A brief answer to the question that how does term life insurance work, is that the term life insurance offers coverage for a specific pre-determined term. The policyholder pays premiums and the insurance company pays guaranteed death benefit to the beneficiary if the policyholder dies during the term.
What is insurance?
Insurance is an arrangement by which the insurance company guarantees the compensation of any losses that happened to the life, health, vehicle, or crop of a policyholder, depending upon the type of policy an insured has bought.
The policyholder pays regular policy premiums depending upon his budget, either on a monthly or annual basis. To better understand that what is insurance, it can be referred to as a fence against unexpected financial damage that may occur to the policyholder. For example, if you have bought life insurance, you don’t need to worry about the financial problems of your heirs if you face an accidental demise.
What are the types of insurance?
Insurance is further divided into various types depending upon the need for the policyholder, such as life insurance, health insurance, pet insurance, or mortgage insurance. Some of these types have been discussed below:
Life insurance
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Life insurance is a type of insurance in which the policyholder pays regular premiums and the insurance company provides guaranteed death benefit to his nominated
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beneficiary/beneficiaries.
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What is life insurance and how does life insurance work? These are the must-know things for a person who is interested in buying a life insurance policy. Life insurance has two main types, permanent life insurance, and term life insurance.
Health insurance
- In a health insurance policy, an insurance company covers the hospital bills or surgical expenses of a policyholder.
- No matter a person is young and healthy, he should be aware that what is health insurance and how much a health insurance, just to convince himself that in this age of various diseases, how important a health insurance policy is.
Car insurance
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Car insurance is mandatory by law in the USA and in the presence of various cheap car insurance companies, one should always go for a car insurance policy to cover the accidental damage to his car.
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Don’t worry at all if you are a new driver and have a fear that there may be any damage to your car. You can go for the car insurance policy for new drivers, to be on the safe side if any loss happens to your car because of less experience on roads.
Mortgage insurance
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If a person is going to be a mortgage lender, he should be well aware that what is mortgage insurance and how can it help him with the problems while mortgaging.
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Mortgage insurance is a type of policy that provides financial protection to the mortgage lender, if the mortgage borrower fails to make pre-decided payments, meets the death, or faces any other problem with the payments of the mortgage.
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This insurance policy either pays to the mortgage lender or heirs of the lender, according to the conditions mentioned in the policy.
Pet insurance
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If you are a pet lover and want to keep a pet, you will obviously have to visit a veterinary hospital. To avoid these veterinary expenses, you should buy a pet insurance policy. To buy the best pet health insurance policy, first, you should know that what is pet insurance and what does it cover?
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Pet insurance is a type of insurance policy that offers the coverage of all veterinary bills of your pet at the pre-determined premium rates depending upon the policy plan.
See also:
Are health insurance premiums tax-deductible?
What is the best pet insurance to get?
How much is renter’s insurance per month?
What is life insurance?
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Life insurance is a legal agreement between an insurer and policyholder, represented by a policy. According to this policy, the policyholder pays premiums either monthly or annually to the insurance company and the company provides a death benefit to the beneficiary of the policyholder when the policyholder dies.
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Main components of life insurance are the policy premiums, cash-value plan in case of permanent life insurance, and a guaranteed death benefit.
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Life insurance is the best option for those who have dependents that will suffer from the financial crisis in case of their accidental death. Especially if you have a dependent spouse or handicap children, you must buy a life insurance policy.
What are the types of life insurance?
Life insurance is an umbrella term that represents a number of insurance policies that differ from each other in the way of payment, premium rates, or the duration of their enforcement.
There are two main types of life insurance policy:
Permanent life insurance
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[Permanent life insurance](https://www.investopedia.com/terms/p/permanent life.asp#:~:text=Permanent%20life%20insurance%20refers%20to, policies%20enjoy%20favorable%20tax%20treatment.), is a type of life insurance policy that remains active throughout the life of a policyholder and doesn’t expire after a specific duration.
