Understanding Life Insurance Coverage: What You Need To Know

Life insurance is a legally binding contract between an individual and an insurance company. The insured person pays premiums to the insurance company during their lifetime, and in exchange, the insurance company pays a sum of money to the insured person's beneficiaries upon their death. The purpose of life insurance is to provide financial security to the insured person's loved ones after their death. The beneficiaries can use the death benefit to cover funeral costs, mortgage payments, education expenses, or any other expenses. Life insurance policies typically cover deaths resulting from natural causes, accidental death, suicide after a certain period, and murder. However, deaths resulting from acts of war or terrorism are usually excluded from coverage. It's important to carefully review the terms and conditions of a life insurance policy to understand what is covered and what is not.

Term life insurance: Coverage for a specific period, typically 10 to 30 years

Life insurance is a legally binding contract between an insurance company and a policy owner, in which the insurer agrees to pay a sum of money to one or more named beneficiaries when the insured person dies. There are two basic types of life insurance: term life insurance and permanent life insurance.

Term life insurance provides coverage for a specific period, typically between 10 and 30 years. It is sometimes referred to as "pure life insurance" because, unlike permanent life insurance, there is no cash value component to the policy. Once the term is over, the policy expires. Term life insurance is ideal for people who want substantial coverage at a low cost. It is also a good option for those who cannot afford or do not want to pay the high monthly premiums associated with whole life insurance.

When you buy a term life insurance policy, the insurance company determines the premium based on the policy's value (the payout amount) and factors such as age, gender, and health. The premium is the money the policyholder pays for insurance. The insurer must pay the death benefit when the insured person dies, provided that the policyholder has paid the premiums as required. The death benefit is the amount of money the insurance company guarantees to the beneficiaries identified in the policy when the insured dies.

Term life insurance policies have multiple lock-in periods, with the most common type being level term insurance, which locks in consistent, predictable premiums for 10, 15, or 20 years. After the level premium period ends, the premiums will increase each year. The earlier you start a term life insurance policy, the lower the premiums will be.

Term life insurance policies are also convertible, meaning that they can be changed into a permanent policy for long-term life insurance protection. The initial cost of term life insurance is generally lower than permanent life insurance, but the cost of temporary coverage increases over time.

If you outlive your term life insurance policy, you do not receive a payout. However, you can convert your term policy to a whole life policy, which will provide lifetime protection and guarantee a death benefit for your loved ones.

Permanent life insurance: Coverage for an entire lifetime, with a cash value component

Permanent life insurance is a type of life insurance that provides coverage for the entire life of the insured, as long as premiums are paid. It is one of the two primary categories of life insurance, the other being term life insurance. Permanent life insurance policies have a cash value component that helps to make the coverage last while the insured is alive and premiums are paid, while also providing other financial benefits.

The cash value component of permanent life insurance functions similarly to a savings account. This means that the policyholder can use the cash value for several purposes, such as taking out loans, paying policy premiums, or even surrendering the policy for cash to fund their retirement. Over time, the cash value can grow into a significant asset, providing financial security for the future.

There are two main types of permanent life insurance: whole life insurance and universal life insurance. Whole life insurance offers a fixed premium that remains the same throughout the life of the policy, a guaranteed death benefit, and a cash value that grows at a guaranteed rate. Universal life insurance, on the other hand, offers more flexibility, allowing policyholders to adjust their premiums within certain limits. However, the premiums, death benefits, and cash value growth rate can vary, making universal life policies more complex.

Permanent life insurance is suitable for individuals seeking lifelong coverage and a cash value component. It is often chosen by families with young children, business owners, high-net-worth individuals, and individuals with special needs. By selecting permanent life insurance, individuals can ensure financial stability for their loved ones and meet various financial goals.

Whole life insurance: Premium remains the same, death benefit guaranteed, and cash value grows at a guaranteed rate

Whole life insurance is a type of permanent life insurance that covers the insured person for their entire life. It is designed to provide lifelong coverage, a guaranteed death benefit, and a savings component that can be utilised during the lifetime of the policyholder.

