Life insurance is essentially a contract with an insurer in which you agree to pay a certain amount of money in premium payments each year in exchange for a cash-payout when you die. However, there’s more to know about life insurance, including which type is right for you, what factors affect your costs, how each type of life insurance can be implemented in your future planning, and a great deal more. Understanding how life insurance works is the first step toward ensuring a solid financial future for you and your family.
Understanding Life Insurance
Never bought life insurance before? Learn what it’s all about and how to choose the right coverage. Really, life insurance is nothing more than a contract you sign with an insurance company. You agree to pay $X in premiums, and the insurance company agrees to pay a lump-sum payment to your named beneficiary or beneficiaries at the time of your death. That lump-sum payment is called a death benefit. Generally, you should choose life insurance based on your specific goals, needs and budget. There’s no one-size-fits-all solution here. You can choose from term life insurance, whole life insurance, or universal life insurance. Term life insurance offers protection for a specified amount of time. Whole and universal life insurance are in effect for your entire life. In most instances, there are no taxes owed on the death benefit from any type of life insurance policy. There are quite a few things to know about each type of insurance, so we’ll run through those in the following sections.
Term life insurance is ideal for those who only need protection for a specific period of time. You can purchase a policy for as little as 10 or 20 years. Term life insurance is also usually less expensive (lower premium payments) than other forms of insurance. It’s a good way to supplement if you’ve lost potential income during your working career, and can form a safety net for your family while ensuring you can meet financial obligations, like making your house payment. However, remember that life insurance pays out in a lump sum, not in installments.
Universal life is a type of permanent life insurance that you’ll keep for your lifetime. However, unlike whole life insurance, universal life insurance is a bit flexible. You can raise or lower the premiums you pay. With that being said, it’s often more expensive than term life insurance. Generally, it’s best used as part of an estate planning strategy if you need flexibility.
Whole Life Insurance
Whole life is a permanent type of life insurance, but it’s less flexible than whole life. You’ll pay more in premiums initially, but those usually reduce over time. You also gain tax-deferred benefits here, because this type of insurance has cash value.
How Much Will You Pay?
The cost of your life insurance, whether term, universal or whole, hinges on a number of factors, called rate classes, or risk-related categories. However, these only affect your costs – the don’t determine the amount of coverage you receive. Factors that apply include your general health and family health history, lifestyle factors like smoking and more. Obviously, factors that increase your risk will increase your costs.