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It has several subtypes, that are termed as universal life insurance, whole life insurance, variable life insurance, and variable-universal life insurance.
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Permanent life insurance is a lifetime companion and not only offers the death benefit but also the cash-value account that serves as an investment account.
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Policyholder can borrow against the accumulated cash value and if there is enough amount in the account, he can even pay premiums from there.
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But there is a need to be careful regarding the cash value account in the sense that if there is an insufficient amount and the premiums are also not being paid, the policy may collapse.
Term life insurance
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Term life insurance is another important type of life insurance that is popular because of certain attractive aspects. Term life insurance policy remains in force for a certain duration, pre-determined in the policy. When the term ends, the policy gets expired.
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Policyholder then can contact the insurer and can proceed in three possible ways.
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Policyholder can renew the term insurance policy for another term
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Policy can be converted from term insurance to the permanent insurance
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Policyholder can terminate the term life insurance policy if he doesn’t need it anymore.
How does life insurance work?
If you want to buy life insurance and don’t have deep knowledge about how does life insurance work? It would be beneficial for you if you go through the details that how does life insurance cost and how can it serve you.
Wise choice of policy
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As above mentioned, details provide a brief knowledge about the differences in permanent life insurance and term life insurance, a person who is interested in buying a policy should make a sensible choice according to is budget and ease.
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If you want to invest your money along with the death benefit, you should go for permanent life insurance. However, premiums for permanent life insurance are higher as compared to the premiums of term life insurance. So, it’s a matter of affordability other than the matter of choice.
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While if you don’t have enough budget to pay heavy premiums, or want to make a separate investment, the term life insurance is the best choice. When the term expires, a policyholder has several options. He can withdraw the money when he needs it the most.
Nominating a beneficiary
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Next step is the nomination of the best suitable beneficiary. The beneficiary is the person who receives the death benefit when the policyholder dies. The policyholder can mention more than one beneficiary with the details regarding the percentage of the share they will receive.
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Other than the primary beneficiary, there is a contingent beneficiary in case of death of a primary beneficiary or any other unexpected situation such as divorce. The contingent beneficiary is the person who will receive the payout instead of the primary beneficiary.
Payment of premiums
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Premium is the money that a policyholder pays to the insurance company. Premiums can be paid either monthly or annual basis depending upon the policy plan or the ease of policyholder.
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Premiums can also be paid in advance and in the case of permanent insurance, the amount accumulated in the cash-value account can also be used to pay premiums.
Claim for death benefit
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When the policyholder dies, there are very low possibilities that the insurance company or an insurance agent would have been knowing about his death. So, it’s the duty of the beneficiary to contact the insurance company and inform them about the death of the policyholder, claiming the death benefit.
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To make a claim, the beneficiary has to submit the death certificate of the policyholder and other required documents mentioned by the insurance company. After a complete investigation, the insurance company pays the death benefit to the beneficiary, maybe within the duration of one month.
Summary
Life insurance is a contract between an insurer and an insured. Insured pays regular premiums and nominates a beneficiary. When the insured dies, the death benefit is claimed by the beneficiary. Life insurance can either be permanent or term life insurance.
What are the average life insurance rates?
Life insurance rates vary according to age, gender, health conditions, type of insurance policy, and the rates of an insurance company. However, some average rates according to the gender have been tabulated below:
Average life insurance rates for males:
| Age | $ 250,000 | $ 500,000 | $ 750,000 |
|---|---|---|---|
| 20 | $ 17.84 | $ 28.25 | $ 29.75 |
| 30 | $ 17.86 | $ 28.73 | $ 40.47 |
| 40 | $ 24.33 | $ 41.03 | $ 58.49 |
| 50 | $ 53.65 | $ 95.55 | $ 138.69 |
| 60 | $ 150.60 | $ 266.75 | $ 390.85 |
Average life insurance rates for females:
| Age | $ 250,000 | $ 500,000 | $ 750,000 |
|---|---|---|---|
| 20 | $ 14.48 | $ 21.64 | $ 29.78 |
| 30 | $ 15.18 | $ 23.03 | $ 31.87 |
| 40 | $ 21.20 | $ 33.81 | $ 48.08 |
| 50 | $ 41.77 | $ 71.66 | $ 104.58 |
| 60 | $ 110.79 | $ 192.53 | $ 283.22 |
See also:
What is universal life insurance and how it works?
