What Is Life Insurance and How Does It Work?
Life insurance has evolved into a versatile and potent financial tool from its original purpose of aiding in funeral expenses and providing for widows and orphans. According to insurance research group LIMRA around half of Americans have some kind of life insurance.
There are two types of life insurance policies: individual and group. Instead of the group life insurance frequently provided through the workplace, we’ll be looking at individual coverage.
What is life insurance?
You and an insurance provider enter into a contract for life insurance. The insurance provider receives premium payments in return for providing your beneficiaries with a death benefit once you pass away. Both natural and unavoidable deaths are normally covered by life insurance. If you are diagnosed with a chronic, serious, or terminal illness that is covered by the policy, some policies also offer “living benefits,” which means they will pay you a portion of the death benefit while you are still alive.
Term life insurance and permanent life insurance are the two main types of life insurance. While permanent life insurance might protect you till the end of your life, term life insurance covers you for a set period of time.
Permanent life insurance is typically more expensive to buy than term life insurance. However, if you have been paying your premiums, permanent life insurance policies, such as whole life insurance, accrue cash value over time and remain in force.
What does life insurance cover?
The primary goal of life insurance is to leave your beneficiaries with money in the event of your passing. However, how you pass away may affect whether the insurance company pays you the death benefit. The following are some examples of what your life insurance may cover:
Normative demises. Typical natural deaths include those brought on by a heart attack, a sickness, or old age.
wrongful demise. Car accidents, drownings, and poisonings are examples of accidents.
Suicide. Suicide is normally covered by most life insurance policies, but only if it happens after the waiting period, which is typically the first two years of the policy.
Homicide. Homicides are frequently covered by life insurance, however the amount may vary depending on the circumstances. The beneficiary, for instance, won’t get the death benefit if they kill the insured person.
illnesses or wounds. For illnesses or accidents that occur while you are still living, some policies provide coverage. For instance, a critical or chronic illness rider covers diseases like cancer as well as ailments that obstruct your everyday activities permanently. If you are told you have a terminal disease, an accelerated death benefit rider lets you obtain your death benefit.
terrorism or war. Some life insurance policies may not cover deaths brought on by terrorism or war.
What does life insurance not cover?
criminal behavior. In general, your beneficiaries won’t get the death benefit if you pass away while committing a crime. This also applies to binge drinking and drug use. For instance, the policy will normally not pay for your death if you pass away while driving while intoxicated, which is against the law.
risky pastimes. Some insurance policies won’t pay out if you pass away while engaging in a risky hobby, such as skydiving.
Misrepresentation. Your policy could be cancelled by the insurer if you lie on your life insurance application. When applying for coverage, be as truthful and transparent as you can.
How does life insurance work?
The insured person’s life is protected by life insurance. The person or entity who pays the premiums to an insurance company is known as the policyholder, who may not be the same as the insured. In exchange, the insurer gives the beneficiaries indicated on the insurance a sum of money.
The operation of term life insurance
With term life insurance, you are covered for the 10, 20, or 30 years you specify at the time of purchase. The policy will pay your beneficiaries the amount specified in the policy if you pass away during the covered period. No one is compensated if you do not pass away during that time.
Because it gives significant payouts at a lesser cost than permanent life, term life insurance is popular. It also offers protection for a predetermined period of time.
The average term life insurance policies come in a few different forms. Longer and possibly more flexible coverage is possible with convertible policies because you can convert them to permanent life policies for a greater cost. The death benefit of decreasing term life insurance plans, such as mortgage protection insurance, decreases over time and is frequently timed to the gradual repayment of significant debts.
How permanent life insurance works
As long as you keep up with your premium payments, permanent life insurance policies normally cover you until your death. The most popular form of permanent insurance is whole life, although there are other varieties as well, including as universal life, indexed universal life, and variable life.
As they get older, permanent life insurance policies accrue cash value. The cash value, which has the potential to earn interest, is increased in part with each premium payment.
While the cash value of universal insurance policies might vary, it grows at a fixed rate for whole life insurance policies.
While you are still living, you can use the cash value of your life insurance. You can withdraw money from it, borrow money from it, or just use the interest payments to pay the premium in the future. You can even cancel the insurance and receive the cash surrender value if you no longer require coverage.
Before using any of these options, consult a fee-based life insurance professional to discuss any potential complex tax implications.
Complete life insurance
Whole life insurance sound like excellent products with their guaranteed payouts, possible cash value, and fixed premiums, but all of stuff comes at a price: money. Compared to term life insurance premiums, whole life premiums are significantly higher.
You can tell the difference if you compare average life insurance premiums. For instance, a 30-year-old woman in good health will pay about $4,015 a year on average for a $500,000 whole life insurance policy. According to Quotacy, a brokerage company, that same level of coverage would run you an average of $188 each year with a 20-year term life policy.
Think twice before considering entire life insurance as an investment. It is merely a type of life insurance that accrues monetary value over time, and other forms of investing are probably going to yield higher returns.