How Do Life Insurance Policies Work

Based on a Forbes Advisor survey conducted in August 2023, while many people find life insurance crucial, over half (52%) of the American population is uninsured.



This blog will help you understand how life insurance works and how it will fit into your long-term financial planning.

Key Takeaways

• Life insurance provides a death benefit to your beneficiaries.
• There are several kinds of life insurance, including term and permanent policies.
• Premiums keep your policy active and can be paid monthly or annually.
• Choosing the right policy depends on your financial goals and budget.
• A life insurance advisor can help you navigate the application process.

What is Life Insurance?

Life insurance policies work by paying out a guaranteed death benefit to your beneficiaries. The lump sum amount of your life insurance covers funeral expenses, outstanding loans, credit card bills, or even daily living expenses.

When you purchase a life insurance plan, you agree to pay premiums either monthly or annually. These payments keep your policy active. In return, the life insurance company guarantees to pay the death benefit to your beneficiaries when you pass away.



You don’t just choose the first insurance policy you see. Choosing the right policy is essential because it needs to match your financial goals and budget. A Moorestown life insurance advisor can help you determine how much life insurance coverage and what type of policy you need.

Types of Life Insurance Policy

Life insurance is a big umbrella—it comes in several types. Understanding the different types of life insurance is key. Each has its benefits and drawbacks. The best choice depends on your individual needs and circumstances. Let’s break it down so you can find the best fit for your needs.

Term Life Insurance Policy

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. Think of term life insurance as a temporary financial safety net. If you pass away within that term, the policy pays out to your beneficiaries.



The catch? If you outlive the term, there's no payout. But term life insurance policies are more affordable, so it's a cost-effective way to secure financial protection.

Permanent Life Insurance Policy

On the other hand, permanent life insurance is like a lifelong companion. This insurance plan includes options like whole life coverage and universal life insurance. These policies cover you for your entire life and often build cash value over time.

• Whole Life Insurance Policy: Offers a fixed premium and guaranteed growth in cash value, which makes it predictable and simple.
• Universal Life Insurance Policy: Adds a bit more flexibility with adjustable premiums and death benefits, making it a versatile option.



Choosing the right life insurance policy type depends on your financial goals, how long you need coverage, and your budget. If you’re looking for lifelong coverage and an investment component, permanent policies are the way to go.

What Does Life Insurance Cover

Life insurance typically covers death from natural causes and accidents. It also sometimes covers suicide, though there might be conditions. It’s always a good idea to check the specifics of the policy you’re considering.

Here are the most common types of death covered by life insurance:

• Natural Causes: Terminal illnesses, cancer, old age, or any natural health condition.
• Accidents: Death from accidental injuries (motor vehicle accident, drowning, and poisoning)

Exclusions

• Suicide: Often excluded if it occurs within the first one to two years of the policy.
• High-Risk Activities: Death from activities like skydiving or extreme sports may be excluded unless specifically covered.
• Illegal Activities: Death resulting from participating in criminal activities is usually not covered.
• Undisclosed Health Conditions: Your beneficiaries won’t receive death benefits if you lie on your application.

How Premiums Work

Knowing how life insurance premiums work will guide you in choosing the best option. 

Your premium is the amount you pay to maintain your policy. Premiums vary based on age, health, type of policy, and coverage amount.



In general, term life insurance has lower premiums at first. But the premium will increase when you renew, especially as you get older or if your health changes.

Meanwhile, permanent life insurance premiums are higher but remain fixed throughout your life.

Many life insurance companies assess risk through underwriting. This process often involves a health questionnaire or medical exam. Healthier individuals often pay lower premiums. For example, a healthy 60-year-old might have lower premiums compared to someone with health issues.

You can choose to pay your premiums monthly, quarterly, or annually, depending on your insurance plan. Some insurers offer discounts for annual payments. To avoid policy lapses, it’s important to keep up with your premium payments.

The Role of Beneficiaries

Whenever you buy life insurance, naming your beneficiaries should be one of your top priorities.

Beneficiaries are the people or entities you choose to receive the death benefit from your life insurance policy. You can name one or multiple beneficiaries and designate percentages of the benefit to each. For example, you might allocate 60% of your policy’s death benefit to your spouse and 40% to your child.

As the insured person, you need to review and update your beneficiaries regularly. Policy reviews should be done, especially after major life events like marriage, divorce, or childbirth. Always keep your beneficiary information up to date to ensure your wishes are honored.