What is spouse supplemental life insurance?
What is life insurance? A complete guide to beginners
What is term life insurance?
In simplest words, term life insurance is a legal contract between an insurance company and the policy owner. In this contract, the policy owner is agreed to pay premiums for a specific term, that can range from one to 30 years.
In return, the insurance company guarantees to pay a pre-determined death benefit to the beneficiary of the policyholder, if he dies during the term of the policy.
Term insurance is less expensive than permanent insurance and offers ow premiums. But there is no cash value facility other than the fixed death benefit.
Procedure of a term life insurance
As the name indicates, term life insurance policy remains active for the specific term as compared to the whole life or universal life insurance policies that don’t get expired and cover the whole life of the policyholder.
There are different types of term life insurance that work in a slightly different way from each other. There are several types of term life insurance that are discussed below along with their way of working.
1. Level term insurance
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As indicated by the name of the policy, in level term insurance, the premiums are leveled throughout the term and so is the death benefit. Neither there is any fluctuation in the rates of premiums nor in the amount of death benefit. It’s the most convenient type of term life insurance.
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Premium is usually paid per month and is calculated according to the age, health condition, and the life expectancy of the policyholder. If the policyholder passes away before the expiry of the term, the insurance company will pay the face value of the policy.
2. Convertible term life insurance
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Convertible life insurance policy has the edge that it can be converted to any type of permanent life insurance before the expiry of the term. There is a time of certain years before expiry, in which the policyholder can convert it from one form to another.
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One of the important benefits of a convertible life insurance policy is that the policyholder doesn’t have to go through a medical exam as happens in the permanent life insurance. No other medical conditions are considered while changing the policy from term life insurance to permanent insurance.
3. Increasing term life insurance
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Increasing term life insurance is an attractive form of term life insurance in the means that it provides an increase in death benefit with the age of the policy. Death benefit increases either monthly or annually.
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Premiums are also increased in some policy plans but it gives the adroitness of paying the low premiums in the early age of policyholder when it’s difficult for him to pay high premiums.
4. Decreasing term life insurance
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By the above-mentioned details of increasing term life insurance details, it’s quite easy to understand that how does decrease term life insurance work, as they both are simply opposite to each other.
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In contrast to the increasing term insurance, the death benefit in the decreasing term life insurance decreases with the increasing life of insurance policy. Premiums remain fixed throughout the term and death benefit decreases monthly or annually.
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This type of insurance policy is also known as mortgage term insurance because the mortgage debts also decrease with the age of the policyholder and so does the death benefit in decreasing term insurance.
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As with the time and age, expenses and personal loans, etc. also decrease, so the policyholder is satisfied with this type of life insurance when there is no need for the high death benefit.
5. Group term life insurance
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You may wonder that what is group term life insurance and how does group term life insurance work if you have started working in a company or organization.
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Group term life insurance is a kind of life insurance that is provided to a whole group of people instead of an individual person. This type of insurance policy is offered to the companies or organizations that want to provide insurance coverage to their employees.
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Premiums of group term life insurance are mostly or fully paid by the company. However, the coverage is not that enough and an employee can buy supplemental life insurance to meet his needs.
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Master contract of the insurance policy is kept by the company owner and the employees are provided with the certificates as proof of insurance policy.
