Life insurance policy explained
Life is full of risks
Risk is a part of everyday life and regardless of preventative measures we make to minimize the chances of adverse events happening, we can’t prevent all bad events in our lives. However, we can buy insurance to help deal with the financial fallout from these adverse events. More specifically, life insurance offers financial protection for surviving dependents after the death of an insured person.
Life insurance options
Life insurance policies come in five different options:
- Term life insurance provides protection for a pre-defined number of years – it does not cover the whole life of an insured person. There are renewable term policies for periods of one, five, ten, fifteen, or twenty years. If the policy owner survives the term, no benefits are paid out.
- Whole life policies give the full coverage as they pay the face value of the contract when the policy owner dies no matter when this event occurs.
- Universal life is a life policy that allows you to change the premium level, payment schedule and death benefit. The main benefit is that it’s flexible; you can dial it up and down as your circumstances change.
- Endowment policies combine term life insurance with a savings plan. Unlike traditional life insurance, which pays benefits when the policyholder dies, endowment insurance policies pay benefits after a pre-determined term has expired or when the insured dies – whichever comes first. Also, compared to term life insurance, an endowment entitles the policy owner to collect benefits even if he or she survives the term.
- Annuities. Unlike other types of life insurance, which are typically there to help the family in case the insured person dies, annuities act as a safety net, usually for older people, by providing them a guaranteed stream of income for life. The insurance company agrees to pay the policyholder a certain sum for a specified period, ranging from several years to the whole life. In other words, the objective of an annuity is to protect the insured person against the possibility that they will outlive their other sources of income.
Unique features of life insurance
Choosing a policy and coverage that best fits your circumstances enables security and is a convenient tool for saving and tax-free estate planning. Compared to other insurance policies, there are two features of life insurance that makes it unique.
First, the beneficiary of a life insurance policy is not the insured person, but other people that has been designated as beneficiaries.
Second, unlike other types of insurance, the event that it covers (death) is uncertain in any given year but is certain in the long term. As the person ages, the probability of death increases over the term of the life insurance policy and, therefore, the insurance company must accumulate funds to pay for a claim that is going to occur with an increasing probability. That’s the reason why it gets more expensive to buy life insurance as you age.
Life insurance policies are also a very tax-efficient way to transfer wealth to your loved ones as death benefits are typically paid to beneficiaries income tax-free.
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