If you have people depending on you and your income, having a good life insurance policy is one way you can protect them if something happens to you. However, not all life insurance policies are created equal. Many have loopholes and legal traps buried in the fine print. Even the most benign provisions can cause you problems if you don't understand them. Here's what you need to understand -- and watch out for -- before signing on the dotted line of any life insurance policy.
1. Term versus perm
Life insurance policies come in two basic flavors: term life and permanent life (also known as cash value life). Term life covers you for a certain length of time (often 10 or 20 years). Permanent life covers you until you die (assuming you keep up your premium payments).
Permanent life insurance is further divided into whole life, which will charge the same premium every year, and universal life, which allows you to change the coverage amount and terms at any time (increasing coverage usually requires you to pass a medical exam). Naturally, changes to the policy also result in changes to the premium that you pay. Permanent life insurance of any kind is much more expensive than an equivalent term life policy -- so term life works out to be a better deal for almost everybody. Unless you have a good reason to decide otherwise, stick with term life insurance.
2. Contestability period
Nearly all life insurance policies include a contestability period, usually two years in length, during which the insurance company can cancel coverage or deny claims if they discover something's wrong with or missing from your application. The insurance company can act even if the error on your application was harmless and unintentional. Thus, it's important to review your application for errors and make sure that you included every possible detail. In particular, check to see that you've spelled the beneficiaries' names correctly -- this is a common error on life insurance applications.
3. Exclusion clauses
Life insurance policies tend to have "exclusions" in the fine print that list situations under which the policy would not pay out after your death. For example, many policies have an alcohol and drug use exclusion, meaning that if you die under the influence of these mind-altering substances, the policy will not pay out -- even if your death was not directly related to being drunk or high.
Another common exclusion is the illegal activity clause, which holds that if you die while committing a crime, your beneficiaries won't collect a cent. While you likely don't plan to take up a career as a hitman or bank robber, this clause may cause problems for even law-abiding individuals. For example, if you were jaywalking across the street when you were hit by a car and died, then technically you were breaking the law at the time of your death and the insurance company could refuse to pay. Read through the exclusion clauses carefully along with the rest of the policy's fine print, and make sure you understand each of these potential minefields.
4. Alert your beneficiaries
It's important to tell your beneficiaries about your life insurance policy and make sure they know how to file a claim. If you die and no one gets in touch with the insurance company, the policy may just sit there in limbo -- unclaimed money that rightfully belongs to your beneficiaries.
Also, keep your beneficiaries' contact information up-to-date with the insurance company. That will make it easy for the insurance provider to reach them in case something does happen to you.
Understanding these things should help ensure that your life insurance does exactly what you want it to do: Provide for your loves ones when you can't.
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