What Is Life Insurance?
New to buying life insurance? Learn how it works and what you need to understand to choose your coverage.
A life insurance policy is a contract with an insurance
company. In exchange for premium payments, the insurance company
provides a lump-sum payment, known as a death benefit, to beneficiaries
upon the insured's death.
Typically, life insurance is chosen based on the needs and
goals of the owner. Term life insurance generally provides protection
for a set period of time, while permanent insurance, such as whole and
universal life, provides lifetime coverage. It's important to note that
death benefits from all types of life insurance are generally income
tax-free.
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There are many varieties of life insurance. Some of the more common types are discussed below.
Term life insurance
Term life insurance is designed to provide financial protection
for a specific period of time, such as 10 or 20 years. With traditional
term insurance, the premium payment amount stays the same for the
coverage period you select. After that period, policies may offer
continued coverage, usually at a substantially higher premium payment
rate. Term life insurance is generally less expensive than permanent
life insurance.
Needs it helps meet: Term life insurance
proceeds can be used to replace lost potential income during working
years. This can provide a safety net for your beneficiaries and can also
help ensure the family's financial goals will still be met—goals like
paying off a mortgage, keeping a business running, and paying for
college.
It's important to note that, although term life can be used to
replace lost potential income, life insurance benefits are paid at one
time in a lump sum, not in regular payments like paychecks.
Universal life insurance
Universal life insurance is a type of permanent life
insurance designed to provide lifetime coverage. Unlike whole life
insurance, universal life insurance policies are flexible and may allow
you to raise or lower your premium payment or coverage amounts
throughout your lifetime. Additionally, due to its lifetime coverage,
universal life typically has higher premium payments than term.
Needs it helps meet: Universal life insurance
is most often used as part of a flexible estate planning strategy to
help preserve wealth to be transferred to beneficiaries. Another common
use is long term income replacement, where the need extends beyond
working years. Some universal life insurance product designs focus on
providing both death benefit coverage and building cash value while
others focus on providing guaranteed death benefit coverage.
Whole life insurance
Whole life insurance is a type of permanent life insurance
designed to provide lifetime coverage. Because of the lifetime coverage
period, whole life usually has higher premium payments than term life.
Policy premium payments are typically fixed, and, unlike term, whole
life has a cash value, which functions as a savings component and may
accumulate tax-deferred over time.
Needs it helps meet: Whole life can be used as an estate planning tool to help preserve the wealth you plan to transfer to your beneficiaries.