Complete Guide to Life Insurance
Health insurance is something that many people have heard about, but don’t necessarily make use of, mostly due to a lack of information. It is also not a topic that people want to discuss, as life insurance is directly linked to life and death. However, it is actually a great way for people to provide stability to their loved ones after they’re gone.
But what exactly is life insurance? How does it work? And who exactly benefits from it? Let’s take a look at some of the basics of life insurance to get a better understanding of how it can help you and your loved ones.
The Basics of Life Insurance
First, let’s discuss how life insurance works. At its most basic, life insurance is an agreement between an individual and an insurance provider, wherein the individual makes monthly or annual payments to the provider. In return, when the individual dies, a third party (spouse, child, etc.) receives a set amount of funds in compensation. In essence, life insurance is meant for those who worry that their loved ones will suffer financially in their absence.
Life insurance can also help with a lot of “end-of-life” costs, such as funeral arrangements. The average funeral costs between $7,000-$8,000, and without some kind of financial assistance, many people simply cannot afford it. There are other costs that could become a burden for loved ones as well, such as debts or unpaid taxes. Rather than leaving your spouse or children with large financial obligations, you can provide them with the funds they need via life insurance.
Do You Need Life Insurance?
Unfortunately, this is not a simple question to answer. When most people die, they leave behind someone who, to one extent or another, depended on them financially. However, for people who don’t have someone depending on them financially, life insurance isn’t really necessary. So, the answer will vary for every person and every situation.
The easiest way to determine if you need life insurance is to ask yourself this question: will someone suffer financially when I die? However, even this question might not be sufficient, depending on your age and life circumstances. Life insurance is much more affordable when you are young, so it is generally best to acquire a policy as early as possible. However, many young people are not married and do not have children, so it can be difficult to predict if they will actually need life insurance. If you are young and healthy, it might still be a good idea to get life insurance now, so that you can get a low premium and be prepared for a future in which you may have one or more people depending on you for financial assistance.
Types of Life Insurance
Unlike health insurance or even home insurance, there are not many different types of life insurance. In fact, there are really only two types: term life insurance and permanent life insurance. Let’s take a look at both to see the pros and cons of each.
Term Life Insurance
Term life insurance is exactly what it sounds like: you pay premiums for a set amount of time (a term), after which time the policy ends. If you die during this term, then the beneficiaries of the policy receive a preset amount of funds. If you do not die during this period, the insurance provider usually keeps your premium payments, and you and your loved ones do not receive anything in return.
For example, let’s say that you purchase a $200,000, 20-year term life insurance policy. You pay $50 per month in premiums. If you die before the 20 years have expired, your loved ones will receive $200,000 from the insurance provider, so long as you have made all of your payments up to that point. However, if you live beyond the 20 year expiration date, even if you have made all of your payments, the insurance provider will not pay out the agreed-upon amount.
You may be wondering why anyone would take out a term life insurance policy if there is a good chance that you won’t see any benefit from it. The truth is that term life insurance is generally far cheaper than other policies. Additionally, the less likely it is that you die during this period (i.e. if you purchase the policy when you are relatively young and healthy), the lower your premiums will be for the duration of the policy.
However, another drawback of term life insurance is the fact that every time your life insurance expires, the insurance provider will need to reevaluate the terms of the policy, which will generally result in higher premiums for the next set term. For example, if you develop health issues during the first term, when you go to establish a second term, the insurance provider will see you as having a greater risk of death, and will therefore raise your premium rates.
It is also important to note that there are different kinds of policies that fall under the umbrella of term life insurance. They can vary in term length, premium rates, and a variety of other factors. Here are a few of the most common types of term life insurance:
- Level Term Life Insurance – This type of insurance guarantees that you will pay the same premium from start to finish of the agreed-upon term. So, if you pay for a 10-year policy, starting at $30 per month, you will continue paying $30 per month for the full 10 years. In many cases, level term life insurance will be renewable, so that you can renew for additional terms, with a maximum guaranteed premium for each new term.
- Return of Premium Term Life Insurance – WIth this policy, you can get your premiums back if you outlive your policy. However, the premiums are generally higher than other types of term life insurance.
- Annual Renewable Term Life Insurance – This kind of term life insurance must be renewed each year. The premiums are generally lower, but you run the risk of dealing with health issues during each year, which could make it more difficult to renew your policy.
