How Does Life Insurance Work?

Shawn Plummer

CEO, The Annuity Expert

Life Insurance is one of the most important things you can do to protect your family’s future. Life insurance provides a lump-sum payment for beneficiaries when the policyholder dies. This money can provide security in many ways but primarily provide financial security when someone passes away. However, not all life insurance policies are created equal! Choosing the right type of coverage will depend on what you want your life policy to do for you and your family. Therefore, it’s essential to make sure that you know exactly how much coverage will be enough before picking out a plan!

This guide tells readers that need life insurance some basics to get started on exploring their options and figuring out which type would best suit them to reach their long-term goals. Then shop and compare life insurance quotes.

What is Life Insurance?

According to the National Association of Insurance Commissioners, Life insurance is a contract between a life insurance company and policyholders. A life insurance policy guarantees the insurer pays a lump sum of money (death benefit), federal income tax-free, to designated beneficiaries when the insured dies, in exchange for the premiums paid by the policyholder during their lifetime. Policies are backed by the claims-paying ability of the issuing insurance company. (NAIC)

The Benefits Of Life Insurance

Life insurance policy benefits include:

  • Provides financial protection for families, key employees, and businesses after unexpected life changes, giving peace of mind.
  • Offers peace of mind for those purchasing their first house and protection of financial needs regarding a mortgage payment and property taxes.
  • The proceeds at death is income tax-free to beneficiaries.
  • Some policies can provide a tax-free retirement income.
  • The coverage can leverage the life insurance death benefits while alive to pay for eldercare expenses, including nursing homes, assisted living, home healthcare, and hospice costs.
  • Coverage options can pay for final expenses such as medical bills, funeral and burial costs.
  • Certain policies can be utilized as a college savings plan to pay for tuition in the future.

Qualifying for Life Insurance

It will be easier to get coverage if you are younger and healthy. If you are old and not healthy, it will be more challenging. Lifestyle choices that are unhealthy, like smoking or skydiving, also make it harder to get a policy in addition to more expensive coverage. If this is the case, contact us for help so you are not declined coverage.

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Who Should Buy Life Insurance?

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Life insurance policies are financial products designed to provide financial support after the insured’s death. Some first priority examples are:

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How much Is Life Insurance?

The tables below are examples of the monthly cost of each type of life policy for common death benefit amounts.

Term Life Insurance Cost

AgeGender$250k$500k$750k$1,000,000
25Female$10.95$16.37$21.79$22.98
Male$12.30$19.08$25.86$30.54
35Female$12.45$18.20$24.54$30.53
Male$13.80$21.64$29.70$33.93
45Female$21.24$36.95$52.67$67.85
Male$26.19$46.67$67.24$87.81
55Female$45.37$84.36$123.78$158.80
Male$61.24$114.71$169.30$221.55

Whole Life Insurance Policy Cost

AgeGender$250k$500k$750k$1,000,000
25Female$108.50$211.75$315.00$418.25
Male$120.97$236.69$352.41$468.13
35Female$163.41$321.56$479.72$637.88
Male$179.16$353.06$526.97$700.88
45Female$255.72$506.19$756.66$1,007.13
Male$281.75$558.25$834.75$1,111.25
55Female$417.38$829.50$1,241.63$1.653.75
Male$462.66$920.06$1,377.47$1,834.88

Burial Life Insurance Cost

AgeGender$20k$25k$30k$40k
55Female$52.21$64.46$76.71$101.21
Male$65.30$80.81$96.32$134.18
65Female$78.82$97.72$116.63$154.43
Male$109.75$136.39$163.03$216.31
75Female$141.62$176.22$210.82$280.03
Male$196.74$254.13$293.51$390.28
80Female$193.66$241.28$288.89$384.12
Male$276.26$334.52$412.78$549.31

The Components Of A Life Insurance Policy

A life insurance policy has either two or three parts. A term life insurance policy has two components: a death benefit and premiums. Permanent life insurance policies have a third component called cash value.

Face Value: The face value of a life insurance policy is the amount of money that the insurance company agrees to pay out when the person insured dies. The beneficiaries receive this money. The insurance company will decide if the person wanting to buy insurance is a good candidate, and the decision is based on many factors. For example, age, medical records, occupation, credit history, driving record, height, and weight are all considerations when determining if the applicant is a good fit.

Premiums: Premiums are the money you pay to get insurance coverage. The results from the medical exam and personal history determine the premium payments. The premium amount is based on coverage and the insured’s life expectancy. Life expectancy is factored by age, gender, medical history, prescription drug history, whether the insured is a tobacco/cannabis user, has a high-risk occupation or hobby.

