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How does life insurance work?
Learn about the types of policies and how they can protect your family.
Life insurance is designed to protect your loved ones after you die or are no longer able to work. With the right coverage, your family will have enough to cover outstanding debts and maintain their current way of living.
What is life insurance?
Life insurance is a protective policy that helps your family recover financially after you die. You pay monthly premiums to the life insurance company with premiums calculated based on your risk of dying. If you die while your policy is active, your heirs receive a payout, called the death benefit, to recover financially from your loss.
Basic terms you should know
You can expect to see the following life insurance phrases when reading a life insurance policy statement:
- Cash value. If you buy permanent life insurance, part of your premium is placed into a savings component of your life insurance, or its cash value. As the value accumulates, you can make limited withdrawals or borrow against the policy.
- Declaration page shows a summary of your policy details. It includes information about the policyholder, the person whose life is insured, beneficiaries as well as the policy number, start date, death benefit and your premium.
- Death benefit is the amount guaranteed to the beneficiaries after the insured person dies, and it’s also called the policy’s face value or coverage. You set the death benefit when you buy the policy.
- Riders are add-ons to your policy that cost extra but provide additional benefits. These may let you convert one type of policy to another, access the death benefit early during serious illnesses or waive your premium if you become disabled.
How does life insurance work?
The life insurance process is pretty straightforward. Once you’ve researched and compared life insurance providers and selected the coverage you want, follow the steps below:
- Sign up for a policy. You fill out an application that typically includes a medical history questionnaire and other background information. You may also be required to take some kind of medical exam because your health condition factors into the premium you’ll pay.
- Sign the contract. If your application is accepted, check over the terms and conditions of your coverage carefully. Then, sign the contract to start your coverage.
- Pay your premiums. You pay your policy’s premiums on time monthly, quarterly, semiannually or annually as specified in your contract. Always pay your premiums in full and on time to avoid having your policy canceled.
- Beneficiaries file a claim. If you die while the policy is in force, your beneficiaries should file the appropriate documentation to make a claim. If you die within the first two years of buying the policy, called the contestability period, your insurer can investigate the claim for possible fraud.
- Beneficiaries receive your death benefits. Your beneficiaries should receive the tax-free death benefit as a lump sum or in payments as agreed in your contract.
- Review your needs if you outlive your policy. If your term life policy ends, you can open a new policy or get your premiums back if you bough a return-of-premium rider.
Watch our short video to learn the basics of life insurance:
What types of life insurance can I get?
When it comes to protecting your family with a policy, you have two main types of life insurance to choose from, term life and permanent life. The only difference is how long you want to be covered for.
What is term life insurance?
Term life insurance is a popular choice for most people. With term life insurance, you choose the term or period when you would need to cover your family’s expenses. For example, if you’re the sole breadwinner of your family and have a 30-year mortgage, a 30-year term life insurance policy would ensure your family could pay to stay in the home until it’s paid off.
What is permanent life insurance?
Permanent life insurance offers lifelong coverage. While you pay much higher premiums, you’re covered for life instead of choosing a coverage term. Your premiums are also invested, which means your policy has a cash value you can dip into once you’ve accumulated enough.
You’ll find several types of permanent life insurance, including:
- Whole life insurance covers you for your entire life, though at a much higher cost in premiums.
- Universal and variable life insurance let you change your premiums and death benefit as well as invest your cash value in more risky and diverse investments.
What is no-exam life insurance?
No-exam or guaranteed issue policies qualify you for a policy without a medical exam or health questionnaire, though with less coverage. One type of no-exam policy is burial insurance, which helps seniors or those with pre-existing conditions pay for basic end-of-life expenses.
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How much does life insurance cost?
Costs vary greatly based on the level of risk a provider or insurer considers you to be. Ultimately, this risk is reflected in the premium you pay, which considers such factors as:
- Your age.
- How much you smoke or drink.
- Your pre-existing and current health.
- Your occupation.
- Your gender.
- How much you’re insured for.
How much life insurance can I get?
Coverage limits vary across insurers and providers, but averages range from $25,000 to up to $1 million or more.
The majority of providers offer coverage in multiples of $50,000 up to $1 million. When you’re young, the difference between adding an extra $50,000 or $100,000 in coverage to your policy can be low.
How much life insurance should I buy?
As a general rule of thumb, many experts say you should take out insurance coverage that’s equal to 10 times your annual income. You can use a life insurance calculator to help you figure what coverage amount you need.
To start determining how much coverage you need:
- Put together a list of your financial obligations — your mortgage, credit card and loan debts and everyday household expenses.
- Consider how long your family would need to pay for those items. For example, if you have five years left on your mortgage, total up five more years of mortgage payments. Or if your spouse is ten years away from retirement, add up the cost to replace your income until then.
- Add in the costs necessary to fulfill your funeral or burial plans, plus any extra considerations for things like lost income due to funeral arrangements.
- Subtract any savings, investments and other assets available to your family.
Can I take out life insurance for my wife or child?
Yes. Most insurers allow you to take out a joint policy to cover your spouse, and many offer coverage options that allow you to extend your policy’s coverage to cover your entire family.
A handful of providers offer standalone life insurance for your children that allows for conversion to a term life policy when they’re grown. Talk to your insurer about your options.
How do I buy life insurance?
You have three main ways to buy life insurance: directly from an insurer online, through an insurance agent or through an insurance broker.The basic steps to purchasing a life insurance policy include:
- Get a free quote. Submit sufficient details to return an accurate quote on the policy type and coverage you’re interested in
- Speak with a representative. If you like the quote, you’ll speak with the provider, an agent or a broker to discuss your options. You’re not obligated to pay any fees or even sign up for a policy at this point.