After your passing, your beneficiaries need to file a claim with the insurance company. This involves submitting a death certificate and a claim form. The insurer then processes the claim and pays out the life insurance death benefits.

Financial Benefits and Considerations

Life insurance isn’t just about providing for your loved ones after you’re gone. It also offers several financial perks that can help you manage your financial obligations and plan for the future.

Cash Value Accumulation

With permanent life insurance policies, your premiums help build cash value over time. Think of this cash value component as a small investment fund that grows at a steady rate.

Unlike term life insurance, which doesn’t accumulate cash value, whole-life policies provide a nest egg you can access. It gives you a financial cushion that you can rely on during tough times.



And after several years, you may have built up a nice lump sum that you can borrow against. If unexpected expenses arise, you’re allowed to take out a loan from your policy without selling other assets.

Tax Benefits

Another positive aspect of life insurance is that the cash value grows tax-deferred. You won’t pay taxes on the growth until you withdraw it. Such tax benefits can help your investment grow faster. This is especially useful when planning for retirement.



Plus, the life insurance death benefit paid to your beneficiaries is usually tax-free. This can be a huge relief because your loved ones will receive the full amount. They won’t carry the burden of paying taxes on it, which can ease their financial obligations during challenging times

Life Insurance as Collateral

Your life insurance policy can also serve as collateral for loans. If you need money for major expenses like medical bills or home repairs, you can use your policy’s cash value as a guarantee. This option is less risky than putting up your house or other valuable assets.

Withdrawals

Since life insurance has a cash value component, policyholders can withdraw money directly from the cash value. However, withdrawals can reduce the policy's value and potentially impact the policy’s death benefit. Make sure to discuss the terms with your insurance provider before making any decisions.

Cancellations and Surrender Value

If you're thinking about canceling your life insurance policy, you might be eligible for a surrender value. This refers to the portion of the cash value that has built up over time.

People usually cancel their policies if they no longer need life insurance or if they want to use their money for something else. When you surrender a policy, you get the cash value minus any surrender charges.

For example, if your policy has built up $10,000 in cash value and there's a $1,000 surrender fee, you’ll receive $9,000.



Keep in mind that canceling or surrendering your policy means you’ll no longer have life insurance coverage. You might also face tax implications on the money you receive. Always consult with a life insurance advisor to understand the impact of cancellations on your financial plans.

Life Insurance Payouts

Life insurance payouts or death benefits are the cornerstone of life insurance policies. They offer crucial financial support to your beneficiaries and can include extra options and certain restrictions.

Understanding Death Benefits

The death benefit is the amount your insurance company pays to your beneficiaries when you pass away. This can cover significant expenses like end-of-life expenses, college tuition, or mortgage payments. Typically, this payout comes as a lump sum, which means your loved ones get the entire amount at once.



Let’s say you have a $250,000 life insurance policy with your spouse as the beneficiary. When you pass away, your spouse receives the entire death benefit of $250,000. This can help pay for daily living expenses or even be invested in future needs.

Additional Riders and Benefits

Riders are optional features you can add to your policy to enhance its benefits. For example, an accidental death rider increases the payout if you die in an accident. Some common riders include:

• Accidental Death: Adds extra payout if death is accident-related.
• Waiver of Premium: Stops premium payments if you become disabled.
• Critical Illness: Provides a lump sum if diagnosed with a severe illness.



Adding these riders can make your policy more comprehensive.

For instance, a critical illness rider might provide funds if you're diagnosed with a serious condition like cancer. This money can help cover medical bills and other expenses during a financial hardship.

The Insurance Application Process

Applying for life insurance involves several steps:



1. First, you must fill out an application with details about your age, gender, health profile, and other personal information.
2. Next, you’ll undergo underwriting where your risk level will be evaluated. This may include a medical exam, where factors like blood pressure and cholesterol levels are checked.
3. Next, the insurer will determine your premium based on this data.
4. Life insurance companies may begin to offer no-cost consultations to help you through the process.
5. Once approved, your policy will go into effect after you pay your first premium.

Let’s Protect What Matters Most

Life Is unpredictable, but your insurance journey shouldn't be.

Leonard Financial Solutions can help you take the guesswork out of insurance. Our Moorestown life Insurance advisors are ready to explain the ins and outs of your insurance coverage.

As a reputable insurance agency, we are dedicated to finding the best policy for your specific needs. We empower our clients and their families by making insurance simple and easy.



Ready to secure your future but don't know where to start? Contact Leonard Financial Solutions today for a free consultation!