Life insurance can feel like a complex, intimidating topic for newcomers. There are many different companies, policy types, policy features, and considerations, all revolving around the tricky, sensitive subject of death. But you don’t need to become an expert overnight in order to understand the basics and shop confidently for a life insurance policy to protect your loved ones against unforeseen circumstances. This “Life Insurance for Dummies” guide will walk you through all the life insurance basics you need to know to get started.
Life Insurance vs Health Insurance
Before diving into life insurance basics, it’s important to understand that life insurance and health insurance are two completely separate things. Whereas health insurance can help you cover the costs of medical expenses and health-related costs, the purpose of life insurance is to help your loved ones cover the costs associated with your death after you pass away.
Life Insurance Basics
The three most basic components of any life insurance policy are the death benefit, beneficiaries, and premiums.
Death Benefit
The death benefit of a life insurance policy is the main reason for having the policy in the first place. Also known as the coverage amount, the death benefit is the lump sum of money that the life insurance company pays out to your loved ones if you die while the policy is active. This money can be extremely useful for making up for lost incomes, funeral expenses, and to cover expenses relating to other financial burdens, including unexpected expenses that may arise in the future.
Beneficiaries
Your beneficiaries are the people who inherit the death benefit payout when you die. You can name one or more primary beneficiaries and can split up the portion of death benefit that you’d like each one to receive however you’d like. You can also list contingent or secondary beneficiaries, who will receive the death benefit in case you outlive your primary beneficiaries.
Beneficiaries must be immediate family members or other close relations whose lives would be significantly impacted by your death. You can update your beneficiary list throughout the course of your life insurance policy to account for changing life circumstances such as marriage, divorce, having kids, and so on.
Premium
The premium is the cost of the life insurance policy. It is the amount of money you must pay regularly to keep the life insurance policy active. If premium payments are not made on time, a policy can lapse or expire, in which case your coverage, too, would lapse or expire, meaning that if you die during this period, your beneficiaries would not receive a death benefit payout.
Typically, the policy premium is paid on a monthly basis, but it can also be paid according to other regular payment schedules, such as annually, quarterly, or even bimonthly.
Life insurance rates are set at the time of purchase and vary based on a variety of factors associated with risk such as age, gender, medical history, and risky habits such as smoking or skydiving, as well as how much life insurance you are purchasing.
Cash Value
Some life insurance policies, in addition to the death benefit, have a cash value that accumulates over time with interest. This is a major advantage of permanent life insurance plans, which will be explained later on.
Policyholder vs Insured
Two more basic terms that are important to understand are “policyholder” and “the insured.” Oftentimes, these two terms refer to the same person, but not always. The policyholder, also known as the policy owner, is the person who maintains ownership of the life insurance policy, can make changes to it when necessary, and pays premiums, while the insured is the person whose life is being insured. Death benefit payouts are initiated when the insured dies, not the policyholder.
The most common way life insurance works is for a person to purchase a policy insuring themselves in order to protect their family. In this case, the policyholder and the insured would be the same person. Sometimes, though, someone will choose to purchase a policy insuring a loved one, such as a spouse or a child. In those cases, the policyholder would be the one who purchased the policy and is responsible for paying the premiums, while the insured would be the loved one.
Financial Needs That a Life Insurance Policy Can Help With
So, a life insurance policy will pay out a death benefit to your loved ones who are named as beneficiaries when you (the insured) die. But how exactly does this aspect of the life insurance policy protect your family?
The basic idea is that you insure yourself to protect the ones who rely on you for income or who would be otherwise adversely impacted financially if you were to die, especially early on in life or unexpectedly.
Final Expenses
One near-universal example of a financial impact that falls upon the shoulders of a person’s loved ones when they die is the category of final expenses. This includes things like funeral costs and burial expenses—important expenses that many of us don’t spend much time thinking about or planning for until it’s right in front of our faces.
Funeral and burial costs, such as the cost of a coffin or cremation, are often more expensive than many people realize. In the event that we leave our family members behind, we want them to be able to grieve without the additional stressors of finding a way to pay for these things. A death benefit payout, even if it’s a relatively small one, can go a long way toward easing this burden on loved ones.
Income Replacement
Another critical function served by a life insurance policy’s death benefit payout is replacing lost income. This is particularly important if you have dependents—children or a spouse who does not work, for instance—who rely on you for income. What would happen to these people if you were to die unexpectedly? Your spouse might suddenly find themselves in the uncomfortable position of having to scramble for employment all while dealing with the emotional toll of the grief over your passing.
A death benefit payout, depending on the amount of coverage, can make up for that loss of expected income for a significant period of time—possibly for the remainder of your loved ones’ lives.
Financial Obligations
Final expenses are one type of financial obligation that may fall upon your loved ones in the event of your death, but there are plenty of other important ones to consider. If you die with unsettled debts, for instance, your loved ones would inherit those debts, which can be particularly tricky if they depended on you for income.
You may also leave behind other financial obligations such as car payments or mortgage payments, which, if left unpaid, could tremendously impact your loved ones’ lives.
The death benefit payout of a life insurance policy can ensure that your family members do not lose their home or car or other important material staples upon which they depend. It can provide them with a means to pay for these financial obligations in your absence, particularly if they were depending on you for income.
Financial Planning
In addition to existing financial obligations, a life insurance policy can help your family plan financially for anticipated financial needs or obligations in the future. If you have children, for instance, the death benefit of a life insurance policy can serve as an additional pool of money to help pay for their college tuition or other major life milestones that can be costly.
Furthermore, a permanent policy’s cash value can be an extremely useful piece of a long-term financial plan, especially for families. Unlike the death benefit of a life insurance policy, the cash value is a living benefit of the policy (for those that have a cash value component). This means the policy’s cash value can be withdrawn or borrowed against for loans while you (or the insured) is still alive.
