How Does Life Insurance Work?

Life insurance is a way to protect your survivors in case you die. For example, if you are the sole breadwinner for a family of four, a life insurance policy would pay your family a lump sum if you suffer a premature death. In this way, your family is protected, and you can have peace of mind. As people get older and have fewer family responsibilities, the need for life insurance is less. Most people drop their policies altogether before they die, but at least they are protected when they need it most. There are two types of life insurance – term life and whole life. They both have a death benefit, but are otherwise somewhat different. Let’s look at them one at a time.

Term life is a fairly simple insurance policy that insures your life for a term of years, perhaps 10, 20 or 30 years. During this term of years you pay a monthly premium and if you die, the insurance company will pay a death benefit. After the tern is up, the policy is over. It’s fairly simple. Who gets the death benefit? Whomever you choose to name as the beneficiary, usually your spouse, but it also could be a parent, child or business partner. It comes to the beneficiary tax-free. Term life is the cheapest form of life insurance, and your premiums are based on several factors including your age, place of residence, lifestyle, and general health. Be prepared to answer some questions or possibly get a physical exam. After the term of the policy is up, the policy expires and you then have to get a new policy or go without.

A whole life policy is different, it covers you for your entire life as long as you pay your premiums. It is much more expensive, but usually includes some form of cash value that builds up over the years. At some point, you can use your cash value to pay the premiums, withdraw the cash value or borrow against it. It you have difficulty saving money, a whole life insurance policy is like a forced savings plan. The general wisdom is that you will do better to get a cheap term life insurance policy and invest the difference in cost.

There are numerous other types of life insurance such as universal life that are combinations of term and whole life. Of course, there are numerous exclusions where the insurance company doesn’t have to pay, so you really should read the policy carefully before buying it, and have your agent explain all the details.