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What is life insurance? It’s a dark subject, but it’s an important thing to understand when you’re building your financial safety net.
The term “life insurance” is actually a bit of a misnomer, as it’s not paid out when you’re alive. Rather, it’s an insurance policy that provides your family with tax-free financial support in the event of your natural or accidental death.
But before you run out and buy a life insurance policy, it’s important to understand what it is, how it works, and whether or not you need it.
What is life insurance and how does life insurance work?
Life insurance is an insurance policy with one major benefit: the death benefit. The name sounds grim, but a death benefit refers to the money paid out to beneficiaries when you, the insured person, pass away.
When you die, your family will receive a set amount of money to replace your income for a short period of time. The value of this amount, as well as the premium you pay to keep your policy active, depends on what type of life insurance you buy.
Typically, term life insurance, which guarantees protection for the duration of the term, provides the most coverage at the lowest cost. Permanent life insurance, on the other hand, never expires as long as you pay your premium.
Aside from which type of policy you buy, the price of life insurance also depends on:
- Your policy length
- The amount of coverage you want your death benefit to pay out
- How risky you are to insure based on your age, health, and hobbies
What is the purpose of life insurance?
Unlike car or medical insurance, your life insurance payment is not linked to a particular expense. Instead, your benefit functions as a financial safety net and temporary income for your family. Your beneficiaries can use your death benefit to pay for anything, including:
- Your end-of-life care
- Rent or mortgages
- Utility bills
- Unpaid debts or loans
Some beneficiaries also use a portion of the death benefit to pay for the policyholder’s funeral.
Does my life insurance kick in right away?
Depending on your policy and insurer, your life insurance payment benefits may kick in immediately. But in some cases, you may have a waiting period of up to five years before the death benefit takes effect, though the average waiting period is usually one or two years. Some companies do offer policies with no waiting period, though these come at a higher cost.
What is not covered by life insurance?
Life insurance pays out the death benefit following most natural and accidental deaths, such as illnesses, car accidents, or workplace incidents. But some cases may not qualify for payout at all, or if they do, it’s only for reduced payouts.
Some of these cases include:
- Application fraud
- Suicide within the first few years of opening a policy
- A beneficiary murdering the policyholder
- Dying during risky activities such as skydiving, auto racing, or mountain climbing
- Dying while working as a logger, offshore oil rig worker, or underground miner
Note that in the events of deaths resulting from risky activities, your beneficiaries may still qualify for life insurance if you pay higher premiums. But some insurers may tack on an exclusion that prevents payouts if you die while working or doing a dangerous activity.
Can you be denied life insurance?
It is possible to be denied life insurance. It’s also not unheard of for an insurer to cancel your life insurance policy. Common reasons to be denied coverage include:
- Old age
- Poor physical health
- A history of mental health issues
- Risky lifestyle choices, hobbies, or occupations
- Having a criminal record
- Having a bad driving record
Additionally, your insurer can cancel your life insurance policy in limited cases including nonpayment of your premium or application fraud.
Do you have to have good credit to get life insurance?
Did you know that having bad credit can actually make it difficult to get life insurance coverage? As of 2018, 90% of U.S. life insurance companies were found using or considering using credit-based scoring as of 2018. And while a low credit score doesn’t mean you’ll automatically be denied coverage, it can make your premiums more expensive.
If you’re worried about your credit score affecting your eligibility for life insurance or any other type of insurance, check out the MoneyLion Credit Builder Plus membership. For just $19.99 per month, you’ll gain access to:
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- Monthly reporting to all three major credit bureaus
- A likely boost of 60+ points in your credit score in 60 days
- Credit monitoring tools with updated weekly reports
- And much more!
Advantages of life insurance
Having life insurance comes with one primary advantage: the life insurance payment your beneficiaries receive when you die. And it’s a big advantage, as the payout–which can reach into the hundreds of thousands or millions of dollars, depending on your policy–will replace your income for a set period of time. Having a life insurance policy can provide peace of mind to yourself and your family because they know they’ll be covered in the event that the worst of the worst happens.
Disadvantages of life insurance
Life insurance comes with a few disadvantages, too. The most daunting aspect of life insurance is the cost, which can reach up to hundreds of dollars per month. And if you opt for term life insurance, you can potentially outlive your policy and be on the hook for a more expensive plan later in life.
Plus, if you miss a premium payment, your insurer may cancel your life insurance policy altogether. In this case, you’ll likely have to reapply and face the possibility of paying more for your new policy.
Life insurance vs annuity
Life insurance policies and annuity contracts are both insurance products but there are some important differences. For one, life insurance pays out on the policyholder’s death. However, annuities function as financial safety nets with a lifetime of guaranteed income.
Secondly, while a life insurance payment is almost always tax-free, annuities can be either tax-free or tax-deferred, meaning your beneficiaries will pay taxes on the payout.
Build your financial safety net with MoneyLion Investing
So, what is life insurance? It’s essentially a very important way of protecting your family’s financial security in case of your premature or accidental death. But it’s not the only financial safety net available to you.
If you’re ready to take charge of your financial future, a MoneyLion Investing account can help. For just $1 per month and no asset-based management fees, you can get invested for as little as $5 upfront. Invest what you want, when you want, or turn on the auto-invest feature and let MoneyLion manage your portfolio for you.
Whether you want to contribute toward an invested retirement plan, bolster your safety net, or save toward specific goals, a MoneyLion account can help you get started.