Even if you don’t currently own a home or a car, for instance, this is money that can be used to help make such major purchases and meet other financial goals when the time is right for your family.
What are the 3 Main Types of Life Insurance?
There are many different types of life insurance policies, but the three basic types are known as term life insurance, whole life insurance, and universal life insurance. Unlike term life insurance, which only offers a death benefit, whole life and universal life policies offer additional benefits, such as a cash value component.
Term Life Insurance
Term life insurance is typically the most affordable option for life insurance. This is because it is life insurance that is purchased for a specific period of time, or term: common term periods offered are 5, 10, 15, or 20 years.
During this preset period of time, the life insurance policy remains active as long as payments are made. If the insured dies during this period of time, the death benefit of the policy will be paid out to the listed beneficiaries. However, once the term ends, the coverage ends, after which there will be no death benefit payout upon the death of the previously insured person. Oftentimes, term life insurance policies can be renewed once the initial term runs out, but they would be renewed at a higher cost corresponding to the age of the insured at the time of renewal.
A term life insurance policy will not ensure lifelong coverage and protection for your family, but it can be a useful way to purchase a large amount of coverage at an affordable cost for a financially vulnerable period of time. You may choose to take out a policy with a term that corresponds to the number of years remaining on your mortgage, for instance, or the number of years during which you expect your children to be living with you and/or their college years.
Whole Life Insurance
Whole life insurance and universal life insurance are the two main types of permanent life policies. These are life insurance policies that are purchased not for a limited period of time, but for the remaining lifetime of the insured. There are many benefits of whole and universal life insurance, and, as such, they tend to have higher premiums than term life insurance of the same coverage amount.
Whole life insurance is typically the simplest, most straightforward form of permanent coverage. The policyholder purchases a policy with a premium rate corresponding to the insured’s age at the time of purchase. The insured will be covered by the policy for the remainder of their life as long as premium payments are made, and the cost of the payments will remain fixed at the same price, no matter how old the insured gets.
A whole life insurance policy also has a cash value that accumulates tax deferred with interest. It can be withdrawn or borrowed against for loans, depending on the specific rules and restrictions of the policy governing when this can occur, how much can be withdrawn, and if there are any penalties associated with doing so.
Universal Life Insurance
Universal life policies are very similar to whole life policies. They also offer lifelong protection at premium rates that will not increase with age. However, the main difference compared to whole life insurance is that universal life insurance allows for more flexible premiums.
The premium rate of a universal life insurance policy will not automatically increase as the insured gets older, but the policyholder may choose to raise or lower premiums at different points throughout the duration of the policy to increase or decrease the death benefit and rate of cash value accumulation.
The advantage of this is that, as you get older, your family’s financial means, goals, and obligations may change. If you are making more money 5 years into the policy than you were when you began, you may choose to raise your own premium, especially if you anticipate future expenses for which an increased death benefit or greater cash value would be useful, such as those mentioned earlier: having kids, paying college tuition, buying a house, etc.
Universal life insurance policies also tend to have different, more flexible rules regarding how the cash value of the policy can be used during the insured’s lifetime, so it’s important to understand these details by talking to an agent.
How to Buy Life Insurance: the Application Process
The process of applying for a life insurance policy can vary by company and policy, but there are certain standard steps you can expect.
Talk to an Agent
Many companies will offer a self-service or expedited process for applying for term life insurance because the risk of such policies is lower and therefore the level of scrutiny on the applicant is lower.
However, most companies will require you to talk to an agent before applying for a permanent insurance policy, such as a whole life or universal life insurance policy. There are several important reasons that necessitate this part of the process.
How Much Life Insurance Coverage is Right for You
The function of a life insurance agent is not just to sell you something. Life insurance agents are trained to ask you questions about yourself, your family, and your life circumstances that better position them to make recommendations regarding which type of policy offered by the company would be best for you, how much coverage you need, and so forth.
Even if you already know what type of life insurance policy you’d like to apply for, though, you will need to talk to an agent to get an accurate quote, or to see if you’d even be eligible for a particular policy, based on your age, health, and other considerations that are better assessed through dialogue than filling out a questionnaire online.
Filling Out the Application
When it comes to filling out the application itself, the procedure can differ across companies and policies. Again, a term life insurance policy will typically be the quickest and easiest to apply for, but filling out a whole life or universal life insurance policy can be relatively quick as well.
At American Fidelity Life Insurance Company, it typically takes our agents between 10 and 20 minutes to fill out an application, which can be done while in person or on the phone with the applicant. Our agents will ask you questions and fill out your answers on the application form and then have you complete it by signing the form and attaching any additional documents necessary, such as a photo of a driver’s license and/or military conversion forms.
In some cases, it may be possible to fill out an application for a whole life or universal life insurance policy online by yourself.
Underwriting Review
The application you fill out will include personal information and health questions pertaining to your medical history. These are all pieces of information that go into the risk assessment part of your application review, which is conducted by a life insurance company’s underwriters. Based on the consideration of several factors, they can choose to approve your application, approve it with certain exclusions or at a higher premium corresponding to higher risk levels, or deny it.
Assessing Health Issues: Medical Exams and Records
If the underwriters need more information to make a decision, they may request a release of your full medical records from your physician or care facility, or, in some cases, may request that you undergo a medical exam to determine more information about your current health and associated risks.
American Fidelity Life Insurance Options
American Fidelity Life Insurance Company offers term life insurance, whole life insurance, and universal life insurance. You can even combine a whole life or universal life insurance policy with a term life insurance policy to get the benefits of lifelong permanent life insurance, along with additional coverage for a set period of time.
To learn more and see what options might be best for you to protect your family and secure your financial future, submit a request to talk to an agent today.
