Explainer: Life Insurance

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No one wants to think about their mortality. That's why life insurance is often placed on the back burner when developing a personal financial plan. But if you want to continue the financial support of your loved ones, it's essential to know your options. Take the time to talk to an insurance agent. Find out how much life insurance you need and get life insurance quotes to cover it.

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What Is Life Insurance?

Life insurance is a contract between you or an entity (like a business) and an insurance company. The policyholder pays a monthly installment to get an amount of coverage that will cover their final expenses like funeral costs.

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This coverage could also provide a death benefit to dependents that can be used for day-to-day financial support or educational needs.

Different types of life insurance can be incorporated into a policyholder's financial plan.

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Consider also​: What Is the Purpose of Life Insurance?

How Does Life Insurance Work?

Life insurance basics are pretty straight forward. You purchase your choice of life insurance products. Each will have a monthly premium. The premium is based on several demographic and health criteria.

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Depending on the type of life insurance you purchase, your dependents or beneficiaries will receive a death benefit as long as you pay your monthly premium. There are two types of life insurance: term life insurance and permanent life insurance.

Term Life Insurance

One type of insurance is a term life insurance policy. The policy duration can be from ten to thirty years, depending on the policyholder's purchase. The amount of coverage can be anywhere from thousands to millions of dollars.

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If you pass away while the life insurance policy is in effect, your beneficiaries receive a death benefit.

The death benefit only pays while the term life insurance coverage is in place. Once the policy comes to the end of its term, there is no longer any life insurance coverage. The benefit is the premiums always stay the same as when the policy was first purchased. The amount paid out doesn't change from what you purchased. It's a safe but limited life insurance policy.

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Term life insurance is often used to meet short-term financial support of loved ones.

Universal Life Insurance

A universal life insurance policy is permanent life insurance. Unlike term life insurance, universal life policies last your entire life or at least as long as you pay the premium. That means your policy's death benefit can be paid to your loved ones at any point when you die.

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Universal life insurance has cash value. The policy holder can borrow against the accumulated funds in the account at any time. But borrowing diminishes the death benefit.

Unlike term life, the monthly premium in universal life insurance varies. As a result, the amount of coverage varies as well.

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There are three types of universal life insurance: indexed universal life insurance, variable universal life insurance and guaranteed universal life insurance.

Indexed universal life insurance policies are based on the stock market and have a maximum and minimum interest rate. They have a cash value.

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Variable universal life insurance's amount of coverage has a cash value invested in mutual funds by the insurance company. It's a hybrid of universal and variable life insurance policies (a straight variable life insurance policy is different). The cash value has the potential to increase or decrease.

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Guaranteed universal life insurance doesn't have the market risk the first two have. It is stable both in the monthly premium and in the death benefit.

Consider also​: Is Life Insurance a Must?

Whole Life Insurance

Whole life insurance is permanent life insurance and also lasts your entire life. Unlike term life insurance, a whole life insurance policy is like Universal because both have cash value. But whole life insurance's cash value is an investment with a tax-deferred savings account. Because of this, it is one of the most popular life insurance products.

Many families with disposable income and long-term dependents opt for the whole life insurance policy. But it is five to ten times more in premium cost than term life insurance.

Variable Life Insurance

This is also a permanent life insurance policy. Variable life insurance should not be confused with variable universal life insurance. A variable life insurance policy is more like investing. The insurance policy's cash value goes into various mutual fund-like sub-accounts. You can receive good returns, but you can also lose money.

This means that the policy's death benefit and cash value will fluctuate. Therefore, if you have impending financial obligations and need a fixed amount of coverage, the variable life insurance policy may not be for you.

How to Purchase Life Insurance

Determine if you need life insurance. If you are single and are only concerned about funeral expenses, a term life insurance policy or your company's group life insurance may be all you need. But if you have a family with dependents, you may want to investigate life insurance.

Talk to a life insurance agent about which types of life insurance you should consider. Ensure that the life insurance company you are considering has a good rating. You should also check that the life insurance agent and company are licensed in your state.

You will need to determine the amount of coverage you want. This is necessary before you go through underwriting. The amount of coverage is one of the basic requirements for life insurance quotes.

When a life insurance company is underwriting prospective policyholders, sometimes a medical exam is required. They will also ask if you are a smoker. If you smoked but are now a non-smoker, they may ask what period of time has elapsed since your last cigarette.

Paying your down payment binds coverage. Premiums must be paid monthly to secure coverage.

Purchase a Life Insurance Rider

There are several life insurance riders you can choose for your life insurance policy:

  • Accidental death benefit rider​: also called double indemnity, it increases your beneficiaries' death benefit if you die due to a covered accident.
  • Children's term rider​: allows the parent to add their children to the policy.
  • Accelerated death benefit​ ​rider​: lets you access death benefits before you die if you have a terminal illness or disease.
  • Waiver of premium rider​: waives your premium if you become disabled due to injury or illness.

Discuss these insurance riders with your life insurance agent before applying to a life insurance company for coverage.

Paying for Life Insurance

Many life insurance companies will take a credit card for the down payment. But most will not allow you to make a recurring charge on a credit card. If they do, there will be a transaction fee assessed.

Most life insurance companies prefer a bank transfer, check or cashier's check for monthly installments.

Consider also​: Life Insurance Basics

How to Collect Life Insurance

For the beneficiaries to collect life insurance benefits, they must contact the life insurance company and fill out a claim form. The beneficiaries will also need to provide a certified death certificate.

If more than one loved one was named, each beneficiary must submit a claim form and certified death certificate. In addition, in case the primary beneficiary passed before the policyholder passed, the alternate beneficiary will need to supply certified death certificates for both the deceased policyholder and the deceased beneficiary.

The payout can be one lump sum or installments. By taking a lump sum, you can collect it tax-free. If you collect it in installments, you must claim any interest it has accrued.

Beneficiaries can use life insurance benefits for the policyholder's burial costs or whatever else they want.

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