How Does Life Insurance Work?

November 8th, 2021 by
How Does Life Insurance Work

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Before we discuss how life insurance works, it may be best to discuss its origin and how it came to be. 

Life insurance was designed originally to help with burial costs and care for surviving spouses and families, according to Nerd Wallet

Today, life insurance has become a powerful financial option. It is a contract between you and the insurance company. You make payments and in exchange upon your passing, it pays a death benefit to your beneficiaries, which can assist them in replacing your income or paying off debt when you pass.

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There are two major types of life insurance: term insurance, and permanent life insurance. 

Permanent life insurance covers you until the end of your life, whereas term life insurance covers you for a fixed amount of time. Term life covers are cheaper to purchase than permanent life. 

However, permanent life policies can build cash equity over time and won’t expire, if you have paid your premiums.  A term life policy has no value if you live the amount of time on the life insurance policy.

Life insurance is coverage that lasts for a certain amount of time. The most common amounts of time of coverage are 10, 20, and even 30 years. During this time period, should you die, the policy pays your beneficiaries the amount stated in the policy.  

If you do not pass during the time that is covered no one gets paid. This type of life insurance is popular due to its large payoffs at a lower cost than its sister policy, the permanent life.  

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Permanent life insurance policies have no limits on the amount of time that the policy covers, this type of insurance never expires as long as you are current on your payments.  

These policies also build cash value as they age. Some of the premium payments are added into a cash account, which can earn interest or be invested depending on the terms of your policy. You can use the cash value of your life insurance while you are still alive. 

Just like any other accounts you can borrow from it, make withdrawals or just use the interest to make payments to your premium. If need be, you can even surrender your policy and cash it for the current cash value of your policy. 

You need to know though that doing any of these actions to withdraw funds from your policy may create complicated tax issues. Make sure you talk to a financial advisor or a tax professional before doing so.

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