- Decreasing Term Life Insurance – The payout (and the premiums) decrease over time with this type of insurance. So, the older you get, the less the insurance provider will need to payout when you die, and the less you will need to pay in premiums.
- Increasing Term Life Insurance – As the name implies, increasing term life insurance policies have a payout that increases over time. Naturally, the premiums also increase accordingly. This type also has the added benefit that you do not have to requalify medically to continue having life insurance.
- Convertible Term Life Insurance – This type of insurance allows you to convert to a permanent life insurance policy. This can be useful if you run into health issues and are worried that you would not qualify for a renewed term policy.
Permanent Life Insurance
Permanent life insurance differs from term life insurance insofar as the policy goes on until death. This is best for people who don’t want to deal with renewing their policies or requalifying every few years. However, there are various kinds of permanent life insurance policies that differ in the kind of coverage they offer. Let’s take a look at the most common types:
- Whole Life Insurance – This is perhaps the most common type of permanent life insurance. WIth this kind of policy, part of your premiums go toward the death benefit payout (just like any term life insurance policy), however part of your premium also goes toward a savings account. The insurance provider pays dividends on this account. If you would like to withdraw a limited amount of money from this savings account early, you may do so. However, if you would like to withdraw all of the accrued savings, there may be stiff penalty fees involved.
- Universal Life Insurance – Universal life insurance has a greater investment component than whole life insurance. The cash value of your savings is linked to a variable interest rate. However, one benefit of this kind of policy is that the premiums are often more flexible; the more you pay, the more money gets invested.
- Variable Life Insurance – This insurance type allows for more diversified investments, however, if markets take a turn for the worse, you can end up losing a lot of your policy’s cash value.
Which Policy Is Right For You?
Naturally, the answer will vary for everyone, but there are a few factors that you must consider when choosing a policy. First and foremost, you should only choose a policy that you can afford. Premiums can vary quite a bit between different policies. If your young and healthy, life insurance could cost you as little as $10 per month. However, if you’re over 65 and suffer from various medical issues, you could pay well over $200 per month. The farther you get past 65, the higher the rates go from there.
It is also important to consider how much insurance you need. Are you getting life insurance to help your spouse pay their bills after you’re gone? Do you need health insurance to cover “end-of-life” costs? Do you want to pass on a nestegg to your children? No matter the reason, you will need to determine what kind of payout your beneficiaries will need when you die. If your beneficiaries only need a small sum, then it wouldn’t make sense to pay high premiums on a policy that goes far beyond their needs.
So, you will want to consider how much you are willing to pay each month and how much you would like the insurance company to payout to the beneficiaries before choosing a policy.
How Do Insurance Providers Set Rates?
There are a variety of factors that life insurance providers look at when determining your premiums and the terms of your policy. The following are some of the most important factors that can affect your premiums:
- Age – This is perhaps the single most important factor. The younger you are, the less likely you are to die. As a result, getting a life insurance policy (especially one with set rates) at a young age can help you save a lot of money in the long run.
- Gender – Statistically, women outlive men, and therefore pose less of a risk to insurance providers. As a man and a woman age, the man can end up paying as much as 40% more for the same coverage.
- Health – Obviously, life insurance providers want to know about your medical history to determine if you are at high risk of death. Insurance providers always review medical and prescription records before they approve a policy.
- Lifestyle – If you take part in dangerous hobbies or work in an environment that poses a risk to your health, insurance providers will want you to pay higher premiums. Additionally, if you smoke or drink regularly, the insurance providers will classify you as “high risk.”
Obtaining Life Insurance
Once you have determined which kind of policy you require, you will need to begin contacting insurance providers and comparing rates. It is easy to shop around online, or if you prefer, you can contact insurance providers directly. In either case, they will need to get some information from you to determine your health class, which will in turn determine the kind of premiums you pay. Once you find an insurance provider that sets the kind of rates and policy terms that you desire, then you can start making payments toward your policy.
It is important to know that, if you are choosing a term life insurance policy, the insurance provider will need to periodically reevaluate your insurability (health, age, etc.), which will sometimes result in higher rates for the future.
If you would like to learn more about the laws regulating life insurance, consult the National Association of Insurance Commissioners’ State Insurance Regulation Guide for more information!
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June 21, 2019
Matthew is an experianced FiGuides writer and researcher. He holds B.A. in Philosophy from the University of Georgia and enjoys taking a deep dive on personal finace projects.