Did you know that only 54% of Americans are covered by some sort of life insurance?
You are surely not the only one who thinks life insurance is complex. However, finding a policy that meets your needs is not difficult at all. If you are getting started, you don’t need to know a lot.
This life insurance 101 article will cover the basics of life insurance, its types, and its benefits.
What Is Life Insurance and How Does It Work?
If you’re wondering, “How does life insurance work?” read along!
Life insurance definition is simple: It is a way of protecting your family financially.
Life insurance is a contract between the policyholder and an insurance company. If your loved ones depend on you for everyday living expenses, you shouldn’t think twice before purchasing a policy that meets your needs.
The process is pretty straightforward: you pay premiums to your insurance company, and, in return, it pays your beneficiaries the tax-free sum of money you agreed upon. One or more people can be your beneficiaries. It doesn’t matter whether they are your family or friends. Moreover, it can be an organization too.
When you pass away, your beneficiary will submit your death certificate. The insurance provider will verify the documents and, if everything is in order, pay the death benefit.
There are three payment options available:
- Lump-sum payout
- Monthly payout
- Annual payout
Life Insurance 101: Glossary of Common Terms
If you are new to the life insurance world, you might not be aware of the meaning of the terms like policyholder, beneficiary, and premium. Our list of terminologies will help you understand the basics of insurance and its various benefits.
Policyholder
The policyholder is the individual that purchases life insurance and pays its annual/monthly premium fee. Simply put, a policyholder is the owner of the policy.
Premium
A premium is a monthly or annual fee paid by the policyholder to the insurance company. The premium fee depends on:
- Age of the policyholder
- The type of policy
- Policy tenure
- Sum assured
- Lifestyle habits of the policyholder
Nominee/Beneficiary
A nominee is an individual who receives the life insurance payout when the policyholder passes away. The nominee/beneficiary is declared at the time of buying the policy. It can be anyone: the policyholder’s family, estate, or any organization.
Death Benefit
It is the amount paid to the beneficiaries when the policyholder passes away.
Cash Value
What is life insurance cash value? Cash value represents the savings element of a life insurance policy. Some policies let you borrow against the policy’s cash value.
Exclusions
A life insurance policy doesn’t cover everything. So, the things that are not covered under the life insurance policy are known as exclusions. For instance, suicide, when committed within the first two years of the policy, is not covered by life insurance. Hence, it’s important to thoroughly go through the exclusions before purchasing a life insurance plan.
Policy Tenure
The period for which a life insurance policy provides coverage is called policy tenure or policy duration. The policy tenure of life insurance varies from company to company and policy to policy. The policy period can range anywhere between a year to 50 years, depending on various factors.
Maturity Benefit
Maturity benefit is paid to the dependents when a policyholder survives a policy tenure. Term plans don’t offer maturity benefits. However, other life insurance policies do.
Grace Period
Grace period is the extension given by an insurance company to the policyholder after the due date of the premium payment. After paying the outstanding amount, the policy is resumed. For a monthly premium, the grace period is 15 days. If you have selected the annual premium mode, you will be offered a grace period of 30 days.
Free Look Period
Most insurance policies come with a free look period, which is the duration within which you can decide to terminate the policy or keep it. The free look period varies from company to company. If you choose to terminate the policy, the premium will be refunded to you after deducting the duty charges and cost of medical examination.
Claim Process
Simply put, the claim process means lodging a claim to receive the death benefit. For example, if the insured customer passes away during the policy tenure, the beneficiary will lodge a claim to receive the set amount.
Rider
The additional add-ons to your existing life insurance policy are called riders. The number and type of life insurance riders vary from insurer to insurer. The policyholder pays extra for riders at the time of buying the policy. The terms and conditions differ, but the most common life insurance riders include:
- Accidental death
- Waiver of premium
- Hospital cash
- Accelerated death benefit
- Return of premium
- Long-term care
- Critical illness
Why Do You Need Life Insurance?
Usually, most people in their 20s don’t even think about purchasing a life insurance plan. However, that’s the perfect age to invest in insurance because you will easily qualify for lower premiums.
There are many uses of life insurance, but most people think that they don’t need it, even though they really do. Who wouldn’t like protecting their loved ones after all?
So, why is life insurance important?
