Five things to know about life insurance

ife insurance is similar in some ways to auto insurance; you pay premiums on a policy designed to protect you from something you hope never happens. In the case of life insurance, it's unfortunately not a matter of "if" your policy pays off, but when. When you pay a car insurance premium you are protecting yourself against the expenses related to an accident; with life insurance you protect your family from the expenses connected with your death—loss of income, funeral costs, and more.

There are five basic things everyone should know about life insurance. Before you sign on the dotted line for a new policy, you should feel comfortable with your understanding of these five things and how they affect your investment.

New Policies

Are you starting your very first life insurance policy or transferring to a new one? If you have never used life insurance before, it's important to evaluate the financial implications of your new plan. What are your premiums? Will they stay the same as your current life insurance quotes over the lifetime of your policy or are they subject to change? Can you afford to pay for life insurance if the premiums go up later on? These are all questions you should ask your insurance agent, and yourself.

If you are transferring to a new life insurance policy, many insurance experts advise against cancelling your old policy—at least until you are certain you are covered by the new policy. Cancelling the old policy too early leaves you without coverage until the official start date of your new plan. If anything happens to you in the meantime, your family won't be paid unless your death occurs on or after the date listed on the new life insurance plan.

Whole Life Insurance

There are two kinds of life insurance, term life and "whole life", also known as "cash value" life insurance. Whole life insurance is advertised as having investment value, with possible dividends and an accrual of cash value. The dividends on a whole life policy are paid only when the insurance company finds the actual costs of the life insurance policy are less than the cost of the premiums. Payments of dividends are at the company's discretion and are not guaranteed.

The cash value of whole life insurance builds up over time, and the terms of whole life insurance allow you to take out a loan against that value (at the interest rate specified by your policy). Under whole life, you aren't simply entitled to the cash value, you must borrow against it. Any borrowed amount counts against the amount of any final settlement in the event of your death.

Under the conditions of your whole life insurance you may be able to cash out your policy at some point to collect the accrued value, but this requires you to cancel the policy. Payments for whole life are stable and won't change over time, which is one reason some people are attracted to whole life insurance.

Term life insurance

The other type of life insurance plan is called term life, which offers death benefits and no investment options such as offered by whole life. Term life insurance policies are attractive to some because they usually feature lower premiums, but those premiums are subject to increases over the life of the policy.

Your insurance agent may recommend using term insurance if you plan on keeping the policy for ten years or less, but other life insurance experts say whole life is a better investment if you need the insurance for 20 years or more (because you may have the option to cash out after the plan expires).

Whether you choose term life or whole life is strictly a matter of choice, but once you decide you may feel committed for the duration of the policy so it's important to consider your needs and ability to pay before signing up.

Renewal Policies

Your life insurance policy may have specific requirements for renewal for a second or third term. Is a health exam required? Will your premiums increase after renewal? How long is your original life insurance policy and how often will you be required to renew? Make sure you understand what conditions may disqualify you from renewing and evaluate your comfort level with those conditions.

Your Health Affects Your Premiums

Many life insurance plans charge more for those signing up with pre-existing health conditions. It's best to invest in life insurance when you are in good health, but this isn't always possible. If you have the ability to invest before health problems are officially diagnosed, you could save yourself a lot of money on life insurance premiums. Know what medical conditions could affect your ability to sign up for a lower rate or renew.