A life insurance policy will pay designated beneficiaries on the death of a covered individual. As a general rule, the higher the payout amount, the higher the premium paid by the owner of the policy. Although life insurance can offer some peace of mind for loved ones, it's crucial to understand how it works, financially speaking. There's a major difference, for example, between term and whole-life policies.
How Term Insurance Works
Life insurance can be a significant investment of money, and considering any life policy means taking a hard look at what the money buys. A term insurance policy is one that simply accepts regular premiums from the owner and then pays out a fixed benefit on the death of whomever the policy covers, who might not be the same individual as the owner. Unlike a whole life policy, a term policy does not accumulate any cash value in the meantime. This means that, upon death of the insured individual, the policy only pays out if payments have been kept current; if payments stop before the individual dies, the policy is no longer in force and will not pay out any money.
The Savings Feature of Whole-Life Insurance
In contrast to a term policy, whole life insurance sets up an investment account for the owner. The monthly or quarterly premium pays for the life insurance as well as a deposit into the account, which may be invested in mutual funds or other vehicles. This "sub-account" gains value free of taxes over the years, depending on how its stocks, bonds or other investments do. In the meantime, the owner of the policy can borrow against it. The death benefit is reduced by any outstanding loan at the time of the death.
Life Insurance Payouts
Both whole life and term policies are financial contracts, in which the insurer guarantees payment on the death of the covered individual. The "face amount" of a term policy is the amount of money to be paid, divided among beneficiaries as indicated in the contract. If beneficiaries don't notify the insurance company of the death, however, the money may simply remain in the company's bank account, unclaimed. Some states enforce a requirement for insurance companies to regularly check the Social Security Death Master File to ensure they don't have an unpaid but legitimate claim on their books.
Lapsing Premiums and Policies
If the owner of a life insurance policy doesn't keep up with the premiums, then the policy lapses. The insurance is no longer good, and the insurance company has no obligation to make the contractual death benefit payment. Also, there's no refund of prior premiums in a term life policy under these conditions.