Insuring Life: Understanding The Basics Of Coverage And Benefits

Life insurance is a contract between an insurance company and a policy owner, in which the insurer guarantees to pay a sum of money to the policy's beneficiaries when the insured person dies. In exchange, the policyholder pays premiums to the insurer during their lifetime. The two most popular types of life insurance are term life and permanent life. Term life insurance covers a specific period, usually 10 to 30 years, and is more affordable than permanent life insurance. Permanent life insurance, on the other hand, provides coverage for the entire life of the insured and often includes a cash value component. This means that the policyholder can borrow or withdraw money from the cash value while they are alive. When choosing a life insurance policy, it is important to consider your financial obligations and goals, both current and future, to ensure that your loved ones are financially protected.

How does life insurance work?

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. This sum of money is known as a death benefit and can be used by the beneficiaries for any purpose they choose, such as funeral costs, mortgage payments, or education expenses.

There are two main types of life insurance: term life insurance and permanent life insurance. Term life insurance is more affordable and provides coverage for a set number of years, typically between 10 and 30. If the insured person dies during the coverage period, the beneficiaries will receive the death benefit. However, if the insured person lives past the selected period, the policy will expire. On the other hand, permanent life insurance does not expire and will remain active until the insured person dies or stops paying premiums. Whole life insurance, universal life insurance, and variable life insurance are common types of permanent life insurance policies.

When choosing a life insurance policy, it is important to consider factors such as the coverage amount, the type of policy, and the cost. The cost of life insurance depends on various factors, including age, gender, health, and lifestyle choices. It is recommended to compare quotes from different insurance companies to find the best coverage for your needs.

Additionally, life insurance policies may offer additional features or riders, such as a guaranteed insurability rider, which allows the policyholder to add more coverage in the future without a medical exam. Some policies may also have a cash value component that grows over time, which can reduce premiums or increase the death benefit.

What are the different types of life insurance?

Life insurance is a contract between an insurance company and a policy owner, where the insurer guarantees to pay a sum of money to the beneficiaries when the insured person dies. There are two main types of life insurance: term life insurance and permanent life insurance.

Term Life Insurance

Term life insurance is designed to last a certain number of years, after which it ends. Common terms are 10, 20, or 30 years. It is generally more affordable than permanent life insurance, as it does not accumulate cash value. There are several types of term life insurance:

• Level term life insurance is the most common type, where the death benefit remains the same throughout the policy's term.
• Decreasing term life insurance is renewable term life insurance with coverage that decreases over the life of the policy at a predetermined rate.
• Convertible term life insurance allows policyholders to convert a term policy to permanent insurance.
• Renewable term life insurance provides a quote for the year the policy is purchased, with premiums increasing annually upon renewal.
• Term life insurance that lasts until a specific age, such as term-to-65.

Permanent Life Insurance

Permanent life insurance is more expensive than term life insurance but remains in force throughout the insured's entire life, unless the policyholder stops paying premiums or surrenders the policy. Some common types of permanent life insurance include:

• Whole life insurance: This type of insurance provides coverage for the entire lifetime of the insured and includes a savings component that accumulates cash value over time.
• Universal life insurance: This type of insurance is flexible, allowing the policyholder to adjust the death benefit and premiums within certain limits. It also has a savings component that grows based on market interest rates.
• Variable life insurance: This type of insurance is tied to investment accounts, and the cash value can rise or fall based on the performance of the selected investments.
• Final expense life insurance: Also known as funeral or burial insurance, this type of insurance offers a smaller and more affordable death benefit to cover end-of-life expenses.

Other Types of Life Insurance

In addition to the main types of life insurance, there are also other variations, such as:

• Group life insurance: Offered by employers as part of workplace benefits, with premiums based on the group rather than the individual.
• Mortgage life insurance: Covers the current balance of a mortgage and pays out to the lender if the insured dies.
• Credit life insurance: Pays off the balance of a specific loan, such as a home equity loan, if the insured dies.
• Accidental death and dismemberment insurance (AD&D): Covers death or serious injuries, such as loss of limbs, resulting from an accident.
• Joint life insurance: Insures two lives under one policy, with variations such as first-to-die and second-to-die policies.

How much life insurance do I need?

When deciding how much life insurance you need, it's important to consider your financial obligations and resources. You want a death benefit amount that will provide funds to cover the items your family will need money for. For example, if you want life insurance to replace your income if you were to die, you need a policy with a much higher death benefit than if you want a policy to simply pay for your final expenses and burial.

