Life Insurance: What Is It? How Does It Work?

Shawn Plummer

CEO, The Annuity Expert

Like most people, you don’t consider life insurance until you need it. But understanding how life insurance works are essential, whether you’re shopping for a policy or are already insured. In this guide, we’ll break down the basics of life insurance so you can decide what type of policy is best for you and your loved ones.

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What Is Life Insurance?

A life insurance policy pays out a sum of money to your designated beneficiary in the event of your death or another qualifying event, which can provide them with financial security and peace of mind.

How Does Life Insurance Work?

Your life insurance policy comes with a death benefit- a set amount of money your loved ones will receive after you die. This money can be used for any expenses or debts they may have, giving them some financial security during difficult times.

Who Needs Life Insurance?

If you have individuals relying on your income, whether children, a spouse, or a business partner, life insurance is an essential step to protecting them financially in the event of your death.

The Benefits Of Life Insurance

Life insurance policy benefits include:

What Age Should I Get Life Insurance?

You’ll save more money if you’re younger and healthier when you buy life insurance. Life insurance rates are cheaper the younger you are, but they typically increase as we age. This is because our mortality rates go up as we get older and develop health issues. So, if you wait until you’re 60 to buy life insurance, it will be much more expensive than buying it at 20.

How Much Coverage Do I Need?

If you want an estimated life insurance coverage amount, most financial planners recommend getting an amount 10-15x your current income. This is because the final cost of life insurance coverage rates is primarily based on several factors, with health having the most significant impact.

How Much Does Life Insurance Cost?

The average cost of a life insurance policy is $20 to $40 per month, but the actual rate depends on the type of insurance, how much it covers, and personal factors. For example, permanent life insurance is usually more costly than term life insurance but functions differently.

Life Insurance Pros And Cons

Life Insurance Pros

  • This policy is permanent and will last for your entire lifetime.
  • Your life insurance rates will never increase.
  • Your death benefit will not be reduced.
  • This product allows you to build cash value over time without paying taxes.
  • Dividends from a mutual insurer may be paid out.
  • Cash can be borrowed without a credit check.
  • You can also withdraw money from the policy.
  • Permanent life insurance is a type of coverage that offers lifelong financial protection.

Life Insurance Cons

  • More expensive than term life insurance.
  • When you are younger, your premiums will be lower.
  • Protection requirements are never fixed; they change with time.
  • The cash value growth of this permanent policy is slower than other options.
  • The premiums for whole life insurance are higher than those of term life.
  • The Policyholder will be charged interest on any loans against the policy.
  • You may have to pay taxes on the money you withdraw from your life insurance policy.
  • More complicated than term life insurance

What Are The Main Types Of Life Insurance?

There are three main types of life insurance: term, whole, and universal.

Term life insurance policy

Term life insurance policies are typically between 10 and 30 years long, making them the simplest form of life insurance. If you die during the period of your term life insurance policy, a cash benefit is paid to your loved ones.

Whole life insurance policy

A whole life insurance policy is an agreement between you and the insurer in which you agree to make level premium payments regularly, and they agree to pay a death benefit to your beneficiaries when you die. The policy also has a savings component called “cash value,” in which interest may accumulate without being subject to taxes.

Universal life insurance policy

Universal life insurance is a type of permanent coverage that, as long as the Policyholder pays their premiums and meets any other requirements specified in their policy, will be covered for the rest of their life.

What Are Things Not Covered By Life Insurance?

Exclusions from life insurance policies include preexisting conditions, accidents while under the influence of drugs or alcohol, suicide, criminal activity, and death due to a high-risk activity such as skydiving or war.

What Is The Best Life Insurance Policy For Me?

The best way to shop for life insurance is by thinking about your loved ones’ future and current needs. In addition, term life insurance policies are often more affordable, allowing you to select a high coverage amount for a set period.

Next Steps

Now that you understand how life insurance works, you can start shopping for a policy that fits your needs. Remember, life insurance is one of the most important investments you can make for yourself and your family. If you have questions about which policy is right, contact us today and shop for life insurance quotes for free.

Life Insurance Basics: What Is Life Insurance? How Does Life Insurance Work?

Need Help Buying Life Insurance?

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 you get coverage so 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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Frequently Asked Questions

What is the most common type of life insurance?

Term life insurance is a type of insurance that covers you for a set period, known as the “term.” If you were to die during this term, your loved ones who depend financially on you would receive money from your policy.

What is better, term or whole life?

Parents with small children should buy term life insurance, which is more affordable. Those who need lifelong coverage should purchase whole life insurance. Every decision is different for each person, so they should gather the information to help them make a choice leading to financial security.

What is the difference between whole life and term life insurance?

Term life insurance is only active for a set duration, while whole life insurance lasts until you die. If you keep up with your payments, that is. The premiums go into a death benefit fund which will be dispersed to your beneficiaries upon passing.

What type of life insurance builds cash value?

Universal life insurance and whole life insurance are flexible premium life insurance policies that feature cash value growth over time on a tax-deferred basis. The insurer invests the premiums you pay into this savings element.

Are life insurance payouts taxed?

Though a life insurance payout is not considered taxable income, anything the policy has gained in interest will be taxed. Additionally, any money inherited by beneficiaries from a life insurance policy is also tax-free. To prevent paying taxes on proceeds, taxpayers list beneficiaries on their policies. However, if they want to transfer ownership of the policy to someone else at any point, they must first get permission from the IRS.

