Life insurance: It’s an important financial topic, but many people just don’t understand it. At its most basic, it’s a way to protect your loved ones in the event of your death—in addition to preparing a will and implementing a financial contingency plan. So, it’s worth taking a little time to learn more about it.
Different Types of Life Insurance
The first thing to know is there are two general types of life insurance policies: term and permanent. As long as you pay your premiums, both come with a death benefit that will be paid to your designated beneficiaries upon your death.
Term life insurance policies are valid for a set period of time, after which they expire. If you die within the term of your policy, your beneficiaries receive the death benefit. You can choose from a variety of terms, including one-year or five-year renewable, 10-year, 15-year, 20-year, 25-year and 30-year. Term life is the simplest to understand and usually the most affordable.
Permanent life insurance policies are not tied to a specific term, meaning your beneficiaries are entitled to the death benefit as long as you pay your premiums. However, some of these policies pay the death benefit directly to the insured if they live to age 99.
Permanent life insurance also has a cash value component, which means part of your monthly premium goes into a savings or investment account that you can access via a withdrawal or loan under certain circumstances. The specifics of that account, its return rate and growth potential—as well as loan and withdrawal options—all depend on the type of permanent policy you choose, which can range from whole life to universal life, variable life or variable-universal life.
Your insurance agent can help assess your needs and determine which type of life insurance is best for you.
Key Life Insurance Terms
Some lingo used relative to life insurance, such as a premium, means the same as it does for homeowners insurance, renters insurance and even pet insurance. However, the following terms and phrases are more specific to life insurance:
Annuity: As a life insurance policyholder, you can typically help determine how your policy’s death benefit will be paid to your designated beneficiaries. Annuitizing the death benefit is one of your options, which means it is paid in pre-determined installments over a set period of time. The other common payout option is the traditional lump-sum payment.
Attending Physician Statement: In some cases, in order to be approved for life insurance, the insurance company requires you to get your doctor submit this written summary outlining your medical history.
Cash surrender value: If you choose to cash in a permanent life insurance policy before you die, this is the amount of the cash value component that you’ll receive after any outstanding loans, interest and administrative fees are taken into account.
Contingent beneficiary: This is the person or persons whom you designate to receive your policy’s death benefit if your primary beneficiary dies before you do, can’t be found or chooses not to accept the proceeds.
Death benefit: This is the amount paid to your beneficiaries upon your death as per the life insurance policy’s face value. It is not subject to income tax.
Exclusions: Life insurance policies generally spell out specific circumstances in which the policy won’t pay the death benefit to the beneficiaries. If the policyholder lies on or omits something relevant from their application, that generally nullifies the death benefit. Other typical exclusions include dying by suicide or while committing a crime.
Face value: If you take out a $1,000,000 life insurance policy, $1,000,000 is its face value, and that is the total amount that will be distributed among your beneficiaries when you die.
Paramedical exam: When you apply for life insurance, you are often subject to this type of medical exam that is paid for and coordinated by the insurance company. Its purpose is to evaluate and classify your overall health, which helps determine your coverage and premium amounts.
Primary beneficiary: This is the person or persons whom you designate to receive your policy’s death benefit.
Preferred rates: Depending on the results of your paramedical exam, your health will be classified by the insurance company. This, along with your age and family medical history, helps determine your coverage and premium amounts. Preferred rates, which are the most favorable, are generally reserved for those in excellent health.
Settlement: This is the process that occurs when a life insurance policyholder dies, their beneficiaries file a claim to receive the death benefit and the insurance company distributes the money.
Surrender: This is when you cancel your life insurance policy before its term has expired in the case of a term life policy or prior to your death if you have a permanent life policy. In the latter case, you may receive some of the money from your cash value component, depending on its value and the timing of your surrender.