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How Does Life Insurance Work?

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Thursday, March 12, 2015

How Does Life Insurance Work?

Everyone's got an excuse to avoid getting life insurance. It's too expensive. It's too complicated. It's just too depressing. (After all, who actually enjoys planning for their death?)

Life insurance isn't fun to think about, and we get that. But your excuses just won't cut it anymore. Because life insurance, at its core, is pretty simple. And most importantly, it protects your family from financial ruin if something happened to you.

Here's a super simple overview of how life insurance works:

  1. You buy a life insurance policy for a certain time period.
  2. You pay to keep your coverage.
  3. If you die during your coverage period, your family gets money from your insurance carrier.

See, that wasn't so bad, was it? If you're not intimidated yet (and you shouldn't be), keep reading. We've got the answers to three big questions we know you have about life insurance.

1) What does life insurance cover?

Life insurance covers your family's cost of living after you're gone. It's a way to replace your income until your spouse gets back on their feet, and your kids are old enough to support themselves.

Now, the exact structure of your insurance plan depends on the type of life insurance you get, and the insurance company you buy it from. And what you pay for coverage depends on how much money you want your family to get if you die.

To figure out how much money your family should get, decide how many years you want your income to be replaced. (For reference, most experts say the minimum amount of income replacement you'll need is five to seven years.) Then factor in the cost of debts you'll have to pay for mortgages, car loans, and credit card payments. Your total will give you a rough estimate of how much life insurance coverage to get.

2) How does life insurance work when you die?

When you die, your life insurance carrier will pay your family the dollar amount you agreed to when you bought your policy. That amount is called a payout (or a death benefit).

So, if you buy a $500,000 policy, your beneficiaries (i.e. your family) will get half a million dollars when you die. They can decide if they want the full amount all at once, or paid over their lifetime.

For your family to actually collect the money, your policy's primary beneficiary (probably your spouse) has to fill out an insurance claim. They'll include your death certificate and cause of death. Your insurer typically has 30 days to review the claim.

If your family's claim is approved, your insurance carrier will fork over the amount you bought the policy for—usually within 30 to 60 days after the claim was filed. That timeframe isn't set in stone, but you should know that insurance companies want to pay your beneficiaries as soon as possible. If they wait too long, they risk being hit with interest charges for delaying your family's payout.

3) How does life insurance make money?

Say you buy a 30-year life insurance policy with a $500,000 value. You agree to pay $1,000 in premiums each year. If you die 28 years into the policy, you've paid the life insurance company $28,000. But once your family's claim has been approved, your insurer pays your family $500,000. That's a huge difference! Seems like your insurance carrier is losing big-time, right?

Not really. Because if you die with life insurance coverage, you're the exception, not the norm. Millions of people have life insurance, but only a small percentage will ever get a payout. Either they'll outlive their policy, or they'll decide they don't want life insurance anymore. Once they stop paying for coverage, or their coverage period runs out, their policy is canceled.

And that's where insurance companies make their money back. Whether or not someone keeps their policy for the long run, the premiums they pay (while they're covered) go to their insurer. Their insurer usually invests that money, and those investments earn interest. From those investment gains, the insurer creates a big enough cushion that they can afford the occasional payout for someone who dies while insured.

Life Insurance Covers Your Family When You're Gone

Investments made by insurance companies are why life insurance is so useful to your family. Insurers can build enough reserves that if you die during your coverage period, your family is guaranteed to get money back-even if it's worth 20 times more than what you paid in premiums.

That's a sweet deal. And it gives you the chance to take care of your family after you die. So, are you finally convinced it's time to get life insurance? Talk to an insurance agent today. They'll help you figure out just what type of plan you want, and how much you'll need to cover your family after you're gone.