Because life insurance is such a valuable asset, you need to make sure that you’re getting the best policy for you and your loved ones. However, before making a final decision, it’s crucial to understand the various components that may be included.
Regardless of the type of coverage you’re looking for, knowing what is inside your policy can help you make the best decision. Here is what you need to know.
Breaking Down a Life Insurance Policy
To make this process easier, we will start from the top and work our way down. There are multiple types of life insurance available, and each one has slightly different advantages and disadvantages. Let’s begin.
Types of Life Insurance
Technically speaking, there are only two forms of coverage available – term and whole (permanent) life insurance. However, you can break these down further to include universal and burial insurance since they have unique features. Here is a breakdown of each type and how it works.
If you simply want to get peace of mind for you and your family without paying a lot per month, term life insurance is the best option. These policies are highly affordable, and you can often get a sizable death benefit. However, the downside is that you don’t get to accumulate any money during the life of the plan. Once it expires, you can either renew it, or you won’t be covered.
Besides affordability, another advantage of term life insurance is that it is easy to understand. All you have to do is pick the length of your plan (the term) and the amount of your death benefit (i.e., $50,000). If you’re unsure how much coverage you need, learn more about how much life insurance you might need.
Typically, when buying term insurance, companies will use a table to determine your monthly rate. These tables typically focus on the following elements:
- Gender (men pay more than women)
- Smoker vs. Non-Smoker
- Death Benefit
There may be other factors that affect your rates, such as your medical history and income. Typically, insurers will want to focus on your health if you have any pre-existing conditions (i.e., sleep apnea or diabetes) or if you are over 50. However, some insurance companies may want to see your medical history, regardless of age.
Your income may come into play if you want to buy high levels of life insurance. Companies will use a table to determine how much you qualify for. Usually, the limits are 25 times your income until age 40, and then it reduces by five for every ten years after that. So, for example, if you make $50,000 at age 40, you could get a policy worth up to $1.25 million. Once you reach 50, the limit becomes $1 million ($50,000 x 20).
Although term life insurance expires, whole life insurance does not which is why it’s sometimes referred to as permanent. As long as you continue making payments, you are covered forever. Because of this, premium costs will be much higher than term policies, and they will only get more expensive as you age.
One of the primary benefits of whole life insurance is the inclusion of a cash value portion. This portion allows you to save money during the life of your plan, which you can use for retirement, to pay off premiums later in life, or to borrow against.
Depending on the company you choose, whole life insurance rates may increase with age after you have purchased a plan. Typically, the premiums will go up every two to five years, which can make coverage prohibitively expensive once you reach retirement age.
Fortunately, some companies will allow you to lock in your rates, which are called level premiums. If you decide to take advantage of this option, be sure to buy early so that you can get lower payments each month.
There are two additional types of whole life insurance – universal and burial. Here are some details about how they work.
- Universal – This option is similar to standard whole life insurance, but it allows you to invest your cash value more aggressively. You can also choose to contribute more of your monthly payment to the CV so that it grows faster.
- Burial – If you want permanent life insurance but don’t care about getting a cash value or high death benefit, burial insurance is a smart choice. These policies have lower benefit limits (i.e., $25,000) since they are designed to cover final expenses, such as your funeral.
Basic Components of a Life Insurance Policy
Now that we’ve covered the various types of life insurance, let’s go over the different elements that may be included. Knowing these terms will help you compare policies more efficiently since you know what to look for before making a final decision.
- Premium – This term refers to your monthly payment.
- Death Benefit – The amount your beneficiaries will receive when you die.
- Cash Value Portion – If you purchase whole life insurance, a part of your monthly premiums will go into a separate account. The longer you have the policy, the more money you can put away.
Another factor to consider when talking about the cash value portion is a paid-up addition. Simply put, this is like buying a one-time policy that adds more money to your CV. Paid-up additions are helpful if you want to build a more significant fund faster and you don’t have universal insurance.
Owner vs. Insured vs. Beneficiary
Here is where the components can get a little complicated. When reading through your policy, you can choose different individuals for each of these titles. Because you don’t have to put the same person in each place, it can seem confusing at first. Here is what they mean:
- Owner – The person who legally owns the policy. So, if you purchase a life insurance plan, you are the owner.