Cash Value: The cash value in a permanent life insurance policy is a savings component that the policyholder can use while active. The cash value grows on a tax-deferred basis. The insured can use the cash value growth for retirement savings or provide money to pay the premiums owed for the coverage. Beneficiaries do not inherit the cash value, only the death benefit.

How Much Life Insurance Do I Need?

Find out how much annual income your household would lose if you died to calculate life insurance needs. The financial obligations will show how much money your family would need to live on. Then get a life insurance quote to see how much it would cost to have this protection. Finally, use our free life insurance calculator.

Ask yourself these questions:

  • If you were to die early, what is my family’s financial impact?
  • How would my spouse and children pay the bills such as a mortgage, car payment, or college tuition?
  • Who else depends on me financially, such as a stay at home parent, grandparent, sibling, or other family members?
  • Do I want to set aside money for my child’s current or future education (private schol or college tution) in the event of my death?
  • How much money is set aside for my family to pay final expenses (funeral expenses and burial expenses) and repay any debts after my death?
  • Do I have family members, charities, or organizations to whom I would like to pass on an inheritance?
  • Will my loved ones have to pay any estate taxes after my death?
  • Is life insurance part of an estate?
  • Will my family maintain their lifestyle financially but keep up with inflation as well in the future?

When solving for assets, count the insurance coverage now, including any group insurance from your employer or veteran’s insurance.

Also, include Social Security Benefits and pension plan survivor’s benefits. Finally, include other assets you have, such as your savings account, investments, real estate, and personal property.

Figure out the assets your family will sell or cash in to pay expenses after your death.

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Life Insurance And Taxes

Is Life Insurance Taxable?

Do beneficiaries pay taxes on life insurance policies? In most cases, no, a life insurance payout is not part of an estate. However, there are a few scenarios when they pay taxes.

Is Life Insurance Tax Deductible?

Can you write off life insurance? Unfortunately, your life insurance premiums are not tax-deductible because they are considered a “personal expense” by the IRS. Therefore, you cannot deduct life insurance payments from your taxes if you buy it yourself. The only times when this is possible are when you pay for someone else’s policy. Life insurance proceeds paid to a beneficiary do not have to be reported as income.

Types Of Life Insurance

The first thing you should know is that not all life insurance policies are the same. In addition, each type of policy can serve a different purpose than providing financial security.

  • Some plans give you coverage for your life while others cover you for a specific number of years.
  • Some policies build up a cash value, and other policies do not.
  • Most policies combine different kinds of insurance like mortgage insurance (mortgage protection), and others let you change from one kind of insurance to another.
  • Some policies may offer other benefits while you are still living, such as long-term care benefits.

Above all, your choice should be based on your needs and what you can afford long term.

There are two basic types of life insurance: term life insurance and cash value life insurance.

Term insurance generally has lower but regular premium amounts in the early years but does not build up cash values that you can use in the future. You can combine cash value life insurance with term insurance for the period of your greatest need for life insurance to replace income.

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Cash Value and Term Insurance Policy Types

There are various types of life insurance.

  • Term life insurance is a type of life insurance that lasts for a certain number of years before it expires. You choose the coverage length when you initially sign up. Most people purchase 10-40 year policies, however, 20 is the most common term length. Below are the many types of term life insurance.
    • A renewable term life insurance policy is one where you are guaranteed coverage for a set period of time. If you need to renew the policy at the end of that time, you don’t have to prove that you are still healthy.
    • A nonrenewable term life insurance policy is a policy that is only in effect for a certain amount of time and then it will not be renewed.
    • Convertible term life insurance policies allow you to change from temporary to permanent coverage without having to prove that you are still healthy.
    • A reentry term life insurance policy means that you can offer evidence of insurability at the end of the term. If you do this, you can get a reduced premium rate that is lower than the guaranteed rate for a renewable term policy.
    • A level term life insurance policy is a life insurance policy where the amount of money that will be paid out to your beneficiaries if you die stays the same for the entire term of coverage.
    • A decreasing term life insurance policy is a type of life insurance that starts with a high amount of protection, but it decreases each year.
    • Increasing term life insurance starts with a low amount of protection. The face amount gets bigger over time.
    • If someone wants immediate protection, they might use an interim term life insurance policy. This is a type of policy that will turn into permanent protection after a certain amount of time.
    • If you outlive the coverage length of your return of premium term life insurance policy, you will get all of the premiums that you paid back in a lump sum. If you cancel your policy early, you might get some of the premiums back.
    • The mortgage redemption policy is term life insurance that will help you pay off your mortgage if you die before the loan is paid off. The amount of insurance will be enough to cover the unpaid mortgage.
    • Deposit term life insurance insurance is a type of life insurance that has a high premium for the first year, but the premium becomes cheaper in following years.
    • Group term life insurance is temporary insurance an employer provides to it’s active employees. Once the employee is separated from the employer, the coverage expires.
  • Permanent life insurance is a type of life insurance that provides lifelong coverage unless the policyholder stops paying the regular premiums or surrenders the policy.
    • Single-Premium life insurance describes paying the entire premium upfront instead of making monthly, quarterly, or annual payments. Also known as a modified endowment contract.
    • Whole life insurance is a type of permanent life insurance that accumulates cash value at a fixed rate.
      • Burial insurance or Final Expense insurance is a type of life insurance (permanent policies) that has a small death benefit used to provide funds for funeral costs and final expenses.
      • Guaranteed Issue is a type of life insurance available to people with pre-existing conditions. The policy will not pay a death benefit during the first two years the policy is in force in most cases due to the high risk of insuring the person with preexisting conditions. However, policy premiums plus interest will be paid to the beneficiaries if the insured dies during that two-year period.
      • Limited pay life insurance are permanent policies that allow you to prepay level premiums for the entire cost of your coverage for a set number of years.
    • Universal life policies is a type of permanent life insurance with a cash value component that earns interest. Premiums and coverage can be adjusted over time, but protect for an entire life.
      • Guaranteed Universal is a type of universal life insurance that does not build cash value and typically is cheaper than whole life.
      • Variable Universal allows investing the policy’s cash value. Policyowners can lose money in a stock market crash.
      • Indexed Universal is a type of universal life insurance that lets the policyholder earn an indexed rate of return on the cash value component without the ability to lose money due to poor market performance.

