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What is Life Insurance and How Does it Work?
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What is life insurance?
Life insurance is a contract between you and an insurance company. In exchange for premium payments, the insurance company pays a death benefit to your beneficiaries when you die. Life insurance typically covers natural and accidental deaths. Some policies also offer “living benefits,” which means they pay out a portion of the death benefit while you’re still alive, if you’re diagnosed with a covered chronic, critical or terminal illness.
There are basically two types of life insurance: term life and permanent life. Term life covers you for a fixed amount of time while permanent life insurance can cover you until the end of your life.
Generally, term life insurance is cheaper to purchase than permanent life. However, permanent life policies, like whole life insurance, build cash value over time and don’t expire, if you’ve paid your premiums.
There are basically two types of life insurance: term life and permanent life. Term life covers you for a fixed amount of time while permanent life insurance can cover you until the end of your life.
Generally, term life insurance is cheaper to purchase than permanent life. However, permanent life policies, like whole life insurance, build cash value over time and don’t expire, if you’ve paid your premiums.
What does life insurance cover?
The main purpose of life insurance is to provide money for your beneficiaries when you die. But how you die can determine whether the insurer pays out the death benefit. Depending on the type of policy you have, life insurance can cover:
Natural deaths: Dying from a heart attack, disease or old age are examples of natural deaths.
Accidental deaths: Accidents may include car crashes, drowning or poisoning.
Suicide: Most life insurance policies cover suicide, but only if it occurs after the policy's waiting period - typically the first two years of the policy.
Homicide: Life insurance often covers homicides, but the circumstances of the death can affect the payout. For example, if a beneficiary murders the insured person, the killer won't receive the death benefit.
Illness or injuries: Some policies offer coverage for illness or injuries while you’re still alive. For example, a critical or chronic illness rider covers conditions like cancer, as well as conditions that permanently inhibit your daily activities. An accelerated death benefit rider provides access to your death benefit if you’re diagnosed with a terminal illness.
War or terrorism: Some life insurance policies may exclude death as a result of war or terrorism.
What does life insurance not cover?
How does life insurance work?
Life insurance covers the life of the insured person. The policyholder, who can be a different person or entity from the insured, pays premiums to an insurance company. In return, the insurer pays out a sum of money to the beneficiaries listed on the policy.
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How term life insurance works
Term life insurance covers you for a period of time chosen at purchase, such as 10, 20 or 30 years. If you die during the covered period, the policy will pay your beneficiaries the amount stated in the policy. If you don’t die during that time, no one gets paid.
Term life is popular because it offers large payouts at a lower cost than permanent life. It also provides coverage for a set number of years.
There are some variations of typical term life insurance policies. Convertible policies allow you to convert them to permanent life policies at a higher premium, allowing for longer and potentially more flexible coverage. Decreasing term life policies, such as mortgage protection insurance, have a death benefit that declines over time, often lined up with large debts that are slowly paid off.
Term life is popular because it offers large payouts at a lower cost than permanent life. It also provides coverage for a set number of years.
There are some variations of typical term life insurance policies. Convertible policies allow you to convert them to permanent life policies at a higher premium, allowing for longer and potentially more flexible coverage. Decreasing term life policies, such as mortgage protection insurance, have a death benefit that declines over time, often lined up with large debts that are slowly paid off.
How permanent life insurance works
Permanent life insurance policies typically cover you until death, assuming you pay your premiums. Whole life is the most well-known type of permanent insurance, but there are other flavors, including universal life, indexed universal life and variable life.
Permanent life insurance policies build cash value as they age. A portion of the premium payments is added to the cash value, which can earn interest.
The cash value of whole life insurance policies grows at a fixed rate, while the cash value within universal policies can fluctuate.
You can use the cash value of your life insurance while you’re still alive. You can borrow from it, make withdrawals or just use the interest payments to cover the premium later in life. If you no longer need coverage, you can even give up the policy and get the cash surrender value in return.
All of these options can create complex tax issues, so be sure you talk to a fee-based life insurance advisor before tapping your cash value.
Permanent life insurance policies build cash value as they age. A portion of the premium payments is added to the cash value, which can earn interest.
The cash value of whole life insurance policies grows at a fixed rate, while the cash value within universal policies can fluctuate.
You can use the cash value of your life insurance while you’re still alive. You can borrow from it, make withdrawals or just use the interest payments to cover the premium later in life. If you no longer need coverage, you can even give up the policy and get the cash surrender value in return.
All of these options can create complex tax issues, so be sure you talk to a fee-based life insurance advisor before tapping your cash value.
Check out these insurance companies that offer term life insurance
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