What Is Life Insurance? Life insurance is a contract between a life insurance company and a policy owner.
A life insurance policy guarantees the insurer pays a sum of money to one or more named beneficiaries when the insured person dies in exchange for premiums paid by the policyholder during their lifetime. Show
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Watch Now: What Is Life Insurance?Types of Life InsuranceMany different types of life insurance are available to meet all sorts of needs and preferences. Depending on the short- or long-term needs of the person to be insured, the major choice of whether to select temporary or permanent life insurance is important to consider. Term life insuranceTerm life insurance is designed to last a certain number of years, then end. You choose the term when you take out the policy. Common terms are 10, 20, or 30 years. The best term life insurance policies balance affordability with long-term financial strength.
Many term life insurance policies allow you to renew the contract on an annual basis once the term is up. This is one way to extend your life insurance coverage but since the renewal rate is based on your current age, premiums can rise precipitously each year. A better solution for permanent coverage is to convert your term life insurance policy into a permanent policy. This is not an option on all term life policies; look for a convertible term policy if this is important to you. Permanent Life InsurancePermanent life insurance stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s more expensive than term.
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Term vs. Permanent Life InsuranceTerm life insurance differs from permanent life insurance in several ways but tends to best meet the needs of most people looking for affordable life insurance coverage. Term life insurance only lasts for a set period of time and pays a death benefit should the policyholder die before the term has expired. Permanent life insurance stays in effect as long as the policyholder pays the premium. Another critical difference involves premiums—term life is generally much less expensive than permanent life because it does not involve building a cash value. Before you apply for life insurance, you should analyze your financial situation and determine how much money would be required to maintain your beneficiaries’ standard of living or meet the need for which you’re purchasing a policy. Also, consider how long you'll need coverage for. For example, if you are the primary caretaker and have children 2 and 4 years old, you would want enough insurance to cover your custodial responsibilities until your children are grown up and able to support themselves. You might research the cost of hiring a nanny and a housekeeper or using commercial child care and cleaning services, then perhaps add money for education. Include any outstanding mortgage and retirement needs for your spouse in your life insurance calculation. Especially if the spouse earns significantly less or is a stay-at-home parent. Add up what these costs would be over the next 16 or so years, add more for inflation, and that’s the death benefit you might want to buy—if you can afford it. Burial or final expense insurance is a type of permanent life insurance that has a small death benefit. Despite the names, beneficiaries can use the death benefit as they wish. What Affects Your Life Insurance Premiums and Costs?Many factors can affect the cost of life insurance premiums. Certain things may be beyond your control, but other criteria can be managed to potentially bring down the cost before (and even after) applying. Your health and age are the most important factors that determine cost, so buying life insurance as soon as you need it is often the best course of action. After being approved for an insurance policy, if your health has improved and you’ve made positive lifestyle changes, you can request to be considered for a change in risk class. Even if it is found that you’re in poorer health than at the initial underwriting, your premiums will not go up. If you’re found to be in better health, then you your premiums may decrease. You may also be able to buy additional coverage at a lower rate than you initially did. Investopedia / Lara Antal Life Insurance Buying GuideStep 1: Determine How Much You NeedThink about what expenses would need to be covered in the event of your death. Things like mortgage, college tuition, and other debts, not to mention funeral expenses. Plus, income replacement is a major factor if your spouse or loved ones need cash flow and are not able to provide it on their own. There are helpful tools online to calculate the lump sum that can satisfy any potential expenses that would need to be covered. Step 2: Prepare Your Application Life insurance applications generally require personal and family medical history and beneficiary information. You may need to take a medical exam and will need
to disclose any preexisting medical conditions, history of moving violations, DUIs, and any dangerous hobbies, such as auto racing or skydiving. The following are crucial elements of most life insurance applications:
