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How Does Life Insurance Work?

what is life insurance

Reviewed By: Rob Pinner

Rob Pinner Rob Pinner is the founder and CEO of Pinner Financial Services servicing all 50 states. Rob started his insurance career in 2002.

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In simple terms, life insurance is a contractual agreement between a consumer and an insurance provider.   The insured agrees to pay a specified amount of money, known as the premium, either monthly or annually for a set amount of time.  In return, the insurer agrees to pay the policyholder’s named beneficiary a specified sum of money should the policyholder die prior to the ending date of the life insurance contract.

If, however, the policyholder outlives the life insurance policy, the policy may be eligible to be extended or converted into a permanent form of life insurance.  Otherwise, the policy will simply lapse or expire.

Who Should Purchase Life Insurance?

Primarily, the head of the household will most likely want to secure a life insurance policy, especially if your family depends on your financial support.  At the time of your death, your life insurance provider will pay a tax free death benefit to your loved ones that they can use to pay the household’s bills, final expenses, college tuition for the kids, pay off the mortgage and replace a breadwinners income.

Individuals that are married need life insurance, even if they don’t presently have children or plan to have children.  If you have co-signed a mortgage or auto loan with your spouse, those payments will become solely your spouse’s responsibility once you die.  This could potentially put them at risk of becoming delinquent on these shared assets if they are not properly prepared.  Even if you don’t have shared assets with your spouse, the death benefit will assist them in covering your funeral and final expense costs, and provide an income stream.

Single individuals that start a business and have a partner, for example, would want to consider purchasing life insurance as well, so that the business partner is able to continue with the venture.  This business partner would be the named beneficiary, and this is referred to as an insurable interest.  There are several types of business policy arrangements and depend on what form of business you have.  A buy-sell agreement can be drawn up with the help of an attorney that details the wishes of the business owners.

business partners life insurance

Even if you don’t plan on starting a business, you’re not married, and you don’t have children as of yet, there’s always the possibility that your plans may change.  Should you then decide to purchase a policy later on down the road, you could find yourself ineligible due to health issues, or you could find that the policies are more expensive because you are getting older.

You may not have a  huge need for life insurance but are in need of a financial product that will help supplement your income during retirement.  An indexed universal life insurance policy can do just that.  By purchasing a small amount of  indexed universal life insurance you can take advantage of the IRS tax code 7702 and use the policy as a supplemental retirement plan.

Purchasing The Right Amount of Life Insurance

Adequate life insurance coverage involves purchasing an appropriate death benefit.  Consequently, the higher the death benefit, the higher the life insurance premiums.  You’ll want to determine how much life insurance coverage you will need prior to receiving quotes, and you can achieve this by calculating the expenses that will accumulate following your death.  Let’s take a look at some of the factors that you will want to consider:

Protection for Your Spouse

It’s important to consider any current debts that you share with your spouse, such as mortgage payments, student loans, and credit cards that you’ve co-signed for.  Life insurance is a tool that can wipe out debt if you die before you can pay it off.  Once you’ve examined your financial obligations, you’ll also want to provide enough of a cushion for your spouse to live comfortably following your absence, as well as the ability to cover your final expenses.

life insurance for spouse

Providing For Your Children

You’ll want to evaluate the cost of your children’s college education.  With the rising costs of tuition, you’ll want to ensure that your death benefit at least covers part, if not all of their college expenses.  Furthermore, you may want to ensure that there’s money set aside for your children to inherit once they are old enough.

insurance for children

Charitable Contributions

Depending on your situation, you may elect to name charitable organizations or institutions as your beneficiaries.  For example, it may be your wish to leave your church a $100,000 gift.  You’ll want to make sure that your death benefit is accommodates that figure.

Business Survival

Suppose that you and a partner have started a business – you’ll want to ensure that your business partner is the named beneficiary.  You’ll want to consider any outstanding business loans and funds needed to keep your business going after you’re gone.

