you can’t afford it? Or is life just so busy that you haven’t gotten the chance to look into it?
Have you ever found yourself wondering how does life insurance work, exactly? If so, come with me and I’ll break down everything you need to know about life insurance.
What is Life Insurance?
You have car insurance and home insurance, but what about insurance for your life and family?
While it may not be your favorite subject to think about, it’s important to consider what would happen to your family if anything ever happened to you. If you have a spouse or children that are dependent on your income, taking out a life insurance policy can ensure that they are taken care of after you’re gone.
In the event of your death, a life insurance policy will give a tax-free lump sum of money to whomever you designate in your policy. Your family and loved ones will be devastated when you pass on, but this way they also don’t have to be struggling financially while they grieve.
How Does Life Insurance Work?
Knowing what a life insurance policy is is a good start. But how do life insurance policies work?
Life insurance is a contract between the person who purchases the policy (the policyholder) and the insurer. The contract itself is known as the policy. The specifics of the contract can vary, but the general concept is that the policyholder makes payments to the insurer, and in return, the insurer will pay the designated beneficiary when the insured person passes away.
The designated beneficiary is the person or people that your policy states will receive the death benefit upon the insured person’s death. The death benefit is the money given by the insurer with the death of the insured person (this is usually the policyholder, but you could buy a life insurance policy for someone else.)
The payments that you make to the insurer are known as premiums, and as soon as you start paying them the insurer promises they’ll pay your beneficiaries the death benefit when you pass away.
What Does a Life Insurance Policy Cover?
Upon the death of the policyholder, all that is usually required of the beneficiaries is to provide a copy of the death certificate, a document detailing the policy, and a filled-out claim form.
Sometimes in addition to the tax-free lump sum received by your beneficiaries, your policy can include expenses like your funeral costs.
Most causes of death are generally covered by life insurance policies. It’s worth noting that if a death occurs within two years of instating the policy, the insurance companies might contest the cause of death. If they find through investigation that pre-existing health conditions were not disclosed at the time the policy was made, they may cancel the policy or change the benefits.
Your insurer could also alter your benefits or cancel your policy if they find any fraud or purposeful misinformation. The death benefit can also be affected if the cause of death is murder or suicide.
What Are the Different Kinds of Life Insurance?
Now we know how life insurance works, let’s learn about the different kinds of policies.
There are two main types of life insurance. Term life insurance provides coverage for a specific number of years, while permanent life insurance provides coverage for your entire life. There are several different kinds of permanent life insurance policies to choose from.
Term Life Insurance
When you purchase a term life insurance policy, you’re purchasing it for a set number of years, usually somewhere between 10 and 30. If and only if you pass away during the decided upon term, the death benefit will be paid to your beneficiaries.
Usually, you can renew your term life insurance policy once the term ends if you so choose.
People might choose a term life insurance policy over a permanent one for a number of reasons. Term life insurance policies have cheaper premiums and are simpler and more flexible.
Permanent Life Insurance
Permanent life insurance policies are more complicated than term life insurance policies, but depending on your circumstances it might be the right type of policy for you. Here are a few of the different types of permanent life insurance policies.
Whole Life Insurance
Whole life insurance has a fixed premium, meaning you pay the same price every year. In this type of policy, some of your premium will go to your death benefit and the rest will go into a cash value account. The cash value account typically grows has a steady interest rate, so it’s like a life insurance savings plan.
Your cash value account can be used in a number of different ways. You can use the cash to pay your premiums, withdraw money from it, or borrow against it. It’s important to note that any money left in the cash value account when you pass will go to the insurer and not your beneficiaries.
Universal Life Insurance
With this type of policy, you have the option to choose the amount of your premium each year. You’re also able to alter the amount of the death benefit.
Some of your premium will go into a cash value account just like in a whole life insurance policy. In a universal life insurance policy, you will have a guaranteed minimum return and a variable interest rate.
Variable Universal Life Insurance
This type of plan gives you more say in how the money in your cash value account is invested. It also allows you to change the amount of your death benefit and your premiums.
This policy also gives you the option of having either a variable death benefit or a fixed death benefit. A variable death benefit means that your beneficiaries will receive the face value of the policy in addition to the cash remaining in the cash value account. If you lose money on your investments, though, it can negatively impact the death benefit your beneficiaries receive.
Which Type of Life Insurance Policy is Right For You?
Now you have all the answers you need when a family member asks you: how does life insurance work? The next step is to determine which kind of life insurance policy makes sense for you and your loved ones.
If you’re thinking about getting a life insurance policy, don’t hesitate to contact us today for life insurance advice.