It helps to know exactly how life insurance works, the types of policies available, what life insurance can be used for, and how much it costs. Keep reading to learn more about life insurance—and how you can sign up for a policy that fits your needs.
Life insurance pays money to your beneficiaries should you die while the policy is in force. Temporary and permanent policies are designed to cover end-of-life expenses, remaining debts, and living expenses of your family or other beneficiaries.
We’ll review what life insurance is, how it works, the types of policies available, and how to choose a life insurance policy that fits your needs.
What Is Life Insurance?
Life insurance is a contract with your insurance company that pays out a death benefit should you die while the policy is active. Life insurance usually requires premium payments to keep the policy active—either monthly or annually. Life insurance can be temporary or permanent, and some permanent policies may offer a cash value component.
Insurance expert and licensed broker Ethan Pease from Visionary Law Group sees life insurance as financial protection for loved ones. “Life insurance protects your family financially after you pass away,” said Pease. The death benefit pays for funeral costs, daily expenses, mortgage bills, and college tuition.
How Does Life Insurance Work?
Life insurance is designed to pay out a death benefit to your beneficiaries if you pass away. If you keep your policy in force by making on-time premium payments, your beneficiaries will receive a payment from the policy and can use the funds for any purpose upon your death. But there are other benefits to life insurance policies that can help policyholders build cash value, cover other family members, or access funds while still alive.
Insurance companies might deny coverage if you have a history of life-threatening illnesses or work in a high-risk occupation. These factors can significantly impact your ability to obtain a life insurance policy.
Once you apply and qualify for a life insurance policy, you’ll choose the type of life insurance you want, the amount of coverage you need, and the length of the policy (if choosing a term policy). Once coverage has started, you’ll need to make regular premium payments to keep the policy active—or risk losing coverage.
What Does Life Insurance Cover?
Life insurance payments can be used for almost anything—but are typically designed to help you cover end-of-life expenses and financial obligations should you pass away. Here are a few common things life insurance covers:
Funeral and burial costs
Mortgage debt
Other outstanding debts
Living expenses for your beneficiaries (such as a surviving spouse)
Estate planning and funding
Inheritance
Some life insurance policies also allow you to access funds while you’re still alive. For example, Whole Life permanent policies with a cash value component let you borrow against the policy's cash value tax-free, and you can use the funds however you wish.
What Isn’t Covered by Life Insurance?
While life insurance generally protects your loved ones financially, certain situations may prevent a payout. Your policy typically won't cover deaths resulting from:
Suicide within the first few years of coverage
High-risk activities like skydiving
Death from participating in criminal acts
Be aware of the two-year contestability period. During this time, insurers can investigate your application for inaccuracies if you pass away. Any misrepresentation of your health or other information could lead to denial of the death benefit.
Remember, maintaining your coverage is crucial. If you miss payments, your policy may lapse, leaving you unprotected. Always review your policy details to understand your specific coverage and limitations.
What Are the Different Types of Life Insurance Policies?
There are two main types of life insurance policies: Term and Permanent.
Term Life Insurance Policies
Term life insurance provides temporary coverage for a specific period, usually ranging from 5 to 30 years. These policies offer high coverage amounts, often up to $5 million or more, at relatively low premiums. Term insurance is straightforward, focusing solely on providing a death benefit without additional features. It's an excellent option if you need substantial coverage for a specific timeframe, such as while raising children or paying off a mortgage.
Term policies may also offer optional riders, such as an accelerated benefits rider. This allows policyholders to access some of the death benefit early should they be diagnosed with a terminal illness or become permanently and totally disabled. Some term policies also offer a “return of premium,” meaning that you can get your premium payments back if the policy expires and you don’t use it.
“For most people, I recommend an affordable term policy to cover essential needs, then investing the savings from lower premiums,” said Pease. “My client saved $2,400 per year by choosing a term [policy] over whole life…Focus on the coverage you truly need, then use the extra money to build wealth in other ways.”
Permanent Life Insurance Policies
Permanent life insurance covers you for a lifetime—with a death benefit that’s guaranteed to pay out. They typically include a cash value component that grows over time, providing a combination of insurance protection and potential tax-advantaged savings. The guaranteed lifetime coverage ensures your beneficiaries will receive a payout regardless of when you pass away.
Here are the different types of permanent policies available:
Whole life policies: These policies offer fixed premiums, cash value with guaranteed growth, and a guaranteed death benefit.
Universal life policies: Universal life policies offer more flexibility. You can adjust your premiums and coverage amounts even after the policy is in force. The cash value can be invested, potentially leading to higher returns. You also have the option to borrow against the cash value or use it to pay future premiums.
Variable life policies: These have a guaranteed death benefit and cash value—but you can invest the cash value to earn higher returns. The investments do come with risk—and may even lose value (though most policies have protections against this). As the cash value grows—you can borrow against it without paying taxes.
