If you’re like most American adults, chances are high that you’ve heard of life insurance and know that it’s something you need. But what is it exactly, and how does life insurance work?
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At its basic level, it’s an agreement between you and a life insurance company. You agree to pay them and in turn, they provide you with insurance coverage. You can think of it like a subscription service: as long as you pay premiums, you’ll be covered.
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The term: The length of time your policy will be in effect for — usually 10, 15, 20, 25, or 30 years, but you can also choose to be covered for your entire life, depending on the type of insurance that’s right for you.
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Life insurance can be extra important for small business owners. You might have taken on business debt using personal assets, like your home, as collateral. In that case, life insurance can help pay off debts that your family might otherwise have to cover.
Anyone with children should consider life insurance, whether they earn a salary or not. Even if you don’t have lost income to replace, you likely provide care that your family would have to pay for in your absence. Life insurance can also meaningfully contribute to college savings.
Covered for what? Well that really depends on you. Maybe you want to make sure your spouse will be able to pay the mortgage, no matter what happens to you. Maybe you want your kids to afford college. Or you might simply want to make sure your people will be ok paying day to day bills if you’re not around to provide for them.
This is a guest column written for The Penny Hoarder by Liana Corwin, director of communications and editor of the financial literacy blog at Ladder, a digital life insurance company that sells term life insurance at rates that can flex as customer’s financial needs change.
If you have a loan that someone else has co-signed, they may be required to make the full payments when you die. Consider life insurance if a parent has co-signed a student loan for you, for instance, or you co-borrowed a mortgage, personal loan, or home equity line of credit with a spouse, partner, or sibling.
How Does Life Insurance Work?
Premiums: The amount of money you pay in exchange for coverage.
The life insurance company will collect all that information when you apply in order to determine your premium. That process is called “underwriting.”
- Your personal characteristics (age, health, gender, etc.)
- The type of life insurance you choose, primarily between term and permanent
- The coverage amount/size of your policy (how much money you want to leave your beneficiaries)
Plus, if you co-own the business, a life insurance policy where your business partner is the beneficiary can allow him or her to buy out your share from your heirs at a price you decide on now. That can prevent a scenario in which your partner isn’t able to afford taking on your share of the business, and your children are left without income from the business or the proceeds from your portion’s sale.
You can think of life insurance as a way of replacing your income if you die during your policy’s term. If you support (or will support) a spouse, kids, parents, grandparents, siblings, or others and the loss of your income would affect whether they can pay for costs like food, housing, or childcare, you need life insurance.
Do I Need Life Insurance?
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1. You Contribute a Meaningful Portion of Your Family’s Income
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2. You Have Kids
Now that you have the basics, you might wonder if you need life insurance. To find out, ask yourself the following question: would your absence cause anyone financial strain? If so, the answer is yes, you need life insurance. Let’s take a look at the five top reasons you may need life insurance.
3. You Have a Mortgage or Other Shared Debt
Life insurance works like a subscription model: as long as you pay premiums, you’ll be covered. That means your beneficiaries should receive money (tax free) if you die, but it’s worth noting that claims can be denied for various reasons, like fraud or material misrepresentation (basically, not being honest on the application or the claim).
4. You Run a Business
Once you’re approved and have accepted your offer, you’ll start paying premiums. If you pass away while your policy is in place, your beneficiaries can file a claim to receive the amount of coverage you purchased.
You may want to consult with an attorney to ensure this is set up appropriately.
If you’re not in any of these groups, you may not need life insurance now, but make sure to reevaluate when major life changes happen, including when you take on debt. Also, keep in mind that buying life insurance when you’re younger can help you lock in a better price.
5. Your Life Insurance Through Work isn’t Enough
The amount you’ll pay in premiums depends on three big factors:
Most likely, it’s not. If you have access to a group life insurance policy at your workplace, there’s usually no harm in participating, especially if it’s included as part of your benefits package. But if you fall into any of the categories above, the death benefit included in your policy at work probably won’t be enough to adequately cover your beneficiaries’ needs.
None of the Above Apply?
Filing a claim: The process by which your beneficiaries can claim the coverage amount if you die.
No matter your goal, the right kind of life insurance should be a simple and affordable way to reduce the risk of getting there.
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Beneficiaries: The people who will receive the coverage amount.