Life Insurance Basics

Life Insurance Basics
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If you'd like a way to provide financial support to your family after you pass away, then a life insurance policy can offer a large payment upon your death and often even has a cash value component that can provide benefits while you're alive. You can find a few types of life insurance options that vary based on the number of years of the policy, policy premium costs, the amount of coverage and special features like being able to make policy changes or take money out of the policy early. Take a look at the life insurance basics you should know to understand the functions of this financial product, the variations available by type of policy, the pros and cons and the important steps for determining your life insurance needs and getting a life insurance policy.

Read More​: Is Life Insurance a Must?

How Life Insurance Works

Often available through group plans offered by employers and organizations as well as directly through insurance companies, life insurance coverage can last for either a specific period of time or your entire life. Having the policy will often result in a lump-sum payout or interval-based payments upon your death while your policy stays in effect, meaning you renew as needed and make your premium payments on schedule. Some types of life insurance go further to build a cash value that you might receive if you cancel the plan early or need the money in an emergency, while others pay you nothing if you cancel or the term expires while you're alive.

When you sign up for a life insurance policy, you choose a type of life insurance, term (if applicable) and death benefit amount. The insurer calculates your premiums based on the level of risk you present along with other factors like the death benefit amount and policy type. Insurers often use medical and lifestyle questionnaires as well as physical exams to better assess whether applicants are risky, how much they should pay and whether they should be approved for a policy at all. Once approved, policyholders must keep up with their payments to avoid coverage lapses that could void the policy's benefits.

Life insurance policies often have several rider options you might consider to get additional benefits. For example, you can sometimes boost coverage by adding a different type of life insurance coverage, putting your spouse and kids on the coverage or adding an accidental death or disability provision. People who struggle to qualify due to poor health may purchase a rider that guarantees they get insured, while those who worry about a future illness might seek an accelerated death benefit rider for early cash benefits.

Understanding Term Life Insurance

Designed to offer just temporary financial protection for a period often ranging from ​10 to 40 years​, term life insurance usually comes with lower premiums and doesn't build cash value like permanent life insurance policies do. Most of these policies have a death benefit amount that doesn't change, while some will have the amount decrease incrementally. If you pass away during the term, then your beneficiary would receive the death benefit; otherwise, the money would be lost. You can usually renew the policy when the term ends to continue to make premium payments and have the death benefit available, or some insurers will let you convert the policy to a permanent one.

These types of life insurance policies can particularly appeal to younger people who prefer paying lower premiums and mainly want a temporary form of financial protection for final expenses and outstanding debts. Term life policies can also offer higher death benefits than you'd find with permanent policies, even though qualification can be harder for people with health issues. On the other hand, this type might not seem appealing to someone who prefers a policy that accumulates a cash value and doesn't require going through a renewal process with typically higher premiums each time.

Exploring Whole Life Insurance

In contrast to a term life insurance policy with an end date, a whole life insurance policy offers lifelong coverage for those who continue to pay premiums when due, so this is known as one of the types of permanent life insurance policies. Unlike with term life insurance, where the premiums rise with renewal, you'll usually always pay the same amount each month, although you can expect to pay higher premiums than with a term policy. For a traditional policy, you can expect to have a fixed death benefit, while variable whole life insurance policies come with values that may go up or down depending on the performance of the investments in the account.

A whole life insurance policy will build some cash value as you pay the premiums. So, you may choose to withdraw some money from the policy from the cash value account during your lifetime.

You might find a traditional whole life insurance policy appealing since you have the security of having a lifelong policy and the benefit of the cash value component you might take advantage of while living. The fixed premiums also make it easier to fit this insurance into your budget. However, you'll want to be aware that these policies usually offer lower death benefit amounts than term ones, plus come with the downside of higher premiums to pay.

Looking at Universal Life Insurance

Similar to whole life insurance in that it's a permanent type of financial protection that builds a cash value, universal life insurance gives you more control over the policy so that you can make changes that fit your needs. For example, you can take advantage of the cash value component to lower your premiums during a time of financial hardship. As long as you're still in good health, you can often change the death value of the policy to get more or less coverage and pay adjusted premiums as a result.