Final expense policies: Designed primarily for seniors, final expense policies cover burial and funeral costs. They typically offer lower coverage amounts and often don't require a medical exam to qualify. These policies ensure that your end-of-life expenses won't burden your loved ones.
How Do You Choose the Right Life Insurance Policy?
Determine Your Needs
To choose the right life insurance policy that fits your financial goals, first ask yourself: "What will the insurance be used for?" Getting a policy to support your dependents is crucial if you have a family, mortgage, or other outstanding expenses. However, you may not need life insurance if you're single without dependents.
Select the Policy Type and Coverage Amount
Once you've determined the policy's purpose, decide on the type of life insurance and coverage amount. A term life policy may fit the bill if you want coverage while kids are at home or while paying off a mortgage. Companies may offer $1 million or more in coverage for relatively low monthly premiums.
However, a permanent policy from a provide may be better if you want to use your insurance policy to grow cash value and save on taxes. This allows you to select a policy that fits your financial goals and risk profile. Be aware that permanent policies can be very expensive, and policy fees and commissions may affect overall returns on the cash value portion.
Consider Professional Advice
Meeting with a financial planner or licensed insurance broker can help determine the best policy for your needs. Remember that many advisors and insurance brokers receive commissions for selling policies, which may influence their recommendations.
What Is the Application Process for Life Insurance?
Applying for life insurance can be done online or through an insurance broker. Our best life insurance companies make it easy—allowing you to sign up for a policy online in just a few minutes. You’ll need to determine what policy you’d like and the amount of coverage needed. Then, you can apply for a policy by submitting an application.
To qualify for a life insurance policy, you’ll typically need to apply online and provide personal health information, including:
Your age
Your job
Your health history (including any illnesses or diseases)
Your family health history (including cancer or other diagnoses)
Whether or not you smoke
Your desired coverage amount
Your desired policy length (for term policies)
You’ll often need to undergo a medical exam to qualify for a policy. This helps insurers determine your health risk when signing up for a policy. Your medical exam results could disqualify you for a policy—or cause the cost of the policy to increase.
Once you qualify for a policy, you’ll need to make monthly (or annual) premium payments to keep the policy in force.
How Much Does Life Insurance Cost?
The cost of life insurance varies quite a bit, depending on the type of policy you choose, the amount of coverage needed, the length of coverage, and your health status.
Here are some average monthly premiums for a $500,000 policy for a 30-year-old in good health:
Term Life (20-year policy from Ethos):
Male: $23/month
Female: $17/month
And here are average monthly premiums for a $100,000 whole life policy for a 30-year-old in good health:
Whole Life (Policy from Liberty Mutual):
Male: $123/month
Female: $104/month
While whole-life policies are considerably more expensive, they offer the advantage of building cash value over time. Term life policies, on the other hand, provide coverage for a specific period at a lower cost.
Note: These figures are averages, and your actual costs may differ based on your circumstances and your chosen insurance provider.
How Do You Designate Beneficiaries and Understand Payout Options?
One of the most important parts of applying for a life insurance policy is designating your beneficiaries. These are the people in your life who will receive a payout if you should pass away while your policy is active.
For most insurance policies, you’ll first choose a primary beneficiary. This is usually your spouse, significant other, or someone else who will receive 100% of the proceeds should you pass away. Alternatively, you can name a trust as your beneficiary. If you choose this option, consult with a lawyer to ensure proper structuring of the trust and correct handling of the policy proceeds.
You can also choose secondary beneficiaries who will receive proceeds should you and your primary beneficiary pass away at the same time. For instance, if you have four children, you might list them as secondary beneficiaries, each receiving 25% of the death benefit.
Death benefits on life insurance policies can be paid out in several ways, including:
Lump sum: The entire death benefit can be paid directly to the beneficiaries' accounts in a single lump sum.
Annuity: The death benefit can be put in an annuity with a lifetime payout or on a specified timeline.
Installments: Proceeds can be paid out regularly to your beneficiaries on a specific schedule with a start and end date.
Retained asset account: Death benefit proceeds can stay in a type of savings account that beneficiaries can access at any time—plus, it may earn interest.
Note: Life insurance death benefits are tax-free to beneficiaries—but if put into an annuity or retained asset account—the interest earned may be taxable.
Summary
According to LIMRA, only 51% of Americans have life insurance. But life insurance is designed to protect your loved ones should you pass away, and can play a critical role in estate planning. Several types of policies can help you provide financial support to your beneficiaries to help pay for your mortgage, financial obligations, and everyday expenses.
While some policies offer lifetime coverage and an investing component, they can be very expensive and come with hidden fees. But if you choose a term policy, remember that it will expire at some point. No matter which policy you choose, remember to review your policy options with a licensed financial advisor to see how it fits into your overall financial plan.
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