Life Insurance

Life Insurance Overview: What It Is, How They Work, Types Of Life Insurance, Riders, and More!


Introduction

While auto and home insurance policies are the most commonly sought-after and purchased coverages nationwide, Life Insurance, though a standard necessity for most households, often gets overlooked. Whether individuals assume coverage through employer group policies or find the topic uncomfortable, the reality remains—it’s just as essential as auto and home insurance.

Life insurance quotes

Before diving into the shopping process, it’s crucial to develop a foundational understanding to assess your life insurance needs effectively. This post will guide you through how life insurance works, the various types of policies available, their distinct roles, customization options, and more.


What is Life Insurance?

Life insurance is a contractual agreement between a policy owner and an insurance company. Similar to other insurance policies, the policy owner pays premiums to the insurance company in exchange for a specific guarantee. In this context, the guarantee is a sum of money provided to your beneficiary upon your passing.

How Does Life Insurance Work?

Premiums are established by the life insurance company and paid by the policy owner for a specified duration. Provided the policy remains active, the insurance company disburses a lump sum of money, known as the “death benefit,” to your beneficiaries upon your passing.


Benefits of Life Insurance 

Life Insurance is an effective instrument best used to protect your assets in various ways. Below are common reasons to secure life insurance:

·  Dependents: In this case, I’m not only referring to minor children but anyone who would otherwise suffer a financial loss upon the insured’s passing. One example is using the policy as an income replacement for two-income households. 

·  Securing plans or aspirations: Life insurance provides peace of mind that your loved ones goals won’t be derailed.

Example: college tuition, mortgage balance paid, and other milestones you planned on setting funds aside for.

·  Tax advantages: The proceeds beneficiaries receive from a formal life insurance policy are not taxable. A feature that also can assist with estate planning.

·  Legacy Aspirations: Some simply want to leave a legacy behind for their loved ones; having a life insurance policy in place will ensure that the scenario you’d hope to leave behind plays out as planned.


Life Insurance Policy Roles 

More often than not the policy owner and the insured is the same individual, but it’s worth noting that the policy doesn’t need to be structured that way. 

Individual Life Insurance Policy
Individual Roles of Life Insurance

Below are key differences to make a note of:

  • Owners can be entities or individuals—for example, trusts, businesses, etc.
  • The policy owner is the individual who purchases the contract and is responsible for the premium payments. 
  • Distribution of the death benefit occurs once the insured passes.
  • Only the owner can make changes to the policy. 

Common scenarios where the policy owner is different from the insured:

  • Parent purchases a life insurance policy with their child listed as the insured.
  • Individual purchases a life insurance policy with their spouse listed as the insured.
  • Business purchases a life insurance policy with a “key employee” listed as the insured.

Types Of Life Insurance

Term life insurance and whole life insurance

Many types of Life Insurance products are on the market today to accommodate common goals and objectives.

The two main categories for Life Insurance products are:

  • Permanent Life Insurance
  • Temporary Life Insurance *Guaranteed for a certain period.

Term Life Insurance Products


Also known as “temporary” policies, term policies are designed to offer coverage for a certain number of years.

Term life insurance

These products provide coverage for a specified time frame because they were designed to cover “temporary” needs.

For instance, imagine you’re in your early 30s, having experienced a year of significant milestones, including welcoming a baby and purchasing a home. After discussions with your spouse about coverage priorities, you decide on a policy size sufficient to cover your mortgage balance and your child’s future college expenses.

The above scenario is a “temporary” need because it will dissipate over time. Over time, you will pay off the mortgage, and your child will finish college. Therefore, the original objective of the term policy has vanished.


Common Level Term Life Insurance policies consist of 10, 15, 20, or 30 years. Since these policies are temporary, the premiums are much more affordable than a permanent life insurance product.

Frequently, term policy premiums are more affordable than those of permanent life insurance, even when the term policy offers a larger death benefit. However, this hinges on a variety of factors such as the insured’s age and life expectancy.

Term insurance can be “personal” policy or as a “group” policy, which entities can buy for the benefit of a group. An example is a company perk for their employees.


Different Types of Term Life Insurance Products

Convertible-Term

This term product allows policy owners to convert a term policy to a permanent life insurance product.

Renewable-Term

These products renew annually, with premiums typically being most affordable at the start of the term compared to similar policies. It’s essential to acknowledge the potential risk of premiums becoming higher than those of peers as the years progress.

Decreasing-Term

A type of term policy where the death benefit amount decreases over the policy’s life.


Permanent Life Insurance

The name speaks for itself. Permanent Life insurance products were designed stay in force for the insured’s lifetime. 

These life insurance products often include a cash value that can accumulate over time. Policy owners can access the cash value in life insurance policies to supplement premium payments or as a loan. 

