Life Insurance Policy

A life insurance policy is a contract between an individual and a life insurance company. In exchange for payments made by the insured individual, the insurance company guarantees to pay a benefit upon the individual’s death. The following are a few of the most common terms to understand when comparing life insurance policies:

  • Policyholder – The individual who purchased the life insurance policy to insure his or her life. A policyholder can also be referred to as the “insured”.
  • Premium – Payment made by the insured to the insurance company. Depending on the type of policy, the premium can be paid monthly, quarterly, annually or as one lump-sum payment.
  • Beneficiary – The person to whom the life insurance company pays the benefit upon the death of the policyholder. A beneficiary can be a family member, such as a spouse or a child, an estate or a charity.
  • Death Benefit – The amount of money paid to the beneficiary upon the death of the policyholder. In most cases, the death benefit is exempt from federal taxes.

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Why Buy a Life Insurance Policy

A life insurance policy offers financial protection and stability. Just as car insurance transfers the risk of the costs of an accident from the car owner to the car insurance company, a life insurance policy transfers the financial risk of death from the insured to the life insurance company. In the event of the policyholder’s death, the beneficiary can use the death benefit in any way he or she sees fit.

The benefit can be used for day-to-day living expenses, mortgage payments or other debt obligations. It can also be used to pay for a child’s private secondary or college tuition. In some cases, the death benefit is needed only to ensure that funeral, burial and other final expenses are covered.

What is a Term Life Insurance Policy

A term life insurance policy is regarded as a “pure” insurance policy. This means that the premium is applied only toward the payment of the death benefit and not to a cash building investment account. If the insured dies during the term, the death benefit is paid to the beneficiary. If the insured is alive at the end of the term, he or she will normally have the option of renewing the policy for another term or converting it to a permanent policy, depending on the age at renewal or conversion.

A term life insurance policy is in force for a specific length of time. The length of time is known as the “term”. While the length of the term will vary based on the type of policy sold and the life insurance company that sells it, the term can be as short as one year or as long as 30 years. The two most common types of term life insurance policies are:

Term Life with Annual Renewable Term

The term length on a term life insurance policy with an annual renewable term is 12 months. At the end of the 12 months, the insured is usually given the option to renew the policy, generally at a higher premium.

Term Life with Level Benefit

A term life insurance policy with a level benefit features a level premium. If the length of the term is 20 years, the premium will not increase during the 20-year term.

The two most important points to understand about term life insurance are that it is temporary and the premium is applied to the death benefit only.

What is a Permanent Life Insurance Policy

Unlike temporary term insurance, a permanent life insurance policy is in force permanently, provided premiums are paid in accordance with the contract. The death benefit is paid to the beneficiary when the policy matures upon the death of the insured. A portion of the premium is applied toward the cost of providing the insurance. The other portion is credited to a cash-building savings account that grows tax-deferred. A policyholder has the option of taking a loan against the accumulated cash value or of using the policy as collateral for a loan.

The premium in the early years of a permanent policy can be more expensive than the premium of a term policy. However, in later years, a permanent policy can be much more cost effective. There are two primary types of permanent life insurance: Whole life and universal life.

Permanent Whole Life Insurance

The most common whole life insurance policy is one that pays a dividend that is tied to the earnings of the insurance company. Known as a “participating” whole life policy, this type of permanent policy helps to ease erosion of the cash account due to inflation by increasing the death benefit.

Permanent Universal Life Insurance

The premium amount and schedule paid a universal life insurance policy can be adjusted according to the needs of the insured. Further, the amount credited to the cash portion of the account is based on a fixed rate of interest that is determined according to the contract and prevailing market conditions.

The two most important points to understand about a permanent life insurance policy are that it provides permanent coverage and builds cash value through a savings component of the premium.

When is the Best Time to Purchase a Life Insurance Policy

Insurance agents will always stress that it is best to purchase an insurance policy at the youngest age possible. The age of the insured at the time the policy is written will be reflected in the premium amount. All other criteria being equal, such as current health status, family medical history and lifestyle choices like tobacco-use, an older person will always pay more for a life insurance policy than will a younger person.

Young people also tend to be healthier than older people. While it is possible for an applicant to purchase a life insurance policy if he or she has high blood pressure, diabetes or heart disease, the premium will reflect the higher risk to the insurance company of having to pay the death benefit.

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