Term Life Insurance

Term life insurance is incredibly straightforward, easy to understand, and cheap. But, as the name implies, the coverage only lasts for a specific period, starting as low as five years and extending up to forty years.

Because these policies are temporary, regular premium amounts tend to be more affordable than their permanent life insurance counterparts, making it the best policy for families on a budget or those who need supplemental accidental death insurance coverage.

Types of Term Insurance:

  • Mortgage Protection Insurance
  • Return of Premium Term Insurance
  • Convertible Term Insurance
  • Accidental Death Insurance

Policy owners can renew most term insurance policies for one or more policy terms, even if your health has changed. However, regular premiums may be higher each time you renew the policy (extended-term insurance) for a new term.

Questions To Ask:

  • Always ask for the annual premium and the monthly premium amount. Sometimes the annual premiums can offer lower rates if you pay once a year.
  • Always ask what the premiums will be if you continue to renew the policy at the end of the term, and if you have to take another medical exam.
  • Another question to ask is if you will lose the right to renew your own policy at a future age.

For a higher term insurance premium, insurance companies will give you the right to keep the policy in force for the coverage length at a fixed price each year. Then at the end of that time, you may need to pass a medical examination to continue coverage, and your premiums may increase.

You may be able to convert the term insurance policy into a cash-value policy during a conversion period, even if you are not in good health. However, premiums for the new policy will be higher than the fixed premiums you have been paying for the term insurance up until that point.

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Permanent Life Insurance

There are three types of cash value life insurance (permanent insurance) that provide lifelong protection which are:

  • Whole Life Insurance
  • Universal Life Insurance
  • Variable Life Insurance

Cash-value insurance is, also known as a Permanent Life Insurance Policy, provides death benefit protection to your loved ones for the duration of your life. Permanent insurance is a type where the premiums charged are higher at the beginning than they would be for the same amount of term insurance.

These policies tend to be more expensive than term policies due to policy provisions, non-forfeiture options, and cash value. However, these features give the policy owner more flexibility, security, and a retirement income replacement.

Whole Life Insurance

Whole Life Insurance covers you for as long as you live if the premiums are paid. So you generally pay the same amount in premiums for your entire life.

When you first take out the insurance policy, premiums can be several times higher than you would pay initially for the same amount of term insurance. However, they are smaller than the premiums you would eventually pay if you keep renewing a term policy until your later years.

Some whole life policies let you pay premiums for a shorter period, such as 20 years, or until age 65. Premiums for these policies are higher since the payments are made on shorter terms.

Types of Whole Life:

  • Burial Insurance and Final Expense (funeral expenses)
  • Single-Premium Whole Life
Universal Life Insurance

Universal Life Insurance is a flexible permanent life insurance policy that lets policy owners vary the premium payment amounts. Universal life also allows you to adjust the face amount of your insurance coverage.

Any increases may require proof that you qualify for the updated death benefit.

The insurance premiums you pay (less expense charges) will go into a policy account that earns interest. Any charges will be deducted from the account. If your annual premium payment plus the interest your account makes is less than the charges deducted from the policy, your account value will be lower. If the account’s value keeps dropping, eventually, your coverage will end. To prevent coverage from ending, you may need to start making additional payments, increase your payment amount, or lower your death benefits.

Even if there is enough in your account to pay the premiums, continuing to pay premiums yourself means you build up more cash value.