Standard forms of identification will also be needed before a policy can be written, such as your Social Security card, driver's license, or U.S. passport. Step 3: Compare Policy QuotesWhen you've assembled all of your necessary information, you can gather multiple life insurance quotes from different providers based on your research. Prices can differ markedly from company to company, so it's important to take the effort to find the best combination of policy, company rating, and premium cost. Because life insurance is something you will likely pay monthly for decades, it can save an enormous amount of money to find the best policy to fit your needs. Benefits of Life InsuranceThere are many benefits to having life insurance. Below are some of the most important features and protections offered by life insurance policies. Most people use life insurance to provide money to beneficiaries who would suffer a financial hardship upon the insured’s death. However, for wealthy individuals, the tax advantages of life insurance, including the tax-deferred growth of cash value, tax-free dividends, and tax-free death benefits, can provide additional strategic opportunities. Avoiding TaxesThe death benefit of a life insurance policy is usually tax-free. Wealthy individuals sometimes buy permanent life insurance within a trust to pay estate taxes. This strategy helps to preserve the value of the estate for their heirs. Tax avoidance is a law-abiding strategy for minimizing one’s tax liability and should not be confused with tax evasion, which is illegal. Who Needs Life Insurance?Life insurance provides financial support to surviving dependents or other beneficiaries after the death of an insured policyholder. Here are some examples of people who may need life insurance:
Each policy is unique to the insured and insurer. It’s important to review your policy document to understand what risks your policy covers, how much it will pay your beneficiaries, and under what circumstances. Considerations Before Buying Life InsuranceResearch Policy Options and Company ReviewsBecause life insurance policies are a major expense and commitment, it's critical to do proper due diligence to make sure the company you choose has a solid track record and financial strength, given that your heirs may not receive any death benefit for many decades into the future. Investopedia has evaluated scores of companies that offer all different types of insurance and rated the best in numerous categories. Consider How Much Death Benefit You NeedLife insurance can be a prudent financial tool to hedge your bets and provide protection for your loved ones in case of death should you die while the policy is in force. However, there are situations in which it makes less sense—such as buying too much or insuring those whose income doesn't need to be replaced. So it's important to consider the following. What expenses couldn't be met if you died? If your spouse has a high income and you don't have any children, maybe it's not warranted. It is still essential to consider the impact of your potential death on a spouse and consider how much financial support they would need to grieve without worrying about returning to work before they’re ready. However, if both spouses' income is necessary to maintain a desired lifestyle or meet financial commitments, then both spouses may need separate life insurance coverage. Know Why You're Buying Life InsuranceIf you're buying a policy on another family member's life, it's important to ask—what are you trying to insure? Children and seniors really don't have any meaningful income to replace, but burial expenses may need to be covered in the event of their death. Beyond burial expenses, a parent may also want to protect their child’s future insurability by purchasing a moderate-sized policy when they are young. Doing so allows that parent to ensure that their child can financially protect their future family. Parents are only allowed to purchase life insurance for their children up to 25% of the in-force policy on their own lives. Could investing the money that would be paid in premiums for permanent insurance throughout a policy earn a better return over time? As a hedge against uncertainty, consistent saving and investing—for example, self-insuring—might make more sense in some cases if a significant income doesn't need to be replaced or if policy investment returns on cash value are overly conservative. How Life Insurance WorksA life insurance policy has two main components—a death benefit and a premium. Term life insurance has these two components, but permanent or whole life insurance policies also have a cash value component.
Good to KnowThe policy owner and the insured are usually the same person, but sometimes they may be different. For example, a business might buy key person insurance on a crucial employee such as a CEO, or an insured might sell their own policy to a third party for cash in a life settlement. Life Insurance Riders and Policy ChangesMany insurance companies offer policyholders the option to customize their policies to accommodate their needs. Riders are the most common way policyholders may modify or change their plans. There are many riders, but availability depends on the provider. The policyholder will typically pay an additional premium for each rider or a fee to exercise the rider, though some policies include certain riders in their base premium.
