What Is Life Insurance and How Does It Work?

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A life insurance plan is essentially a contract between a person and the insurance company where the company guarantees a lump sum payout as a death benefit to the policyholder in exchange for premium payments that the policyholder has to make on the policy. The money is paid out to the nominee(s) of the policyholder in case of an untimely demise to help them meet their financial needs and requirements such as paying off EMIs, higher education for the children, and mortgage payments, etc. This makes a life insurance plan one of the most important investments for a person, as it allows their dependents to continue to live their lives without having to compromise on their dreams and ambitions. 

Types of Life Insurance

There are multiple types of insurance policies available today; however, two of them are the most common: 

  • Term life insurance: This is an insurance policy that guarantees life cover only till a certain period after which the policy terminates even if the policyholder is alive. 
  • Permanent life insurance: This insurance cover is a whole life cover and stays in effect as long as the person is alive. 

Now let’s look at these two policies from a wider perspective to better understand how they work! 

Term Insurance Policy

This is considered to be one of the most affordable plans in the market and is arguably the highest selling one due to its coverage amount and lower premiums. This policy is best for people with dependents looking for a pure life cover for a certain period only with no savings or maturity benefit component involved. 

A term insurance policy comes with a variety of term periods which can vary from 10 years to 30 years, and the premium remains the same throughout the policy term with no increase. In the event of an untimely demise of the policyholder, the nominee(s) get a lump sum amount up to the sum assured paid out as a death benefit which is non-taxable. 

Once the policy period is over and you want the coverage to continue, then you would need to renew the policy on a yearly basis, and the premiums would shoot up each year. 

Permanent Life Insurance Policy

As the name suggests, this policy offers lifelong coverage to the policyholder and is significantly expensive compared to a term insurance policy. Moreover, unlike a term policy, it usually helps you build a corpus which gets accumulated over the duration of the policy on a tax-deferred basis. This allows the policyholder to borrow money against the policy and also make a withdrawal. This gives the policyholder the dual advantage of a term insurance policy coupled with a savings and maturity benefit component. 

Now that we have looked at both the policies let’s look at how you can decide which one you should go for! 

It all depends on your personal preference and what you want to achieve from the policy. If your goal is to simply have a life cover for a certain period which is affordable, and you don’t want any savings or maturity benefit component as part of the plan, then a term insurance policy should be your ideal approach. However, if you are willing to pay a higher premium to get coverage for life, along with a building cash value, then you should invest in a permanent life insurance policy.