Life insurance is a contract between an insurance company and a policyholder. It guarantees the insurance provider pays a sum of money to one or more beneficiaries if the insured person passes away during the policy term, provided the policyholder continues to pay their premiums.
The beneficiaries can use the money for any purpose they choose. Often it will cover the funeral and final expenses and then be used for everyday expenses like paying bills or a mortgage and putting children through school.
A life insurance policy can provide peace of mind that your family can maintain their quality of life if you pass away. Let’s learn more about how life insurance works and the options available to applicants.
How Life Insurance Works
Life insurance works by providing a death benefit in exchange for paying premiums. The policy has two main components: a death benefit and a premium. A permanent life insurance policy will also have a cash value component.
Death benefit – The death benefit is the amount of money the insurance company guarantees to the beneficiaries identified in the policy when the insured person passes away. The insured person will choose the death benefit amount based on the anticipated future financial needs of the beneficiaries.
Premium – The premium is the amount of money the policyholder pays for insurance. It is based on factors influencing life expectancies, such as age, sex, and medical history. The insurance company must pay the specified death benefit if the premiums have been paid.
Cash value – The cash value is a savings account that the policyholder can access during the insured person’s life but remains with the insurance company when the insured person passes away. The cash accumulates on a tax-deferred basis, meaning that no taxes will need to be paid unless some or all the cash value is withdrawn.
Types of Life Insurance
There are two main types of life insurance – term life insurance and permanent life insurance – each with several subtypes.
Term life insurance – Term life insurance is the most affordable and most popular type of life insurance. It provides coverage for a certain amount of time, typically 10, 15, 20, 25, or 30 years. If you pass away during your policy term, your beneficiaries will receive your death benefit tax-free. Once the policy expires, you can renew it at a higher rate.
Permanent life insurance – Permanent life insurance is more expensive than term life insurance because it provides lifelong coverage and can build a cash value. If you end the policy, you can get the cash value minus any surrender charge.
Benefits of Life Insurance
Life insurance is a reliable way to provide financially for your beneficiaries if you pass away. There are a few other benefits to purchasing life insurance:
Tax-free payouts – Life insurance death benefits are paid as a lump sum and are not subject to federal income tax because they are not considered income for beneficiaries.
Coverage for final expenses – Funeral and other final costs can be significant. These can be avoided with a life insurance policy that can accommodate those extra expenses.
Additional retirement savings – The cash value can augment your retirement savings if you purchase a permanent life insurance policy.
Financial peace of mind – Your beneficiaries will not have to worry about living expenses like mortgages and college tuition if the death benefit is large enough to cover them until they are grown up. Most policy calculators recommend seven to 10 years of your gross income for your death benefit.
Factors Affecting Life Insurance Premiums
Life insurance premiums are paid monthly or yearly and will vary significantly based on several different factors. The most significant cost factor will be the type of life insurance you buy since a term life insurance policy is considerably less expensive than a permanent life insurance policy with the same amount of coverage. Here are a few other factors that will affect your life insurance rates:
Age – Younger people have a smaller chance of death within their policy term than older people, so they will not have to pay as much.
Sex – Females have a longer life expectancy than males, so they generally pay less for life insurance premiums.
Medical history – Your health significantly influences your life insurance premiums. While options are available for applicants with medical conditions, they will pay higher premiums for the same coverage as applicants with a clear history.
Lifestyle – Your driving history, criminal record, and dangerous occupations and hobbies can all result in higher life insurance rates.
Life insurance is a significant financial commitment but protects your beneficiaries if you pass away. Ensure you adequately research any life insurance providers to ensure they have a good track record before committing.