How Does Life Insurance Work?

Let’s be honest: life insurance isn’t a pleasant topic. But it’s something most people eventually need, and it’s important to understand how it works. With life insurance, you pay premiums to the insurance company so that the company will pay a certain amount to your family when you die to cover funeral costs and help them adjust to not having your income anymore.

 

Pricing Depends on You

The price that you pay depends on the type of insurance you’re getting, but also on your life expectancy. The company uses data about your health history to estimate your life expectancy. It accounts for your age, sex, family history, use of tobacco, health, dangerous activities, and more. The premiums you pay are meant to cover the eventual benefits your family gets back, some administrative fees, and at least a small profit for the insurance company. So if you’re old and in poor health, it’s going to be pretty expensive because you will probably pay higher premiums for a shorter period of time. If you’re young and healthy, the chances that you’ll die early are low, so it’s more likely that you’ll be paying smaller premiums for a longer amount of time.

Payouts

When the time comes for payouts, there are a couple of options. When you die, your family will either get a lump sum payment or an annuity. If the benefit is paid as a lump sum, they will get all the money at once, but also have to pay taxes on all of it at once. If it is paid out as an annuity, they will get money in payments for a set period of time, or for their entire lives, depending on the case. Most life insurance policies do not cover suicide, and will open an investigation if they suspect fraud.

There are  a few different types of life insurance, all with different advantages and disadvantages.

Term Life Insurance

With term life insurance, you make regular payments for a certain amount of time. If you die within that period of time, your family gets the death benefit. Policies are renewable in most cases, and often have low premiums.

Whole Life Insurance

With whole life insurance, all you have to do is keep paying. If you keep paying premiums, you are insured. Whole life insurance policies typically have an investment portion, so there is a bit of growth that can be withdrawn or borrowed against. This is the simplest type of life insurance.

Universal Life Insurance

With universal life insurance, there is a guaranteed minimum interest rate with which your money grows. There are short term interest rates, and any premium payments that exceed the cost of the insurance are added to the part of the account that grows interest. The upside to universal life insurance is that you have a savings and insurance portion, but the downside is that the interest rate can change.

Not Fun but Necessary

Life insurance is a scary thing to think about, and an even scarier thing to have to put your money into. But it’s good for your family in the long run, and it’s important to consider.

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