Types of Universal Life:

  • Universal Life Insurance
  • Guaranteed Universal Life Insurance
  • Index Universal Life Insurance (IUL)
  • Protection IUL
  • Accumulation IUL

Shop universal life insurance quotes and apply for a policy in under ten minutes.

Variable Life Insurance

Variable Life Insurance has an investment component where the death benefits and cash values depend on one or more separate accounts’ investment performance, which may be invested in mutual funds or other investments allowed under the insurance policy.

Be sure to get the company’s prospectus when buying this policy and study it carefully.

If the underlying investments do well, you will have higher death benefits and cash value.

Your benefits and cash value will be lower or may disappear if the investments you chose didn’t do as well as you expected.

You may pay an extra premium for a guaranteed death benefit.

Comparing Life Insurance

To find the best life policy for you, start shopping for life insurance quotes. Shopping for a life insurance quote will provide you with the best value for the long haul because you find the most coverage with the lowest premiums. However, A simple comparison of life insurance premiums is not enough—other things to consider, such as financial strength, coverage parameters, and additional benefits, determine the best life insurance policy.

Questions To Ask Yourself:

  • Do your insurance premiums or benefits vary from year to year?
  • How much do the benefits build up in the policy?
  • Which portion of the premiums or benefits is not guaranteed?
  • What is the effect of interest on premiums paid and received at different times on the insurance policy?
  • Who are the best life insurance companies, and will they be around for my lifetime?

You should know that no life insurance company offers the lowest cost of all ages for all kinds and amounts of life insurance coverage.

Related Reading: How To Find The Best Life Insurance: A Guide for Finding the Right Coverage

Life Insurance

Replacing Policies

If you are thinking about dropping a policy, decide the long-term economic value first. Here are some things you should consider:

  • Don’t cancel the old policy until you have received the new one.
  • A new plan may be costly to replace the old policy since you are older.
  • If your health has changed, remember there probably will be a medical exam, and the new policy’s insurance premium amount will often be higher.
  • You will not be able to buy a new policy because now you are not insurable.
  • You may have valuable rights and benefits in the policy you now have that are not in the new one.
  • You might be able to change your policy or add to it to get the coverage or benefits you now want.

Living Benefits and Riders

Many life insurance companies will let you change your policy and customize it to meet your needs. For example, life insurance plans with living benefits or riders are a type of change you can make to your plan. You may need to pay more for the rider or an extra fee, but some come with the base plan, so this won’t happen often.

  • Accidental death benefit rider provides additional coverage if the insured’s death is accidental.
  • Waiver of premium rider waives premium payments if the insured becomes disabled and unable to work. 
  • Disability income rider pays a monthly income if insured becomes unable to work for several months or longer due to a serious illness or injury.
  • The accelerated death benefit rider allows the insured to collect a portion or all of the death benefit if the insured is diagnosed with a terminal illness.
  • The long-term care rider pays for a nursing home, assisted living, or in-home care when the insured requires help with activities of daily living (ADL), such as bathing, eating, transferring, and using the toilet.
  • A guaranteed insurability rider offers the option to buy additional insurance in the future without a medical review.

Waiting Periods

How long do you have to have life insurance before you die? Every policy is different. The life insurance company may have a waiting period before paying for inevitable deaths. For example, if someone commits suicide in less than 24 months after buying a policy, the beneficiary might not get any money. Before purchasing a life insurance policy, make sure that you read the types of deaths it covers. Also, look to see what is not covered and any limitations or exemptions for certain types of death.

How to Find A Policy on a Deceased Person

Beneficiaries can find life insurance policies from the deceased by contacting the National Association of Insurance Commissioners (NAIC). A death certificate from the funeral home that conducted the burial or cremation would improve the NAIC’s search for forgotten policies. The policy locator service is free with no limitations, and the process could take up to 90 business days. Be prepared to have as much personal info or pertinent information on the deceased as possible.

Conclusion

Life insurance provides financial support that can help pay off debts, including mortgage, outstanding loans, and replace daily income. Business owners can also use the insurance payout to pay off business debts or protect key employees.

Term insurance provides coverage for a period known as a “term,” while permanent life insurance (whole life and universal life) provides lifetime coverage.

Now that you understand a little more about the different types of life insurance policies and what they can be used for, it’s time to get a life insurance quote. Request one below and our team will help you find how much life insurance you need and the best policy with the highest-rated life insurance company for your specific situation. Thanks for reading!

Need Help Getting Coverage?

If you have a preexisting medical condition and want to buy life insurance, you will need help from an expert. This person can help ensure that you get coverage so that you don’t get declined.

Warning: Applying for life insurance without a medical exam can be risky. If you get declined coverage, it could be at least two years before you can get any life insurance.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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