- Insured – The individual being covered by the policy. For example, if you buy life insurance for yourself, you are both the owner and the insured. In this case, once the insured dies, the policy activates, and a death benefit is paid.
- Beneficiary – This is the person who will receive the money once the insurance goes into effect.
Typically, people will buy life insurance for themselves, but it is possible to purchase plans for others as well. There was a time when anyone could get coverage for anyone else, but insurance companies have prohibited that in recent decades.
As a rule, anyone you name as the insured has to be related to you, and you will need their consent. For example, if you want to buy a policy for one or both of your parents, you will need written permission from them to do so. This stipulation exists to prevent insurance fraud.
You can buy life insurance for your children as well. The benefit of doing this is that you can transfer ownership once they turn 18. For example, you can buy a universal life policy for your child and contribute funds into the cash value portion until they turn 18. Afterward, they can assume ownership, and now they have life insurance coverage and a substantial CV, which they can borrow against or continue to grow.
When it comes to beneficiaries, you can name multiple individuals. Depending on the situation, there are two terms to know – per capita and per stirpes. Per capita means by the individual, while per stirpes means by the branch of the family.
For example, let’s say that your death benefit is $100,000, and there are four beneficiaries. Under per capita, each person would receive $25,000. However, let’s say that two of them are your children, while the other two are grandchildren of one of your kids.
The per stirpes designation only comes into play if a beneficiary predeceases you. So, if the child with grandchildren dies before you, their portion of the death benefit ($50,000) would be split between the grandkids.
You can find out more about how per stirpes and per capita work here.
Another critical component of life insurance is a coverage rider. Most companies will offer these as additional benefits on your policy. Depending on the insurer you choose, you may have access to more riders, which can make your coverage even better.
In most cases, riders will cost extra, but not always. The purpose of these add-ons is to make your life insurance more comprehensive. Typically, they can either increase the death benefit under specific circumstances or allow you to access living benefits.
Here is a breakdown of standard life insurance riders you can find.
Accidental Death and Dismemberment
This is one of the most prevalent options, and almost all insurance companies will offer it. Best of all, it is often free, so there is no downside to adding it to your plan. AD&D riders will add an extra portion to your death benefit if you die from an accident. For example, if your plan will pay $100,000, the rider may add another $25,000 for your beneficiaries.
In cases of dismemberment (where you lose a limb), you can access the rider benefit while you’re still alive. In this instance, you can receive $25,000 for losing an arm, and your beneficiaries will still receive $100,000 when you die.
Unfortunately, extended stays at the hospital can be quite costly. Whether you need to have surgery or long-term treatment, you could have to spend thousands of dollars until you get better.
With a critical care rider, you can access a portion of your death benefit to help cover these expenses. This rider has specific requirements, such as a minimum length of stay. For example, you can’t access the money for an overnight visit to the hospital, but you can if you are there for three days or more.
This rider does cost extra, and you cannot access the full death benefit. The exact amount available will depend on your plan and the insurance company.
While a critical care rider covers medical costs associated with a significant injury, terminal illness riders provide more flexibility with how the funds are spent. The goal of this rider is to help you make final preparations, which may or may not include medical costs. As with the critical care rider, this option costs extra, and the amount of money you can receive varies.
There are two ways that you can receive benefits if you become disabled. As a rule, a disability prohibits you from performing specific tasks, making it much harder for you to find work. Some insurance companies may want to conduct a medical exam to determine the extent of your disability, so be aware of that.
The first option is a waiver of premium rider. In this case, the company will waive all premiums without canceling your coverage. This rider goes into effect for as long as you are disabled. There is usually a two-year waiting period, and individuals with pre-existing conditions or disabilities cannot qualify.
The second option is a disability income rider. In this instance, you can receive a portion of your death benefit if you become disabled. This money can either be paid out in a lump sum or installments, depending on your plan.
Contact NextGen Life Insurance Today
Buying a life insurance policy is one of the most crucial decisions you’ll make, so you want to choose wisely. While this information is useful, it can seem a bit overwhelming, particularly when comparing plans and rates from different companies.
Fortunately, we can make the process easier by walking you through each step. Get your free quote today or call us at 646-216-4199 to get started.