There are multiple formulas to help you calculate your potential life insurance needs, including:

• Multiplying your income by 10
• Multiplying your income by 10 and adding $100,000 per child for college expenses
• The DIME (debt, income, mortgage, and education) method

However, these methods don't offer a full financial picture and don't take into account your savings or existing life insurance policies. A more accurate way to calculate your life insurance needs is to use a life insurance calculator, which can be found on sites like NerdWallet and Forbes. These calculators take into account factors such as your annual income, mortgage balance, future needs (such as college fees), and funeral costs.

Another way to manually calculate your life insurance needs is to use the following equation:

Financial obligations – existing assets = your life insurance need

• Income replacement: Multiply the salary you want to replace by the number of years you want to replace it.
• Mortgage: Include the balance of your mortgage so your family can stay in their home.
• Other large debts: Consider any other large debts that your family would struggle with if you passed away unexpectedly.
• Children's college tuition: Add tuition money to ensure your children can pay for college.
• Existing life insurance: Subtract any other life insurance that you already have.
• Savings: Subtract any savings your family would use to pay expenses.
• Funeral expenses: Consider whether you want life insurance to cover funeral and final expenses.

It's important to note that your life insurance needs may change over time, so it's a good idea to reevaluate your policy annually or after significant life events such as marriage, divorce, the birth or adoption of a child, or major purchases such as a house.

How much do life insurance policies cost?

The cost of life insurance policies varies depending on several factors, including age, gender, health, lifestyle, and the type of policy chosen. Here are some key points to consider:

Age and Gender

Age and gender are significant factors in determining life insurance rates. Generally, younger people pay lower premiums than older individuals since they are less likely to have health problems. Additionally, women tend to have longer life expectancies than men and thus pay lower rates than males of the same age. For example, a $50,000 policy for a 25-year-old woman may cost around $14 per month, while the same policy for a 55-year-old woman could be about $60 per month.

Health and Lifestyle

Insurers evaluate an individual's health by considering their height, weight, medical history, and any pre-existing conditions. Chronic illnesses, such as heart disease, cancer, or diabetes, can increase premiums. Lifestyle choices, such as smoking or engaging in risky activities like skydiving, can also impact rates. Smokers typically pay higher premiums due to the associated health risks.

Type of Policy

The type of life insurance policy chosen also affects the cost. Term life insurance, which provides coverage for a set number of years, is generally the most affordable option. Permanent life insurance, on the other hand, lasts for the policyholder's entire life and includes a cash value component, making it more expensive than term life insurance. Whole life insurance, a type of permanent life insurance, may cost more than $100 per month for older individuals.

Coverage Amount

The amount of coverage selected will influence the cost of the policy. A higher death benefit will result in higher premiums. For example, a $250,000 term life insurance policy for a healthy 20 to 40-year-old typically costs between $24 and $29 per month.

Other Factors

Other factors that can impact life insurance rates include occupation, criminal history, and financial history. Hazardous jobs, such as police officers or firefighters, may lead to higher premiums. DUIs, arrests, and bankruptcies may also affect rates or eligibility for coverage.

How do I buy life insurance?

The process of buying life insurance can seem daunting, but it doesn't have to be. Here is a step-by-step guide to help you navigate the process and ensure you get the coverage you need.

Decide if you need life insurance

Ask yourself if your family or beneficiaries would face financial hardships without your income, or if they would be left with a large amount of debt after your death. Also, consider if you want to cover end-of-life expenses or provide for a dependent's tuition, day-care, or retirement costs. If any of these apply to you, then you may want to consider purchasing life insurance.

Determine how much life insurance you need

The amount of life insurance you need depends on factors such as your income, the needs of your dependents, and your financial goals. Consider how your income loss would affect your dependents and how much financial support they would need. Also, think about the day-to-day expenses you want to cover and the end-of-life expenses your loved ones would have to bear. It is recommended to discuss your concerns with a trusted financial advisor to help you identify a suitable policy.

Determine the type of life insurance that is right for you

There are two primary types of life insurance: term life and permanent life. Term life insurance provides coverage for a specific period, usually between 10 and 30 years, and is more affordable. On the other hand, permanent life insurance covers you for your entire life and is more expensive. It also offers a cash value component that grows over time, which you can withdraw or borrow against.

Decide if you need life insurance riders

Riders are additional benefits or options that can be added to your policy to customise your coverage. Common types of riders include the accelerated death benefit rider, accidental death benefit rider, and waiver of premium rider. Consider whether adding riders is necessary and how they will impact your premium.

Choose a life insurance company

You can work with an insurance agent, insurance broker, or directly with an insurance company to purchase a policy. It is recommended to review company ratings, get referrals and reviews, and compare quotes from at least three companies before making a decision.

Purchase your policy

Complete the life insurance application, providing basic contact information, Social Security number, driver's license number, financial information, and health details. You will also need to choose a beneficiary or beneficiaries for your policy. Depending on the type of policy, you may need to undergo a medical exam.

Frequently asked questions