Another feature that sets this option apart from the other types of life insurance is that the cash value account gains interest based on the money market rate at the time. There's also a variable-universal life option where you can experience changes to the death benefit and cash value amounts based on investment performance.

Overall, you might opt for this type of life insurance for the security and flexibility it provides. The ability to change the death benefit and premiums can come in handy as your financial situation changes in life, while the cash value of the policy might come in handy should you need to withdraw funds early or surrender the policy. However, you'll want to keep in mind the interest earned on the cash value component can fall if the market rates do, and variable policies come with more risks.

Weighing Life Insurance Pros and Cons

All options provide the benefit of financial support for beneficiaries who need to pay for expenses you leave behind or who need the money for daily living expenses that your income otherwise would have paid. Having the policy can reduce the financial stress on your survivors during a difficult time and can provide funds for other wishes you might have like charitable donations. If the policy builds a cash value, you additionally can benefit from access to the money while living if you get in a tough financial situation. Life insurance payouts are usually tax-free, and simple peace of mind also serves as a key benefit.

Pros and cons will also depend on the type of life insurance policy. While term life policies can offer higher benefit amounts and lower payments, their downsides include no cash value and the need to renew at the end of the term. Whole life insurance and universal life insurance both offer the benefits of the cash value component although with the downside of higher premiums and lower death benefit amounts. For these permanent policies, the cash value and final death benefit will vary depending on how well the investments the insurer has chosen perform on the market during the policy's life.

Obtaining a Life Insurance Policy

If you've decided life insurance will offer the financial protection you and your family need, you'll want to both select the right type and determine an amount. You'll want to weigh the pros and cons of the options discussed to determine which you prefer and then think about the amount of money your loved ones would need should you pass away. When deciding how much life insurance you need, it helps to use an online calculator that lets you enter your financial data. However, you can also estimate outstanding debts, funeral expenses and any necessary income replacement and then look at the money you have saved as well as any other income sources that will still exist.

Unless you just get life insurance through a job or association you're affiliated with, you'll want to research the various insurers available and make sure they're financially solid, offer good service and have a good reputation for handling claims. Once you find a life insurance company, you can look for a local insurance agent who can help you pick your policy and its features, or you can handle the entire process online through the insurer's website if you don't need the guidance. In either case, getting multiple life insurance quotes is recommended as it can help you find the best rates and more easily compare options.

You can expect to fill out a life insurance application that will ask you about yourself and your finances as well as include plenty of questions about your health status and lifestyle. For example, you'll be asked whether you have health conditions, if you smoke or drink, whether you participate in risky activities and what your family's history looks like. If your insurer requires a medical exam, you'll have to pass that to get your coverage and then make your premium payments on schedule, usually monthly or annually.

Considering Life Insurance Alternatives

If you decide against getting a life insurance policy, you have alternatives to consider such as the following:

  • Cash savings​: Rather than pay life insurance premiums, you could stash away money regularly into an account such as a 401(k), individual retirement account or investment portfolio so that you can see the money grow with interest and dividends. You'll need to have a good idea of how much money your beneficiaries would need for expenses or income replacement and then come up with a savings strategy to meet that goal.
  • Annuities​: An annuities contract that offers ongoing payments or a lump sum that can work as a way to replace income once you pass away since your beneficiary can continue to benefit. These contracts exist in indexed, fixed and variable versions, and you'll need to consider the various fees involved and risks with each type.
  • Specific insurance products​: If you're concerned about paying off a specific type of debt, then you can find special kinds of insurance that can cover common debts like your mortgage or credit cards if you pass away. You can also find accidental death and dismemberment insurance that can offer your family financial protection should you pass away or face a significant disability from an accident. Prepaid funeral insurance can help with handling funeral expenses.

Read More​: Examples of Annuities