Choosing The Right Life Insurance Policy

Aside from choosing the appropriate amount of life insurance coverage, it’s important to determine the most suitable form of coverage.  You also want to make sure that you choose a policy from a reputable life insurance company.  Two considerations to keep in mind include how long you will want your coverage to last and whether you’d prefer for your death benefit to increase over the time that you have it.  Let’s take a brief look at the different types of life insurance coverage:

Term Life Insurance

Due to the fact that term life insurance is the most basic of life insurance policies, it’s certainly the most affordable form of coverage.  With term life insurance, you are covered for a specific time period which you select.  Once you cease paying your monthly premiums, the coverage stops.  There are no extra features, however, your coverage can be strengthened by adding policy riders.

If the unexpected occurs during your policy term, your named beneficiaries will receive the death benefit.  On the other hand, if you survive your policy’s term period, you’ll receive nothing from the life insurance company.  Many life insurance brokerage agencies can help you find the policy that fits your needs.  Ogletree Financial will work with you to help you save money on life insurance.

Whole Life Insurance

This is a permanent form of life insurance coverage.  Instead of paying monthly premiums for a specified term period, you’ll pay them until your death, at which time your beneficiaries will receive the death benefit.

Whole life insurance also has a cash value component to the policy, which grows in value as long as you pay your premiums.  This cash value feature may raise the death benefit value, and in some cases, may even pay you a surplus on the increasing cash value.  Another feature of this type of policy is that you’ll have the ability to take out a loan against the policy or withdraw funds from the cash value.  Just keep in mind that these actions could decrease the death benefit, potentially leaving your beneficiaries with nothing.

Universal Life Insurance

This is also a form of permanent life insurance coverage.  Unlike whole life insurance, the cash value of this type of policy is linked to a specified stock index as seen fit by the insurer.  With this coverage, should the stock market decline, the cash value will also decline.  This could mean that you’ll have to pay higher premiums in order to keep your desired coverage amount.

Variable Life Insurance

Similar to universal life insurance, variable life is tied to stock market trends as well.  However, you have the ability to choose what types of assets you will invest in.  The premiums associated with variable life are fixed, and as long as the assets you select do not surpass the death benefit value, you most likely will not see any difference in your coverage.

Most life insurance policies will require you to take a medical exam in order to underwrite you.  We do have policies that can underwrite you with no medical exam.

How Much Does Life Insurance Typically Cost?

Your cost of life insurance will depend on how much risk you present and how much coverage you require.  Simply stated, healthier individuals will pay less for their life insurance, as do those with a less risky lifestyle or occupation.  Unfortunately for those that are less healthy or that enjoy risky hobbies, such as skydiving, they will pay substantially more.  If the latter is your situation, you can make your coverage more affordable by purchasing smaller amounts of coverage or by choosing a shorter term period.

What About The Contestability Period?

Lying about your health status in order to receive a better premium rate could catch up to you eventually.  A policy is considered contestable during the first two years that it’s in force, which means that the insurer has the right to contest any claim filed by your beneficiaries after your passing.  If the insurance company determines that you misrepresented your health at the time of application, they may choose to either reduce your death benefit or worse, cancel the policy altogether.  This could leave your loved ones with nothing except a refund of the premiums that you paid in.  Once the two year contestability period ends, your coverage is secured, provided there are no acts of fraud.

How Will My Beneficiaries Get Paid After I Die?

If you die while your policy is in force, your beneficiary will need to file a claim with your life insurance provider.  Be sure to inform your beneficiary of your policy’s existence, as well as its location.  They will need to submit their proof of identity, your death certificate, and a claim form documenting the circumstances regarding your death to the insurer.  As long as your life insurance company does not contest the claim and there was no illegal activity or fraud involved, your beneficiary will receive payment of the death benefit.

Ogletree Financial has helped thousands with life insurance over the last 20 plus years.  We can help you too.

We can be reached at 1-800-712-8519.

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