How Does Life Insurance Work?

Posted by in Insurance | Updated on August 25, 2022

In the United States, 54% of the population has life insurance. There were 837 companies offering life insurance in the U.S. in 2019, and more people are considering getting life insurance today.

But not everyone knows where to get started with life insurance or how it works. If you don’t have one yet, chances are you’re asking questions such as “How does life insurance work?” or “Are life insurance proceeds taxable?”

Well, here are some things you should know about life insurance before you enter a contract with an insurance company.

What Is Life Insurance?

Life insurance refers to a contract where the insurer guarantees that they will give money to your family if you die. They will do this in exchange for premium payments.

After your passing, your beneficiaries can choose what to do with the money received. They may support a child in college, pay bills, etc. Life insurance will act as financial protection for your loved ones, especially when your passing would impact them greatly.

There are different policies for each life insurance, and every state has different laws when it comes to regulating insurance policies. This is why before you settle for any life insurance, you must know how it works, the laws involved, and the policy of the insurance.

To get the best benefits with your life insurance, you need to choose the right one.

What Are the Types of Life Insurance?

Life insurance comes in different types, with each one of them providing coverage for a certain amount of time. Depending on what your goals are, you may choose one or the other.

Here are the types of life insurance you can opt for:

Term Life Insurance

Term life insurance is one of the most common types of insurance people go for. This is because it is the most affordable option, being available for pretty much anyone.

With term life insurance, you get coverage for a specific amount of time. Usually, you can get it in 15-, 20- or 30-year policies. However, each insurer is different, meaning you may be able to get different policy lengths based on the company you pick. During the policy’s duration, the premium payment amount will not change.

In case you pass away before you’re done paying for the term life insurance policy, the beneficiaries can still get the money by making a claim. It will be free of tax as well.

If you finish paying for the insurance policy, you will be able to renew the coverage for one year at a time. The more you renew it, the more the rates will grow every year, though.

Ladder Life Insurance

Individuals who want to apply for life insurance can opt for Ladder Life insurance. This service offers policies of different terms, such as 10-, 15-, 20-, 25- and 30-year ones. What’s great is that you can apply for the insurance online, and you will not have to go through a medical exam. This way, you will not have to use agents to help you out.

Permanent Life Insurance

Permanent life insurance is, as the name suggests, a type of insurance that offers coverage throughout your whole life. Due to the fact that it builds cash value and lasts until you pass away, this insurance form is more expensive.

Throughout the life of the policy, the cash value will keep growing on a tax-deferred basis. You will be able to make a withdrawal or borrow against the cash value of your policy. You can also choose to terminate the policy, in which case you will obtain the cash value without the surrender charge.

Permanent life insurance will also come in different types, so you must be aware of this before you choose this form of policy.

You can get universal life insurance or whole life insurance. The latter gives you a fixed death benefit as well as a cash value component that increases over time at a specific return rate. Meanwhile, the former allows you to change your death benefit and premium payments as long as they don’t exceed limits.

Universal life insurance will also make the value of the cash increase based on the type of policy you choose.

Another type of permanent life insurance you can get is survivorship life insurance. It can offer coverage for two people at the same time under one policy. It is a preferred option for married couples, offering the beneficiaries money once both spouses have passed.

Lastly, there is also burial insurance – this one offers money to beneficiaries to pay for the funeral costs of the insured person, as well as other related expenses.

How Does Life Insurance Work?

When you get life insurance, you will enter a contract where you agree to pay premiums in order to keep the coverage going. The insurance will give you coverage over a certain amount of time, and after your death, the people named as beneficiaries on the policy will receive the money.

This money can be used either to pay for funeral expenses or to support the beneficiaries. Some life insurance types can bring living and death benefits to the table. Living benefits will let one take advantage of the death benefit of the policy even if they didn’t pass away.

Most individuals who have living benefits can take advantage of them in case they are ill and don’t have money to pay for medical treatments.

How to Choose the Best Life Insurance for Your Needs

It may be hard to choose a life insurance policy, especially considering there are different types to pick from.

You can go with term life insurance if you want a more pocket-friendly option or if you only need insurance for a certain period. It’s cheaper, and it will not last forever. This is a great choice for people who may want to cover their working years to help their relatives with finances after their passing.

But if you want to build cash value instead, you should look towards a permanent life insurance policy. Also, it lasts until your death.

How to Determine Your Life Insurance Coverage Amount

How can you tell how much insurance coverage you need? Well, there are a few things you can do to estimate the best amount for you.

Take all the expenses you want to cover and add them up. Then, subtract the amount of money that the beneficiaries would need to cover those expenses, like existing life insurance and savings. Retirement savings shouldn’t be included if your spouse may need them at some point.

The number you get will be the ideal amount you should opt for in your life insurance.

Life Insurance FAQ

Let’s take a look at some questions you may still have about life insurance:

How much does life insurance cost?

How much your life insurance costs will depend on a few things, like the insurance company you go for, the insurance type you choose, and your family history, health, and other aspects. Some people may only pay about $30 monthly, whereas others may pay more.

How much life insurance do you need?

Everyone will need different life insurance types. You can calculate your life insurance by considering your mortgage balance, your annual salary, and any expenses your family may need to deal with if you die.

Can you get life insurance with a pre-existing condition?

You can get life insurance even with a pre-existing condition, even if it’s more difficult. However, you should know that certain conditions may increase premiums, though.

How long do you have to pay into a life insurance policy before it pays out?

Usually, as soon as the life insurance policy begins, it will pay out upon the insured person’s passing. It all depends on the type of insurance you settled for.

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Final Thoughts

Life insurance comes in various types and will have different costs for everyone. If you want to apply for one, see how this kind of insurance works and establish if it’s right for you. Hopefully, this article was helpful in this regard.