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How Does Life Insurance Work?

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Life insurance works by providing a financial safety net for loved ones if you pass away.

It’s essential to know the details of how life insurance works so you can decide what type of coverage you need, how much you need and how it will fit into your long-term financial planning.

What Is Life Insurance?

Life insurance is a contract between you and an insurance company. In exchange for your premium payments, the life insurance company will pay a lump sum known as a death benefit to your beneficiaries after your death, as long as your policy is in force. If you have permanent life insurance, there may be a cash value component, too.

How Does Life Insurance Work?

Life insurance works by providing your beneficiaries with a death benefit payout if you die, but only if your policy is in-force when you pass away—meaning you have paid the required premiums while you’re alive. The death benefit can be used for any purpose your beneficiaries choose.

Before you enter into a life insurance contract, the life insurance company will determine your required premiums. There are several factors that affect life insurance quotes, including:

  • Age
  • Gender
  • Health and medical history
  • Coverage amount you choose
  • Type of life insurance (such as term life vs. whole life)

The younger and healthier you are, the better your quotes will be. Comparing life insurance quotes with several reputable companies is a great way to start finding the best coverage for a good price.

What Is the Purpose of Life Insurance?

Financial protection and peace of mind are at the forefront of life insurance. The best life insurance companies offer coverage options that help you ensure your loved ones will be financially taken care of if you die. Knowing your family will not face financial hardship when you’re gone provides peace of mind.

What Is Life Insurance Used For?

Life insurance beneficiaries can use the money paid out by a policy for whatever purpose they choose. Often this includes:

  • Paying for living expenses that were previously covered by the insured person’s income.
  • Paying off credit card bills, medical bills, mortgages or car loan balances.
  • Paying for funeral and final expense costs.
  • Funding children’s college tuition and expenses.

Having the safety net of life insurance can ensure that your family can stay in their home and pay for their wants and needs.

In addition, many life insurance policies include living benefits. This feature allows you to take money from your own death benefit while you’re still living, but only in specific cases outlined in the policy. These can include cases where:

  • You’re diagnosed with a terminal illness.
  • You develop a chronic or critical illness.

You can use money from living benefits to pay for anything you like, such as medical bills not covered by health insurance or mortgage payments. When comparing life insurance vs. health insurance there are no similarities, but living benefits can pay health care costs.

What Does Life Insurance Cover?

Life insurance typically covers all causes of death—generally excluding suicide within the first two years of the policy. That means all these causes of death, and more, are covered:

  • An accident, such as a car crash
  • Heart attack or disease
  • Homicide (except if the insured is murdered by a beneficiary)
  • Illness
  • Old age
  • War or terrorism

What Does Life Insurance Exclude?

Most life insurance policies have a suicide exclusion: The company will not pay out a death benefit for suicide within the first two years of the policy.

Although suicide is usually the only listed exclusion, a life insurance company still has the right to deny a claim if it believes there was misrepresentation on the life insurance application, especially if the death is within the first couple of years of owning the policy. For example, if someone lies about their health or other information on the application, the life insurance company could deny a claim by the beneficiaries.

In other extremely narrow cases, a life insurance claim could be denied if the beneficiary killed the insured person. This exclusion is called the “slayer rule.”

If the claim is disputed by someone who says the policyholder was coerced into changing the beneficiary, a court may have to decide who gets the death benefit money. Still, the life insurance company will pay the claim once a court decides who is the rightful beneficiary.