How Does Life Insurance Work? The Process Overview
- Author: Toni O'Hara
- Posted: 2024-08-21
A life insurance policy is a contract between an insurance company and a person (or legal entity). Its fundamental aim is to compensate the policy beneficiaries if the insured person dies. The policy pays a "death benefit" to the specified dependants upon the premature death of an insured person.
Most life insurance policies consist of an incontestability clause. If the policyholder dies within two years of purchasing the policy, the insurer can contest or probe the claim raised by the beneficiaries. It could mean compensation doesn't happen immediately since the insurance company must review medical records. If there is no consensus on how the disbursement of proceeds, the insurer can file for interpleader with the court.
Fundamental Features of a Life Insurance Policy
The way a few basic features define this policy work:
- The Death Benefit refers to the amount of money the insurer pays upon the premature death of the policyholder. Usually, this benefit attracts zero income tax.
- The Beneficiaries: These are specified individuals in the policy who benefits from the death benefit. Beneficiaries can be a single person (e.g., a surviving spouse) or divided by percentage among a few people. For instance, the surviving spouse can get 50%, and two adult children could each receive 25%. The beneficiary doesn't need to be directly related to the policyholder. The policyholder can prefer to leave the entire or part of the death benefit to an entity, such as a charitable cause.
- The Policy Length or Term: It refers to the amount the policyholder consent to pay a death benefit. It can be 10, 20, or 30 years. Alternatively, the insured can purchase a permanent policy. It is valid for the insured's entire life, as long as there is no default premiums payment.
Different Types of Life Insurance
Although looking for life insurance is not daunting, you are constantly confronted with two tough decisions: The best type of life insurance and the amount of life insurance needed. Here is a comprehensive guideline of the different types of life insurance:
- Term Insurance: If rates remain unchanged, it has a particular end date for the level term period. Coverage for a specific term or time is usually between 10 and 30 years. After the period elapses, you can renew the policy at higher rates every year.
- Whole Life insurance is the seamless form of permanent life insurance. It offers coverage for your entire life. Like its permanent policies counterparts, it also incorporates a cash value component. This policy has three defining attributes: The premium level remains unchanged for life, and the death benefit is assured as long there is no default payment of the premiums. The policy entails warranted cash value that increases at an assured rate.
- Universal Life Insurance: It provides cash value and lifetime coverage benefits for the entire life. The main difference compared to whole life insurance is the versatile premiums. With this, you can either increase or reduce the premiums paid as you see fit.
- Final Expense Insurance: The policy only intends to take care of expenses arising upon death, for example, funeral, and burial costs. Its coverage has no limit because the insurer won't change the policy if you are consistent with the premium payment. However, final expense insurance doesn't include cash value or investment components.
- Simplified and Guaranteed Issue Insurance: When applying for different life insurance policies, you must undertake a medical exam to allow the provider to examine your risk to insure. However, this is different with simplified and guaranteed issue policies, as the provider doesn't have to evaluate the risk to insure the policyholder. The policies serve older applicants or those with severe medical issues who lack eligibility for policies that need a medical exam.
Benefits of Life Insurance
- Payouts attract zero taxes: If you die while your coverage is functioning, your beneficiaries will get a tremendous amount as death benefit as no income is applied.
- Your dependents won’t have to worry about living expenses: Life insurance can take care of your children's education and other expenses.
- Can cover final expenses: It’s expensive to bury a loved one but this policy can cover the entire burial expenses.
- It covers Chronic and Terminal Illnesses: In case of a terminal illness, life insurance can cover it.
- It can supplement your retirement savings: The various life insurance policies, such as whole, universal, or variable, can build up cash value and offer death benefits. As the cash value accumulates over time, you can utilize it for settling expenses.