In our life insurance 101 article, we present the list of seven compelling reasons why you need to buy a life insurance policy:
It Provides Peace of Mind
Do you sometimes think about what will happen to your family when you are gone? Will they have to leave their home? Will my children go to college? If you are the only provider, this thought might have crossed your mind several times.
Therefore, if you want to help your family when you are gone, your best bet is to purchase life insurance. Whether it's about paying for your child’s education or ensuring that your spouse is financially secured, buying a life insurance policy will provide peace of mind when you are alive and financial support when you pass away.
It Protects Your Family’s Financial Future
Out of the most common life insurance benefits, this is the most obvious one. Buying life insurance is a financial and emotional decision.
Dying suddenly in an accident or of natural causes can happen at any time. We don’t know what the future holds, but all we can do is be prepared for it. The insurance company will provide tax-free money to your beneficiaries when you pass away.
Purchasing a life insurance policy is a way of ensuring that your children’s education won’t get compromised and your family won’t have to downsize your home.
It Helps You Deal With Debt
Life insurance purchase guarantees that your death doesn’t mean debt. Moreover, it can help your dependents deal with financial issues after your death. By buying the right insurance policy, you would be taking care of personal loans, auto loans, and home loans.
It Buys Time and Options
Right after an individual dies, the dependents are forced to make tough decisions fast. Dealing with your death and solving financial matters can take a toll on your family’s health. Life insurance helps pay off debts, take care of your children’s education costs, and meet housing payments and other living expenses.
It Supplements Your Retirement Goals
Life insurance does more than just securing your family’s future. You need to purchase a life insurance policy if you want your retirement savings to last until you do. Similar to a pension plan, putting money into a life insurance product can get you a regular stream of income every month — for as long as you want.
It Takes Care of Your Business
Aside from your family or friends, your beneficiary can also be your business you wish to protect from financial loss and liabilities if you die.
Life insurance helps maintain the company you have worked so hard to build. Apart from benefiting your business, you can also donate your money to a nonprofit organization.
It Covers Some of Your Medical Bills
Wondering what happens if you get diagnosed with a terminal disease? If you add an accelerated death benefit rider to your existing policy, you can use a part of your death benefit to pay for your medical bills.
Types of Life Insurance
Before making the final purchase, you must understand the structure of life insurance.
There are a lot of life insurance options, which might seem overwhelming at first, but they are not confusing at all. The three most common types of life insurance include term life, whole life, and universal life.
Understanding life insurance is nowhere near complicated. All you have to do is thoroughly read about the different policies and select the one best suited to your needs.
Term Life Insurance
Term life insurance is the simplest variant of life insurance that lasts anywhere between 1 to 30 years. The policy period varies from company to company. If you die before the policy term ends, the death benefit will be paid to your beneficiaries. If you don’t die during the set term, your policy expires, and you or your nominees won’t receive anything.
The monthly/annual premium amounts depend on the policyholder’s health, life expectancy, age, risky activities, coverage amount, term length, and riders. The premiums are fixed and paid throughout the length of the term. Some insurance companies might also ask for a medical exam. Generally, term life insurance is less costly than permanent life insurance.
Term life policy is further divided into two parts:
Level term: The monthly/annual premium fee stays the same for the entire policy period.
Decreasing term: It is the renewable term life insurance policy with the decrease of the benefit on a monthly or yearly basis. The coverage drops over time, which makes it a more affordable option than the level term.
Whole Life Insurance
Whole life insurance is a type of permanent life insurance that offers lifetime coverage. It is more comprehensive than term life insurance. Whole life provides a guaranteed death benefit to your beneficiaries when you are gone.
The policy also includes a cash value component that accrues value over time. Moreover, the cash value growth is tax-deferred.
The premium fee for whole life insurance is fixed and never increases. Unlike term life insurance, it doesn’t expire after a specific number of years. Also, the coverage can’t be canceled due to health problems or illnesses.
If you are dealing with financial issues, the coverage allows you to borrow money against the policy. Moreover, with whole life insurance, you can pass the money onto the next generation, make donations, and secure your family’s financial future. However, since permanent life insurance policies offer lifelong coverage, they are more expensive than term life insurance.
