Let’s say you buy a life insurance policy that has kicked in immediately or after a waiting period, and you meet your unfortunate demise a day, or several years, later. Will your beneficiaries receive the entire payout? Broadly speaking, yes.
Did someone say “waiting period?” That’s the time between the opening of the policy and when it actually goes into effect.
Term life insurance is known for having no waiting period. Coverage starts when the policy is approved. Other kinds of insurance that might not have a waiting period are whole life policies that involve questionnaires and medical exams, and simplified issue life insurance, which is seen as a last resort.
More on waiting periods later.
So, how long do you have to have life insurance before it pays out? If you have, say, a 25-year term life policy, then your loved ones are usually covered for 25 years. If you have an active whole life policy, the entire death benefit is generally in place during your lifetime. (A caveat: Suicide within the first two years of a policy or fraud can nullify the death benefit.)
There’s a significant cost difference between term life and permanent life insurance, though. Stay tuned.
Life Insurance Basics
Life insurance can be an important step in financial planning, and there are several options when it comes to plans. The two main types to evaluate are term life and whole life. These two kinds of policies are sold by the majority of life insurance companies.
Life insurance is meant to protect a spouse or partner, children, or other family members upon your death. It is intended to replace your income and avoid a large financial loss while paying the costs of a funeral or a memorial service.
The two types of policies have a vastly different approach to how payments are made. Because everyone’s financial circumstances vary, discussing your options with a financial, legal, or tax professional can be helpful before you make a decision.
Understanding the basic goals of term life insurance and how it is different from whole life insurance is helpful. Life insurance policies typically have many rules and fine print.
How Does Term Life Work?
Term life insurance is often viewed as more cut and dried because it pays for a set period of time, such as 20 or 30 years—the term. Policy owners make regular monthly payments during the term.
Term life insurance covers a set period, such as 20 or 30 years.
Parents often buy term life insurance while their children are younger and before they go to college or establish careers.
The insurance company pays out the amount of the coverage if the policy owner dies during the term.
The coverage can range from $100,000 to several million dollars, depending on financial needs and plans. If a policyholder dies after the time period chosen, the insurance company will not provide the payout.
The intent of term life insurance is to ensure that your financial responsibilities are taken care of in case of an illness or tragedy. A life insurance policy can support the financial needs of children, address a stay-at-home parent, or cover a mortgage, credit card bills, or other debt.
Monthly payments for term life insurance are fixed, which means they are the same each month.
Some people who choose term life insurance do so because they are also saving money. They project that combination of the insurance and their savings will be sufficient to take care of the financial needs of their family in case of their death, or their children will be self-sufficient by the time the policy ends.
What Is Permanent Life Insurance?
The other type of life insurance is called permanent life insurance, and it provides coverage for a lifetime. When you purchase whole life insurance, a common kind of permanent life, the policy remains in effect for the rest of your life unless you cancel it or miss payments.
Whole life insurance is more complicated because there is a “cash value” included in the policy. These financial products are seen as a combination of insurance and savings.
One of the main differences between term life and whole life insurance is the amount of the premium, or the money that you pay each month to maintain the policy. Whole life insurance is usually more expensive than term life insurance because it provides longer coverage.
There are several things to evaluate before you purchase either term or whole life insurance. Examining the options will help you decide which type of insurance will meet your financial needs the best.
Some life insurance companies will make policies effective immediately, while others impose a wait of a year or two.
Waiting periods were created to avoid fraud and are one way that insurance companies protect themselves. For instance, if you die before you make a payment for your premium, the insurance company will not make a payout.
If the insurance company does not have a waiting period, the policy is likely to be more expensive than one that requires someone to wait.
A waiting period of two years is common, but it can be up to four. If you were to die during the waiting period, your beneficiaries can claim the premiums paid to date, or a small portion of the death benefit.
When applying for any life insurance policy, it’s best to ask if there is a waiting period and whether any exceptions exist. Then, once a policy is issued, it’s smart to confirm the details.
The Price Tag
One major factor in weighing term life and whole life insurance policies is the monthly premiums. Typically, term life insurance costs less—often much less—than whole life insurance, even though the coverage amount is the same.
The difference is that whole life insurance has a cash value component, and if you need to borrow money you can use that money as collateral based on the interest rate given in a policy. The cash value part of a whole life insurance policy is taxed by the IRS because it is accruing interest.
Whole life insurance has a cash value component and costs more than term life.
Cash value can be viewed as an expensive way to save money, thanks to commissions paid on the premiums and other built-in costs.
One main difference between term life and whole life is that if you live beyond the term that you chose, no money is paid out. Term life insurance policies have no cash value.
Making the Right Choice
Choosing between term life and whole life insurance policies can be difficult. While whole life insurance policies have a savings portion, the “cash value” is invested by the insurance companies and they choose what assets they want to invest in.
Other criteria that may help you make a decision are whether you are married or not, if you have children and how old they are, if you think your salary will increase over time, and how much debt you have, such as your mortgage, other loans, and credit cards that would need to be paid off if you died.
Changing a Current Policy
You may already have a life insurance policy, but life circumstances can change rapidly: remarriage or divorce, adoption of children, or a change in salary. Some life insurance companies will allow you to either increase or decrease the amount of coverage easily.
Whole life insurance policies usually are more complicated, and changes may mean that you will have to pay administrative fees.
Some permanent life policies have a surrender charge, which is subtracted from the top of your policy if you end, or surrender, sooner than expected. Surrendering a policy means giving it up. You’ll receive the cash value, minus any fees. By canceling the policy, your heirs will receive nothing from it when you die.
Ladder Life term life insurance policy made available through Ladder Insurance Services, LLC (Ladder) and underwritten by Fidelity Security Life Insurance Company, Kansas City, MO. Product availability and features may vary by state. Not available in New York. The California license number for Ladder is OK22568. Policy Form No. ICC17-1069, M01069, Policy No. TL-146.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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