Cash Value (Permanent products only): The cash value in permanent life insurance policies accumulates on a tax-deferred basis. Listed below are a few common ways cash accumulation values are used:

Term Life Insurance
  • Supplement premium payments.
  • Purchase another life insurance product such as an annuity.
  • As a loan, the insurance company will deduct any outstanding loan balances after the insured passes.
  • Cash withdrawal – tax implications will apply. Some policies may have withdrawal restrictions, which usually revolve around the purpose of the withdrawal.

Different Types of Permanent Life Insurance Products

Whole Life Insurance:

This is the basic form of permanent life insurance. Whole Life policies feature consistent premium payments throughout the policy’s duration. Notably, while premiums remain constant, the payment period can apply for the entire policy term or for a specified period, termed a “Paid Up Whole Life” policy.

Whole life insurance

A “Paid-up” policy designates a specific period during which premiums must be paid. After this period concludes, no additional premiums are required, and the policy remains in force for the insured’s lifetime. This characteristic makes these products especially popular for children.

Universal Life Insurance, aka

Also known as “UL Insurance or ”IUL,” policies offer flexible premium payments instead of the level premiums that term and whole-life policies. These policies may have a “level” death benefit (predetermined death benefit amount that remains static for the policy’s life) or an increasing death benefit.

Variable Universal Life Insurance, aka VUL Insurance

Just like any other Universal Life product, the premium payments are flexible. The main difference between a VUL and a UL is the growth aspect of the cash value. The cash value in Universal Life and Indexed Universal Life products accrues interest versus Variable Universal Life policies. The cash value in Variable life insurance policies are kept in a separate account and invested in the stock market via sub-accounts (mutual funds).

Please Note: The flexible premiums feature in universal life insurance products can certainly appeal to consumers; it’s essential to understand the pros, cons, and items to consider before purchasing.


Life Insurance Riders 

Riders are optional features that policy owners can add to life insurance policies and annuities (another product issued by Life Insurance companies). This in turn allows policy owners to customize their policies based on their needs.


Note: Adding a rider often affects the base premium amount as they typically carry a fee. However, some life insurance policies include riders at no additional cost.

Best life insurance

Types of Life Insurance Riders

There are many types of Life Insurance riders, but the riders offered vary between each life insurance product and company.

  • Accidental Death Benefit Rider: This rider provides the beneficiary an increased death benefit value if the insured’s death is accidental. The insurance company multiplies the original death benefit value by a percentage rate selected by the policy owner.
  • Accelerated Death Benefit Rider: With this rider, terminally ill insureds can access an allotted amount of the death benefit proceeds prior to their passing.
  • Guaranteed Insurability Rider: Provides the ability to purchase additional life insurance at a later date without a medical review.
  • Waiver of Premium Rider: Policy owners can have the premium payments waived if the policyholder becomes disabled and unable to work. 
  • Disability Income Rider: Pays a monthly income if the policyholder cannot work for several months or longer due to a severe illness or injury.
  • Long-Term Care Rider: Similar to the Accelerated Death Benefit, this rider allows the insured to use a portion of the death benefit value if they can’t perform two of the six qualifying daily living activities. If required, proceeds can be used to pay for assisted care expenses such as assisted living, nursing home, or in-home care.


Riders can add value to a policy, but stipulations often apply before the riders’ coverage can be utilized.


Cost Of Life Insurance

As mentioned above, product-wise term policies often have lower premiums than permanent life insurance products but there are many other variables come into play regarding the cost for life insurance policies.

Best term life insurance price

The most important factors are the insured’s age and health status.

For example, suppose the premium payment for a 30-year-old healthy male will be lower than for a 55-year-old male applicant in “fair” health. Of course, an individual’s health status can be beyond someone’s control, but the purchase date of the policy is within your grasp.

The younger you are, the lower your premium. If you find that the decision for your health rating (aka risk class) is something that you can improve upon, you can always request to be considered for a different health rating.

The insurance company then reviews your updated health assessment to determine whether or not a premium decrease is warranted.

The worse the insurance company can say is that your premiums will remain the same; they cannot increase your premium, even if they find you’re in poorer health.


Life Insurance Needs

Keep in mind that life insurance proves valuable in alleviating concerns about potential financial hardships for your beneficiaries in the event of your sudden passing. It can also play a crucial role in estate planning, covering common end-of-life expenses, and fulfilling broader legacy aspirations.

Always remember that individual insurance needs differ. For example, a household may discover that a combination of term and whole life policies suits them well, addressing both temporary and permanent needs. Explore more examples in my latest post.


Unsure if your need is temporary or permanent? Let me know in the comments, or send me a message!

Disclaimer: The opinions expressed in this blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security, investment, or insurance product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.


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