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How does life insurance work?

Permanent life insurance is a policy that you maintain for the rest of your life—unless you cancel the policy. It’s usually bought for estate-planning purposes; that is, leaving a lump sum to your beneficiaries. The other key differences are that your premiums typically don’t increase and most permanent policies accrue some cash value.

There are three subtypes of permanent life insurance:

  • Whole life, often considered the “standard” of permanent life insurance. It has a cash value that builds up over time, so you’ll get some money back if you cancel, and you’ll likely be able to borrow money from it or use it as collateral for a loan. Although bear in mind that if you don’t completely repay what you borrow from your policy, this will affect the payout your beneficiaries receive.
  • Universal life is insurance and an investment account in one. Like whole life insurance, it has a cash value, but you can also use the account to make investments, which will affect the value of the policy; invest wisely and your loved ones will get a bigger payout. One caveat is that your premiums could increase if there’s a consistently poor return on your investments. 
  • Term-to-100 is a hybrid of term and permanent life insurance. It provides level coverage through to age 100, but it doesn’t offer any cash value. Accordingly, premiums are lower than those for the other types of permanent life insurance. 

Term vs. permanent life insurance

Term life insurance policies are typically less expensive than permanent life insurance policies because the majority of people will outlive the policy and therefore not collect (unless you buy a 100-year term). The amount you pay in premiums is determined when you purchase the policy and will stay the same for its duration, but you can expect premiums to increase if and when you renew your policy (after, say, 10 or 20 years), as the costs are adjusted to reflect the increase in your age. Term life insurance is of good value for temporary needs and is what most people opt for when they still have young families, debt and/or a mortgage.

The premiums for permanent policies are higher since a payout at some point is guaranteed (because everyone dies eventually). But, on the upside, you can rest assured the premiums won’t increase as you age or face health challenges. So the younger and healthier you are when you acquire your policy, the lower the premiums. 

There can be some flexibility with permanent life insurance premiums in that they can be paid either over the duration of the policy or over a shorter period by paying an increased amount. As well, universal life and some whole life policies offer the option to pay more so you can take full advantage of the investment option, a strategy that can be used to increase the final payout or to help fund retirement or other income needs later in life. But it’s generally used by high-income earners who are at their limits with traditional tax-free investments. (Learn if life insurance can be used as a fixed income investment.)

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Who can be named as a life insurance beneficiary?

When you are insured, you can name a spouse, children or other dependants, such as a friend or extended family member or even a charitable organization, as a beneficiary. If you name more than one beneficiary, the insurance company will divide the death benefit between all chosen beneficiaries. You can also elect to specify what percentage of the payout each beneficiary will receive—for example, 75% to your spouse and 25% to your child.

You can choose to name your estate as a life insurance beneficiary, in which case the death benefit becomes a part of your estate and is distributed as specified in your will. However, that the benefit would then be subject to estate administration tax and creditors could potentially claim the funds to pay any outstanding debts.

With a life insurance policy, beneficiaries can be revocable or irrevocable. Revocable beneficiaries can be changed at any time without the need to notify them. With irrevocable beneficiaries, you must have written permission to change the beneficiary.

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