How does a life insurance policy work?

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In this day and age, passing up on life insurance can put your family in serious financial risk. So what makes it worth buying? A life insurance policy covers you in the event of death, paying out a cash lump sum to your family when you die. This can provide them with financial security for years to come, covering various future costs. 

In this article, we’ll explain how a life insurance policy works, as well as the types of cover available…

Types of life insurance policies

Once you have been accepted for cover, you start paying a regular premium. You need to continue making these monthly payments to remain covered during the policy term. There are different types of life insurance plans, depending on your needs and budget. Here’s a breakdown of the three main types of life insurance to choose from…

Whole life insurance

As the name may already suggest, whole life insurance covers you for the rest of your life. When you die, your insurer pays out a cash lump sum to your family, helping them through this difficult time. Unlike a standard life insurance policy, whole life insurance pays out regardless of when you die – so long as you continue paying premiums.

There are two types of whole life insurance policies:

  • Standard whole life cover – During the policy, the cost of your premiums and the value of your death benefit remain fixed indefinitely.
  • Maximum whole life cover – Your insurer invests the money from your monthly premiums to cover the eventual pay out. If the investment is successful, you can receive bonuses. But if it fails, your insurer may increase your premiums to make up the loss.

One downside to whole life cover is that premiums are typically more expensive than other types of life policies.

Term life insurance

While whole life insurance covers you indefinitely, term life insurance covers you for a set period of time. The policy pays out, providing you die within the agreed term. If you survive, the policy expires, and you won’t be able to claim anything on the premiums paid up until that point. A term life insurance policy has 3 levels of cover:

  • Level term cover – Both your premium rate and death benefit have a fixed value throughout the policy. For cheaper premium costs, you should apply for cover at the earliest stage.
  • Increasing term cover – the death benefit of your policy increases over time to protect its value from inflation. This means your family receives the same amount of money, keeping in line with the cost of living. One downside to this is that your premiums may also rise over time.
  • Decreasing term cover – Ideal for covering large payments, your family would struggle to pay alone, such as a mortgage loan. As you make repayments, the value of the death benefit decreases. That way, if you die before the mortgage has been repaid, your family will be left with enough money to clear the outstanding balance.

Term life policies are usually the most affordable type of life insurance, however it only provides cover for a certain amount of time. Another option to consider is applying for a joint life insurance policy.

Joint policies cover two people in one policy, often working out cheaper than buying separate policies. The policy typically pays out after the first death in the couple – known as ‘first death’. You can also get a ‘second death’ policy, which pays out after you and your spouse have both died.

What does a life insurance policy cover?

The pay out from your life insurance policy can help your loved ones cover future finances:

  • Funeral costs
  • Living expenses
  • Household bills
  • Outstanding debts and loans
  • Money to cover your family unable to work due to illness or injury

If you want to know how much cover you need, it’s best to look at your monthly income. This can open a window as to how much money your family will lose each month after your death. life insurance policy. For further advice on how much cover you need, you should speak to an insurance advisory broker or financial consultant.

Can I cash in a life insurance policy?

Yes, you can cash in a life insurance policy. However, it is important to know that cashing in a life insurance policy is not always as easy as it sounds. The first thing you need to do is find out whether you can cash in the policy – for this, you’ll need to contact your insurance provider.  When cashing in a life insurance policy, you typically incur a surrender penalty. With this, the money you receive from the policy will be much less than the original amount.

Now that you know how a life insurance policy works, choose from one of the countless life insurance providers online to give your family peace of mind. Or if you’re looking for an affordable policy, apply through a specialist advisory broker.

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