Whole life insurance policies offer several benefits, including:

• Lifetime coverage: Whole life insurance provides coverage for the entire life of the insured person, unlike term life insurance, which is limited to a specific number of years. This means that as long as the policyholder continues to pay the premiums, the policy will remain active until their death.
• Guaranteed death benefit: The death benefit, also known as the "face value," of a whole life insurance policy is guaranteed and remains the same throughout the duration of the policy. This benefit is paid out to the beneficiaries upon the death of the insured person.
• Premium remains the same: Whole life insurance policies typically feature level premiums, meaning the amount the policyholder pays every month remains unchanged. This predictability can help with long-term financial planning and ensure peace of mind.
• Cash value growth: Whole life insurance includes a cash value component that grows over time. This savings element allows policyholders to borrow against or withdraw from the accumulated cash value during their lifetime. The cash value typically earns a fixed rate of interest, providing steady and guaranteed growth without the volatility associated with market investments.

While whole life insurance offers these advantages, it is important to consider potential drawbacks as well. Whole life insurance policies tend to be more expensive than term life insurance due to the lifelong coverage and accumulation of cash value. The cash value may grow at a slower rate compared to other policies, such as universal life insurance, which offers variable growth based on investment returns and interest rate fluctuations. Additionally, whole life insurance policies may lack flexibility, as they usually do not allow adjustments to the premium or death benefit.

Universal life insurance: Flexible payments, potential to increase the value of subaccounts

Life insurance is a legally binding contract between an insurance company and a policyholder, in which the insurer agrees to pay a sum of money to the policyholder's beneficiaries in the event of their death. In exchange, the policyholder pays premiums to the insurer during their lifetime.

Universal life insurance is a type of permanent life insurance that offers flexible coverage. It has a cash value component that can be used during the lifetime of the policyholder, and it allows the policyholder to adjust their premiums and coverage amount based on their changing financial needs.

Universal life insurance policies have two parts: the cost of insurance (COI) and the cash value. The COI is the minimum premium payment required to keep the policy active and covers the charges for mortality, policy administration, and other associated expenses. The cash value component, on the other hand, allows policyholders to build wealth over time. The cash value earns interest, and any premiums paid over the COI amount are added to this balance. Policyholders can use the cash value for various purposes, such as taking out loans, paying premiums, or supplementing their income in retirement.

One of the main advantages of universal life insurance is its flexibility. Policyholders can raise or lower their premiums within certain limits, making it a good option for those with variable incomes. Additionally, universal life insurance offers the potential for increasing the value of subaccounts. This is achieved through variable universal life insurance (VUL), where the cash value is invested in subaccounts that mirror the performance of underlying investments, similar to mutual funds. While this type of policy comes with higher risk due to market volatility, it also offers the potential for increased returns.

However, it is important to note that universal life insurance is more complex than other types of life insurance and requires careful management. Reducing or skipping premiums can cause the cash value to drop, and if it falls below a certain threshold, the policy may lapse or end. Additionally, the returns on universal life insurance are not guaranteed, and some withdrawals may be subject to taxes.

Variable life insurance: Potential to increase the value of subaccounts for greater growth over time

Life insurance is a legally binding contract between an individual and an insurance company. The insured person pays premiums to the insurer during their lifetime, and in exchange, the insurance company guarantees to pay a sum of money to the beneficiaries chosen by the policyholder when the insured person dies.

Variable life insurance is a type of permanent life insurance. Permanent life insurance lasts for the entire life of the insured person, as long as they pay their premiums. It is generally more expensive than term life insurance but provides additional benefits, including a cash value. Variable life insurance offers a fixed death benefit, plus a cash value account that gives the policyholder the freedom to invest their equity in a variety of subaccounts. This allows the policyholder to potentially grow their investment tax-deferred.

Variable life insurance policies have some potential drawbacks, including higher premiums and investment risks. The investments come with the risk of loss, and the cash value can decrease depending on investment performance. Additionally, variable life insurance policies are not suitable for short-term savings.

However, variable life insurance can be a good option for those seeking a long-term growth opportunity and those who are hands-on investors. It also offers tax benefits, as earnings on the cash value of the account may grow tax-free.

The cash value of a variable life insurance policy can be increased by investing the cash value into various investment options, known as "sub-accounts." These sub-accounts are similar to mutual funds and typically invest in stocks, bonds, and other variable instruments. Over time, the investments in these sub-accounts can grow tax-free, potentially increasing the value of the policy.

Frequently asked questions