Borrowing Money. Most permanent life insurance accumulates cash value that the policyholder can borrow against. Technically, you are borrowing money from the insurance company and using your cash value as collateral. Unlike with other types of loans, the policyholder’s credit score is not a factor. Repayment terms can be flexible, and the loan interest goes back into the policyholder’s cash value account. Policy loans can reduce the policy’s death benefit, however. Funding Retirement. Policies with a cash value or investment component can provide a source of retirement income. This opportunity can come with high fees and a lower death benefit, so it may only be a good option for individuals who have maxed out other tax-advantaged savings and investment accounts. The pension maximization strategy described earlier is another way life insurance can fund retirement. It’s prudent to reevaluate your life insurance needs annually or after significant life events, such as divorce, marriage, the birth or adoption of a child, or major purchases, such as a house. You may need to update the policy’s beneficiaries, increase your coverage, or even reduce your coverage. Qualifying for Life InsuranceInsurers evaluate each life insurance applicant on a case-by-case basis, and with hundreds of insurers to choose from, almost anyone can find an affordable policy that at least partially meets their needs. In 2018 there were 841 life insurance and annuity companies in the United States, according to the Insurance Information Institute. On top of that, many life insurance companies sell multiple types and sizes of policies, and some specialize in meeting specific needs, such as policies for people with chronic health conditions. There are also brokers who specialize in life insurance and know what different companies offer. Applicants can work with a broker free of charge to find the insurance they need. This means that almost anyone can get some type of life insurance policy if they look hard enough and are willing to pay a high enough price or accept a perhaps less-than-ideal death benefit. Insurance is not just for the healthy and wealthy, and because the insurance industry is much broader than many consumers realize, getting life insurance may be possible and affordable even if previous applications have been denied or quotes have been unaffordable. In general, the younger and healthier you are, the easier it will be to qualify for life insurance, and the older and less healthy you are, the harder it will be. Certain lifestyle choices, such as using tobacco or engaging in risky hobbies such as skydiving, also make it harder to qualify or lead to higher rates. Who Needs Life Insurance?You need life insurance if you need to provide security for a spouse, children, or other family members in the event of your death. Life insurance death benefits, depending on the policy amount, can help beneficiaries pay off a mortgage, cover college tuition, or help fund retirement. Permanent life insurance also features a cash value component that builds over time. What Affects Your Life Insurance Premiums?
What Are the Benefits of Life Insurance?
How Do You Qualify for Life Insurance?To qualify for life insurance, you need to submit an application. But life insurance is available to almost anyone. However, the cost or premium level can vary greatly based on your age, health, and lifestyle. Some types of life insurance don't require medical information but generally have much higher premiums and involve an initial waiting period before the death benefit is available. How Does Life Insurance Work?Life insurance works by providing a death benefit in exchange for paying premiums. One popular type of life insurance—term life insurance—only lasts for a set amount of time, such as 10 or 20 years. Permanent life insurance also features a death benefit but lasts for the life of the policyholder as long as premiums are paid. DisclosureWe publish unbiased product reviews; our opinions are our own and are not influenced by payments we receive from our advertising partners. Learn more about how we review products and read our advertiser disclosure for how we make money. And see our complete list of the best companies for different types of policies. Which of the following is not example of a business use of life insurance?Which of the following is NOT an example of a business use of Life Insurance? Workers Compensation is a benefit payable when a worker is injured by a work-related injury, regardless of fault or negligence. It is not considered a business use of insurance.
Which of the following is not a feature of life insurance?Lending of funds is not a function of insurance.
Which of the following is an example of life insurance?The endowment policy is a life insurance contract designed to pay a lump sum after a specific term (on its 'maturity') or on death.
What is the business of life insurance?Life Insurance can be defined as a contract between an insurance policy holder and an insurance company, where the insurer promises to pay a sum of money in exchange for a premium, upon the death of an insured person or after a set period.
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