Summary
Term life insurance policy remains active for a specific term and when the term reaches, it gets expired. After expiry, it can be renewed, converted, or terminated by an insured.
Advantages of term life insurance
Term life insurance policy should be considered when you want to give your loved ones an immediate financial help just after your death. Although it’s a single product policy yet it’s beneficial in several ways.
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Low premiums and high death benefit
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Best way to fulfill short term needs
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Young policyholders may get more coverage at a low premium rate
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Convertible policy, if a person wants to switch it from term insurance to the permanent one without passing through any medical exams
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Renewable once gest expired, can be renewed for next term
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Various kinds of term policies (e.g. level term, increasing term) can be acquired in combination to meet the needs
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It provides confidentiality regarding the beneficiary and amount of death benefit
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Payouts are not considered to be taxable and are totally tax-free
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After the receiving of death benefit by the beneficiary, it’s free from estate taxes.
Frequently asked questions
There are a lot of questions that have been asked by people who are interested in the life insurance policy, for their own satisfaction. Some of these questions are answered below:
How much life insurance do I need?
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Having a life insurance policy is a wise decision to ensure the coverage of the financial needs of the heirs, in case of death of a policyholder.
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How much life insurance a person needs varies according to the personal and financial situation of a policyholder. However, the insurance amount should be enough that it should be a replacement for the income and cover the expenses of the dependents of a policyholder.
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Experts advise that the insurance amount should be 10 to 15 times the income of the policyholder to meet the required needs of his heirs in case of his death.
What does life insurance cover?
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Life insurance covers most types of natural deaths, death due to medication overdose, death in a road accident, death because of some lethal diseases e.g. cancer or sometimes it also covers a suicidal death.
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If a policyholder dies because of any of the above-mentioned causes, the insurance company is obliged to pay the pre-determined death benefit to his beneficiary/ beneficiaries.
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This death benefit is usually enough to cover the expenses of dependents of the policyholder. However, how much death benefit a beneficiary receives, depends upon the policy that the policyholder has bought.
What are the rates of the best life insurance companies?
Some best-known life insurance companies and their monthly premium rates have been tabulated below along with their ratings in the year 2020.
| Company | Monthly cost | Rating |
|---|---|---|
| Haven life insurance company | $ 10.93 | 4.3 out of 5 |
| State farm insurance company | $ 15.02 | 4.2 out of 5 |
| Banner life insurance company | $ 8.78 | 4.1 out of 5 |
| Principal insurance company | $ 9.00 | 4.0 out of 5 |
| Northwestern mutual insurance company | Not available | 4.6 out of 5 |
Which is better term or whole life insurance?
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Both types of insurance policies have their associated pros and cons. Although whole life insurance covers the full life of an insured and offers a cash value along with the death benefit, yet there are some cons that it offers high premium rates as compared to the term life insurance.
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Term life insurance policy remains active during a specific term and offers the death benefit to the beneficiaries if the policyholder dies within that specific term. It has the edge of having low premiums as compared to the whole life insurance. However, it offers no cash value plan as an investment account.
Is life insurance taxable?
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If you are interested in buying the life insurance then the question must pop up in your mind that is life insurance taxable? Generally speaking, life insurance is not taxable, especially the term life insurance is totally tax-free.
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However, a permanent life insurance policy becomes taxable in certain situations. For example, money accumulated in the cash value account if exceeds the paid premiums, because of the interest build-up, excess money when withdrawn is considered as taxable.
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Similarly, employer-paid premiums as happens in the group term life insurance, if exceed the limit of $50,000 considered to be taxable.
Conclusion
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The answer to the question that how does term life insurance work lies in a simple explanation. Term life insurance is a contract between an insured and the insurance company. According to this, the term life insurance offers coverage for a specific term that may range from 1 t 30 years.
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Policyholder pays premiums either monthly or annual and when the term expires, the policy can be renewed for the next term, can be converted to another type, or can be terminated by the policyholder.
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