What Is Life Insurance?
Life insurance acts as a financial safety net for your family. If you die while it’s active, your insurance company pays a sum of money to the people you’ve named in your policy. This money, known as the death benefit, can help your beneficiaries replace your lost income and cover expenses like housing, food, and utility bills. Life insurance can be used to pay for funeral expenses, cover outstanding debts, or leave a legacy for loved ones or charitable organizations.
Key Takeaways
- Life insurance is a type of contract in which you make regular payments to an insurance company. In return, when you die, the company pays a sum of money to your chosen beneficiaries.
- Term life insurance offers affordable coverage for a specific period, like 10 or 20 years
- Permanent life insurance provides lifelong protection with a cash value component.
- Life insurance premiums are determined by factors such as the policyholder’s age, health, and lifestyle, with younger and healthier individuals paying lower rates.
How Life Insurance Works
Life insurance can seem complicated, but understanding how it works, who’s involved, and everyone’s responsibilities can help you make informed decisions about your coverage, whether you’re new to life insurance or looking to switch policies or insurers.
Policyholder and Beneficiary
The policyholder is the person who owns the life insurance policy and is responsible for paying the premiums. The policy usually insures the policyholder, but you can also purchase and manage a policy on behalf of someone else. For example, a business owner might buy a policy on behalf of a high-performing employee, making the company both policyholder and recipient of the death benefit. Similarly, you can take out a policy for a loved one, like a spouse, while acting as the designated policy owner.
Premiums
Premiums are the regular payments you make to your insurance company to keep the policy active. They are based on factors like age, health, lifestyle, and the amount of coverage you need. For example, a 30-year-old in good health should have significantly lower premiums than a 50-year-old smoker with a history of health issues. The type of policy also matters: Temporary term insurance costs much less than permanent insurance.
Death Benefit
The death benefit is the money your loved ones receive when you die. When submitting a life insurance claim, they can usually choose how they want to receive the money:
- Lump sum: They get the entire amount in a single payment.
- Specific income provision: They can receive the money over time according to a predetermined schedule.
- Lifetime income: Beneficiaries receive guaranteed monthly payments for the rest of their lives. The amount of each payment depends on the total benefit amount as well as the gender and age of the beneficiary at the time of your death.
- Interest income option: The insurance company holds onto the money and only pays the interest earned on it to the beneficiary. When the first beneficiary dies, the original death benefit goes to a secondary beneficiary.
Claims Process
To receive the death benefit, your beneficiaries need to file a claim with the insurance company. To initiate the process, they’ll need copies of the death certificate (including a certified copy from the funeral director), the insurance policy, and any other required forms. The insurer will then review the claim. If everything checks out, the company will pay the death benefit to your beneficiaries, usually within 30 days of when the claim was first submitted.
Types of Life Insurance
There are two main types of life insurance: term life insurance, which provides coverage for a specific period, and permanent life insurance, which covers you for your entire life and often comes with a savings or investment component.
Term Life Insurance
Term life insurance covers you for a specific period—such as 10, 20, or 30 years. Once the period is over, you stop paying premiums and your policy expires. Because of this time limit, term life insurance is generally the most affordable option, making it ideal for anyone looking for low-cost coverage for a specific timeframe.
For example, if you’re planning a family, you might consider a 20- or 30-year term policy to ensure your children are supported financially, at least through college graduation. Your premiums stay the same during the entire term. However, the longer the term you pick, the more expensive the initial premiums because you lock in the cost for more time.
Permanent Life Insurance
With permanent life insurance, such as whole life or universal life, you pay policy premiums your entire life rather than a set number of years, providing you and your family with lifelong financial protection (or for as long as you pay premiums). Similar to term life, permanent life policies also pay out a death benefit to your beneficiaries. Permanent life insurance also usually comes with a cash value component that can earn interest and grow over time as you continue paying premiums.