- Compare your policy options. You’re typically provided a variety of policy, coverage and premium options that meet your specified needs and circumstances. By comparing prices, benefits, exclusions and riders, you can narrow down an affordable policy with adequate coverage.
- Submit your application. You’ll work with your chosen provider, agent or broker to submit your application and necessary paperwork to the insurer assigned to your policy.
- Wait for a decision on your application. After considering the full scope of your application — including your health records — the insurer will decide whether to provide you with coverage and an appropriate premium. You may be asked to submit further information, including medical records and tests.
- Sign your policy contracts. After your application is accepted, you’ll sign a contract of agreement with the insurer, who then puts your coverage in place.
- Begin paying your premiums. You’ll pay your premiums as specified in your contract. As long as you continue making payments on your policy, it remains active.
How to pay life insurance premiums
Most insurers will allow you to pay your premium by a personal check, cashier’s check or bank transfer. None accept cash.
Some carriers will let you pay your initial premium using a credit card, while Transamerica is the only insurer we know of that accepts credit cards for recurring payments.
Choosing life insurance beneficiaries
Part of the process of signing up for a life insurance policy is designating the people who will receive your policy’s benefits after you die. Most policyholders designate their spouse or children, but you can assign your benefits to anybody who depends on you financially — even friends or business partners.
If you don’t assign at least one beneficiary or you outlive your beneficiaries and fail to update your policy, your funds are distributed to your estate as outlined in your will.
What if I want to change my life insurance beneficiaries?
Updating your policy is simple: Just call your insurance company and ask how you can remove or add a beneficiary. If you have an estate planner, you’ll want to let them know of the change as well.
How do I cash in my life insurance policy?
If you are the policy owner, you can access the cash value of your permanent life insurance in three ways:
- Withdrawal. Depending on your policy terms, you may be able to make limited cash withdrawals. You won’t have to pay taxes on your withdrawal as long as you don’t withdraw more than what you’ve paid in to the policy in premiums. But there may be a fee attached, and some insurers subtract your withdrawals plus the fee from your death benefits.
- Loan against cash value. You can apply for a loan against the cash value of your policy, but if you don’t pay it back, the amount of the loan plus interest is subtracted from your death benefit.
- Surrender the policy. If you decide you no longer need your insurance policy, you can cancel it and take the cash value, minus a surrender fee. But once the policy is canceled, your beneficiaries will no longer get the death benefit, no matter how long you paid into the policy.
Can I cancel my life insurance policy?
Yes. If you decide you no longer need the protection it offers, you can let your insurer that you’d like cancel your life insurance.
Note that your insurer is not obligated to refund any of the premiums you paid. And if you change your mind after canceling your policy, you’ll likely face higher premiums and other restrictions if you’re older than when you initially signed up or have since had health issues.
If you’re recently signed up for the policy you’d like to cancel, you might be within a “cooling off” period. Many providers allow you up to 30 days to change your mind without fees or penalty, even refunding any premiums you’ve paid in the meantime.
Can my life insurance company cancel my policy?
Yes, but generally only in two specific circumstances:
- You stop paying your premiums. You’re typically extended a grace period that keeps your benefits active even if you’ve occasionally paid a premium late. After the grace period, your insurer reserves the right to cancel your policy.
- Your application is found to be fraudulent. If your insurer finds that you purposefully lied on your application or provided fraudulent supporting documents, your insurer has just cause cancel your policy. If the fraud isn’t caught until after your death, your insurer can cancel any claim due to your beneficiaries.
How do life insurance payouts work?
Most life insurance policies pay out the death benefit to designated beneficiaries after you die. They might have the option of receiving a one-time lump sum or installments over time — also called annuities.
As for how life insurance works for beneficiaries, the onus is on them to start the claims process when the policyholder dies. The process varies between insurers, but most require you to complete a claims form and submit supporting documentation — such as a certified copy of the death certificate.
How to file a life insurance claim
As a beneficiary, it’s your responsibility to file a claim when the policyholder dies. These are the steps:
- Prepare to file. To file a claim, your insurer will typically require a copy of the death certificate, related medical reports and any original policy documents available.
- Notify your insurer. Your beneficiary or rep contacts the insurance company by phone or online to start a claim. At this point, only policy information and the date and cause of death are required.
- Follow your insurer’s procedure. From here, the process depends on your insurer. Generally, your beneficiaries will receive hard-copy forms to complete against specific instructions. Your insurer may also assign an officer to your claim.
- Submit forms and supporting documentation. Your beneficiaries submit completed claims form, your death certificate and other documents as requested. They’ll also indicate their payout preferences, either a lump sum or structured annuities.
- Wait for assessment. Your insurer assesses your policy’s claim and supporting documentation. The process can take anywhere from a week to a month or more.
- Learn claim decision. Your insurer announces whether your policy’s claim is accepted, declined or requires additional information. If it’s accepted, your insurer pays out the claim by check as requested by the beneficiaries. Ongoing payments can be sent by check or direct deposit to a bank account.
- Policy is closed out. After your insurer pays out the benefit to your beneficiaries, your policy is considered closed. The payouts might be subject to taxes depending on your circumstances.
What if my claim is rejected?
If your insurer declines the claim, your beneficiaries can ask for the case to be reviewed — unless the rejection is due to fraudulent or falsified information in the policy or claim.
What about critical illness or disability insurance?
Successful critical illness or disability claims are typically paid out in a lump sum that you spend however you’d like. If your critical illness or disability benefit is a rider or otherwise bundled with your life insurance policy, your coverage amount is reduced by the benefit you’re paid.
The right life insurance policy can help keep you and your family financially secure even if there’s a sudden loss of income. To find the right policy for you, compare life insurers and get quotes from your top providers.
Frequently asked questions about life insurance policies
Image source: Getty Images
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