life insurance is a contractual agreement between a policyholder and a life insurance company. Policyholders agree to make premium payments to the company, and, in exchange, the company agrees to pay your beneficiaries a sum of money if you die while the policy is still in force.
It can also be used for final expenses like medical bills or funeral costs that survivors would have to pay when a death occurs. Life insurance is an important part of financial planning for families and individuals.
Explaingin Our Life Insurance Definition More Concisely
Most often, the purpose of life insurance is to maintain the financial security and well-being of one’s family or dependents in case of a wage-earners death. If you have others who are financially dependent, you should have a life policy.
However, life insurance can also be used for the following reasons:
- Mortgage Protection – to cover your mortgage loan or payments
- Retirement – the savings, cash value build-up or investment opportunity help build a family’s net worth or nest egg
- Childcare – to replace a home-maker’s contribution
- Estate Protection – to help cover estate taxes
- Protect Your Business – to protect a business against the loss of a key employee, known as key man life insurance
- Employee Benefits – typically offered as group life insurance through your employer
Parts of A Life Insurance Policy
Most life insurance policies consist of some or all of these components. The following are brief definitions of the terms that will frequently show up in your contract.
- Cash Value – An interest-bearing savings or investment account included in permanent life insurance policies.
- Death Benefit – A lump sum payment or series of payments made to your beneficiaries upon your death.
- Health Class – An insurance company’s medical evaluation of an individual’s health after an exam. This medical information, along with age, gender, occupation, and lifestyle habits, is used to calculate the insured’s mortality risk and determine rates.
- Premiums – A periodic payment (monthly, quarterly, semi-annually, or annually) from the policyholder to the life insurance company to keep the contract valid and in force.
- Quotes – Life insurance quotes are rate estimates made before the official application process, detailing the costs of the policy.
- Rates – See Premiums. The price or premium required to maintain coverage.
- Riders – Policyholders may customize, add features or coverage options to their policy by attaching a document called a life insurance rider.
- Taxes – Life insurance is generally income-tax free and the cash value grows tax-deferred, but beneficiaries may have to pay estate taxes, if applicable.
A Life Insurance Policy Is A Legal Contract
A life insurance policy is a legal contract between the insured person and the life insurance company, and like all contracts, it is enforceable by law and shouldn’t be entered into lightly. Both parties have certain rights and obligations which are explained in the policy, so it is critical that anyone buying protection read the contract and its fine print before signing it.
For example, there may be exclusions in the contract for certain causes of death, such as suicide, where the company can legally refuse to pay the death benefit.
Additionally, deaths occurring within 2 years of purchasing coverage, also known as the “exclusionary period”, may not be eligible for a death benefit payout and may result in your carrier returning your premiums instead.
Do You Need Life Insurance?
Any wage earner with financial dependents – a spouse, kids, etc. – should have life insurance to provide for his/her dependents in case of premature death.
Non-wage earners who make significant contributions to the home, like child care and household management/maintenance, should also have life insurance in order to pay for those services should they pass away. Adults who may leave medical expenses or funeral costs should consider covering their final expenses so survivors will not be left with debts.
The Different Types of Life Insurance Policies
There are different types of life insurance which meet the needs of different people at various stages of their lives. The major types are term, whole, universal and variable life insurance; but there are different kinds of plans within each category as well. Each plan offers specific benefits for different families.
All contracts have a death benefit which is payable if an insured person dies while the policy is in effect, but the terms and conditions differ.
- Term life insurance requires regular, fixed premium payments and provides coverage for a certain, predetermined period of time outlined by the initial contract. Policies last anywhere from 1 to 30 years, and, in most cases, the policy only pays a death benefit if the insured individual dies before expiration. Term life insurance is the cheapest and most popular.
- Whole life insurance, a form of permanent protection, requires regular, fixed premium payments which are higher and more expensive than term life insurance. Whole life policies guarantee coverage for life and guarantee the payout of a death benefit at some point. Whole life also includes a cash value, meaning the equity portion can be liquidated, used as collateral for a low-interest loan from the insurance company, or serve as a nest egg for retirement. The rate of return on the cash value is fixed when the policy is purchased, and usually hovers around 4%.
- Universal life insurance, another kind of permanent coverage, offers you the flexibility of paying between a minimum and maximum premium payment. Minimum payments maintain the insurance portion of the policy, and premiums above that amount get directed to the investment component. The investment component, also known as the cash value, is then invested in stocks and bonds listed on the investment menu the insurance company provides. Similar to whole life, the cash value can be paid out or borrowed against.
The best life insurance policy for you depends on your individual financial circumstances, income level, assets vs. liabilities and your stage in life. You’ll have to compare life insurance policies to find which will best serve your family’s needs.
Life Insurance Is A Gift
In the end, life insurance offers you peace of mind. Because life is uncertain, it is important to plan for the unexpected, and those with life insurance know their family’s financial needs will be met if they are no longer around.
Ensuring that your spouse and children will be able to cover mortgage payments, credit card bills, daily living expenses, education costs, and other debts is a legacy gift that demonstrates the love you have for your family.