How long do you pay for life insurance?

A term life insurance policy that can provide financial security for your loved ones in the event of your death. The typical policy lasts 10-30 years, and you pay premiums regularly. If you die at any point during the policy period, the insurer will give a cash sum to your beneficiaries.

Can you cash out life insurance?

If you need cash and are a policyholder, you can take a loan from your permanent life insurance policy. By taking cash from their life insurance policy through a loan, the Policyholder borrows money against the death benefit that will be paid to beneficiaries upon their death. If repaid in full, the beneficiary will receive the total amount of coverage; however, if Policyholder dies with an outstanding balance owed on the loan plus interest), that unpaid debt, plus any accumulated interest, will reduce what is paid to the Beneficiaries from proceeds of Death Benefit.

Do life insurance policies expire?

Term life insurance policies have an expiration date, after which the policy matures, and your coverage ceases. You can typically only own a term policy for a specific period; this period usually lasts between 5 and 30 years, depending on your policy. Most term life insurance policies can be renewed yearly until you reach the age of 95.

Does life insurance cover suicidal death?

Most life insurance plans have a suicide clause which states that the company will not payout if the Policyholder takes their own life within the first few years after obtaining the policy. If you switch your plan to another one, it resets this period back to square one. If life insurance companies investigate and think that suicide may be what caused someone’s death, they would ask for more documentation to rule out that option before considering any benefits.

What is the average life insurance cost per month?

On average, a 20-year $500,000 term life insurance policy for a healthy middle-aged person will cost about $26 per month. Please note that the price range for this type of coverage can differ between individuals.

How much is a million-dollar life insurance a month?

If you’re seeking a 10-year $1,000,000 life insurance policy, you’ll pay an average monthly premium of $32.05. If you want a 20-year plan instead, your monthly payments will be approximately $46.65 on average.

How much is life insurance when someone dies?

The life insurance company will pay the death benefit to the named beneficiary or, if no beneficiary is named, to the deceased’s estate upon the policy owner’s death. The typical time frame for receiving a Death Benefit payout is 30 days after receiving confirmation of death.

How much do life insurance policies pay out?

The average life insurance payout is $168,000. Many experts recommend that your policy’s death benefit should be seven to 10 times your annual salary.

Can you change your life insurance at any time?

While you may be able to cancel your existing policy and purchase a new policy, many life insurance professionals may advise against doing so. You’ll want to examine your needs and budget before making this decision.

How do you use your life insurance while alive?

There are three ways to get money from your life insurance policy while you’re still alive:
First, get a loan, make withdrawals, or surrender your policy.
Second, apply for living benefits such as medical expenses and long-term care costs coverage.
Third, sell your policy in a life settlement to receive cash now while continuing coverage until death.

Does life insurance pay for funeral costs?

After you pass away, the life insurance policy you have in place will pay a lump sum to whoever you named as the beneficiary. In the event of your death, this money can be used by your beneficiaries for funeral expenses or any other type of bill they might have.

What happens with life insurance when someone dies?

The life insurance company will give your named beneficiaries a death benefit if you die. Some policies also have living benefits riders that let you use part of the death benefit while alive.

What happens if a life insurance policy owner dies before the insured?

A life insurance policy is a lot like any other asset. For example, suppose the owner and the person insured are two different people, and the owner dies first. In that case, someone else has to become the new owner of the policy until the death of the insured results in proceeds being paid out to a beneficiary.

Who does the life insurance go to if I do not have a will?

If you don’t name a specific person to receive your life insurance policy proceeds, the money becomes part of your estate. The life insurance money will be distributed with your other assets when you die. This process is typically lengthy and costly, going through probate before your heirs can receive anything.

When should you use life insurance?

Life insurance pays out a death benefit to your loved ones when you pass away and allows you to build cash value through the policy that accumulates over time. This life insurance policy provides financial security and other benefits while you’re still alive instead of after you die.

Can you use life insurance for anything?

Permanent life insurance policies have many uses, such as providing extra retirement income or taking out loans from the policy’s cash value with tax advantages. In addition, indexed and variable life insurance policies are often marketed to create an income stream.

Is life insurance better than savings?

Unlike savings account holders, who are taxed yearly on their interest, they are not policy owners of whole life insurance reinvesting their cash value. Additionally, you can gain income tax-free by borrowing against your principal.

What reasons will life insurance not pay?

If you die of natural causes, your life insurance policy will payout. However, if fraud is committed or you die under certain excluded circumstances, such as suicide within the first two years, your life insurance policy might not be honored.

What is a good age to get life insurance?

Typically, the younger you are, the cheaper your life insurance quote will be. As we age, we’re more likely to develop health problems that could lead to a higher mortality rate.

Do you pay life insurance for life?

Whole life insurance policies are active for your lifetime, as opposed to term life insurance which expires after a set number of years. However, the initial cost of premiums is higher than term insurance because the policy does not expire.

What should I know before getting life insurance?

You don’t need as extensive of a life insurance policy if you’re wealthy and have few debts. However, suppose you want your loved ones to be looked after once you’re gone. In that case, a few things to consider before buying life insurance are age, physical and mental well-being, life expectancy, revenue, and unpaid debts.

How long do you have to pay on a life insurance policy?

A term life insurance policy pays out a death benefit to your chosen beneficiary if you die within the duration of the policy. The typical policy lasts 10-40 years, and you pay a premium for the term. A permanent life insurance policy will require payment for the rest of your lifetime.

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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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