The types of whole life insurance include:
- Level premium whole life insurance
- Participating whole life insurance
- Single premium whole life insurance
- Interest sensitive whole life insurance
- Limited payment whole life insurance
- Non-participating whole life insurance
- Whole life economic insurance
- Indeterminate premium whole life insurance
Universal Life Insurance
Universal life insurance is a version of permanent life insurance that offers a flexible premium option. With universal life insurance, the insured person is covered for the whole life as long as the premiums are paid.
It consists of two components: a cost of insurance (COI) and a cash value. COI is the minimum premium fee you have to pay in order to keep the policy active. Each month, a certain amount of the paid premium goes into a tax-deferred account, known as the cash value of the policy. You can use the cash value to pay your premiums, depending on how much value it has built. People who want to build tax-deferred savings should purchase universal life insurance.
Universal life insurance lets you withdraw money or borrow against the policy’s cash value. Furthermore, it provides flexibility with premiums and allows you to adjust death benefits. The downside of the insurance is the interest rate, which affects the potential growth when the policy doesn’t perform well.
Whole life insurance is more pricey than universal life insurance because the universal life insurance premium payments are typically lower during periods of high-interest rates.
The four types of universal life insurance are:
- Traditional or non-guaranteed universal life insurance
- No lapse guaranteed universal life insurance
- Indexed life insurance
- Variable universal life insurance
Life Insurance Coverage
To determine how much coverage you require, you need to know what is covered by life insurance and what’s not.
What Does Life Insurance Cover?
Standard life insurance policies cover almost all types of death. Beneficiaries get a death benefit in case of:
If you die from a car accident, accidental overdosing, or drowning, the insurance company will be liable to pay the death benefit to your beneficiaries.
If the policyholder dies because of cancer, kidney failure, heart attack, infection, or some other natural causes, the death benefit will be paid to the named beneficiaries.
Life insurance doesn’t cover suicide when the death occurs within the first two years of the coverage — commonly known as the contestability or exclusion period. If the suicidal death happens after these two years, the beneficiaries will get the death benefit.
Your nominees will receive the death benefit if you get murdered — unless your beneficiary is involved in murdering you.
If you have an existing policy, the insurance company will pay out the death benefit to the nominee if you die because of an ongoing pandemic.
Beneficiaries can spend the death benefit however they want. They often use the financial support for:
From groceries to utilities, beneficiaries can use the death benefit to pay for everyday expenses.
- Paying the outstanding debt
They can use the death benefit to pay auto loans, credit card debt, and home loans.
- Paying end of life expenses
The nominees can use the death benefit to cover the cost of burial and funeral expenses.
Life insurance will ensure the continuity of your child’s education.
- Child care and dependent expenses
If you have a family, consider purchasing life insurance. Whether you are bringing up a special needs child or your wife is fighting cancer, the death benefit can be used to cover child care and dependent expenses if you pass away.
When the policyholder passes away, life insurance can help your spouse to keep paying for the mortgage.
What Does Life Insurance Not Cover?
Life insurance provides the death benefit for most causes of death. However, there are situations in which your beneficiaries may not receive the death benefit.
By lying on the application, your insurance company can cancel your policy or decrease the death benefit.
If you stop paying the premium fee, your policy will expire. As soon as it expires, your beneficiaries will lose out on the death benefit.
If you die while committing a crime, the insurance company will not pay out the death benefit.
Similar to other insurance policies, life insurance also doesn’t cover everything. For example, if you die of a cause mentioned as an exclusion on your policy, your beneficiaries will not receive the death benefit.
- Risky activities (depends on the insurance company)
Some insurance policies do not cover death caused by participating in risky activities. The most common of them include:
- Scuba diving
- Hand gliding
- Auto racing
- Your beneficiary murdering you
The insurance company won’t pay out the death benefit if your beneficiary tries to murder you or plays a role in the murder.
How to Get Life Insurance
Getting a life insurance policy is no rocket science. After learning about life insurance and selecting a policy, you have to:
- Choose an insurance company
- Fill out an application form
- Undergo a physical exam (not all insurance companies ask for one)
- Pay the premium for the chosen policy
Final Thoughts
We hope that this life insurance 101 guide has answered all your queries.
Life is uncertain. You never know what the future holds. If you want to financially secure your family, your bet is to purchase a life insurance policy. Compare the three policies and choose the one which is best suited for your needs.
