When you’re buying life insurance, understanding key terms is crucial to making the best choice.
Here are some terms that will come up as you’re purchasing and, then later, managing your policy.
Your beneficiary is the person who will receive your policy’s death benefit. While you probably designated a beneficiary, or beneficiaries, when you bought your policy, you may need to revisit the selection over the years.
For example, if you divorce, or if one of your beneficiaries dies, you may need to designate a new one. You can also specify percentages of the payout for each primary beneficiary (for example, 70% for one and 30% for another) or choose contingent beneficiaries in order to prioritize who receives the life insurance payout.
» MORE: Life insurance definition
Permanent life insurance policies — whether universal, variable or whole life insurance — place portions of your premium payments in a separate account. This account grows as part of or in addition to your death benefit, depending on your policy, and is called your cash value.
Once you’ve built up enough cash value, you can make withdrawals or take loans from it in order to fund expenses or pay premiums. Keep in mind that cash value typically takes several years to start to build up.
Some people buy term life insurance because it’s the best option at the time, then later find that they prefer a permanent life insurance policy. For this situation, many term life insurance policies have a “term conversion rider,” which allows you to convert term to whole life insurance.
You won’t have to undergo a new medical exam to qualify, but you must generally convert within a certain time period after buying the term life policy. So if you know you want to switch, don’t delay.
You may have heard of dividends as they relate to stocks, and life insurance dividends are no different. They’re a piece of your life insurance company’s profits that you may be issued if you have what’s called a “participating policy.” You can receive the dividend payment in cash, add it to your cash value, use it toward premiums or use it to buy additional insurance.
A lapse occurs if your life insurance policy is discontinued for nonpayment of premiums. Sometimes a lapse is intentional — maybe you decide you no longer need a term policy, or can’t afford your premiums. Or you might simply forget to pay your bill, in which case your insurer probably offers a grace period — around 30 days — to get caught up on payments. A permanent life policy might also lapse if you are using your cash value for premium payments and the account runs out of money.
Your life insurance policy matures when the amount you’ve paid in premiums matches your death benefit. Many policies mature when you reach a certain age, for example, 95 or 100. When your policy matures, your insurer pays you the death benefit and the policy ends.
When you switch to a reduced paid-up policy, you use your surrender value (see below) to pay in one lump sum for a new life insurance policy with a lower death benefit. You’ll continue to have coverage — just less of it — and you’ll no longer have premium bills. You might do this if you decide you’re happy with a lower coverage level or if you’re having a hard time affording your premiums.
If you decide you no longer want your permanent life insurance policy, you might expect that you can cash out — that is, cancel your policy and take the accumulated cash value. What you’ll get instead, however, is the surrender value of your policy. That’s the cash value minus any surrender fees, which will vary by insurance company. For the first few years, surrender fees will probably make it impossible to drop your policy and receive any cash value.
NerdWallet’s life insurance quotes tool can help you zero in on the best rates.
Image via iStock.