In this article:
You work hard to provide for your family, but have you taken steps to protect their financial future when you're no longer around? Life insurance pays a sum of money to your beneficiaries if you die while the policy is in force. In addition to helping to support your surviving loved ones, some kinds of life insurance also offer benefits during your lifetime.
Here's what you need to know about how life insurance works, types of life insurance to consider and how to get life insurance.
How Does Life Insurance Work?
Life insurance is a contract between you and the insurance company. You purchase a policy and pay premiums on an ongoing basis. In exchange, the insurer pays a death benefit to your beneficiaries if you die while the policy is in place. Here are the key parts of a life insurance policy.
- Insurer: A company that sells life insurance
- Insured: The person whose life is insured
- Beneficiary: The person or legal entity (such as a trust or charity) that receives the death benefit after the insured's death. A policy can have more than one beneficiary (the insured's adult children, for example). Insurers may require choosing a secondary beneficiary to receive the death benefit if the original beneficiary cannot.
- Death benefit: Also called a settlement or payout, the death benefit is the money the insurer pays out if the insured dies while the policy is in force. You select the death benefit amount when you purchase life insurance. Beneficiaries file an insurance claim to receive the death benefit and can generally choose between installment or lump-sum payments.
- Premium: The price you pay for life insurance. You can generally choose to make monthly, quarterly, semiannual or annual payments.
- Term: How long the policy remains in force (assuming you stay current on your premium payments). You select your term when you buy life insurance.
- Cash value: In addition to the death benefit, some types of life insurance build cash value that may be available for you to withdraw, borrow against or use to pay your premiums.
- Rider: You may be able to add extra benefits to a life insurance policy by purchasing a rider. For instance, you might add a rider that lets you convert term life insurance to whole life, purchase more coverage without a medical exam, or waive your premiums if you become disabled.
Types of Life Insurance
There are several types of life insurance to choose from.
Term Life Insurance
Term life insurance lasts for a set term, typically one to 30 years. You choose the term when purchasing the policy. At the end of the term, your policy expires. You may have the option to renew your policy or convert it to permanent life insurance, or you may have to buy a new policy in order to continue coverage.
Premiums for term life insurance usually stay the same throughout the term. People typically buy term life insurance to cover their families' financial needs during a certain stage of life. For instance, if you have a 30-year mortgage, you might buy enough 30-year term life insurance to cover the mortgage in case you die.
Permanent Life Insurance
As long as you pay your premiums, permanent life insurance lasts your entire life or up to age 99, depending on the policy. It costs much more than term life insurance—up to 10 times as much, according to Guardian Life. In addition to providing lifetime protection, permanent life insurance builds cash value you can use in various ways. Different types of permanent life insurance include:
- Whole life insurance is permanent life insurance whose cash value grows at a guaranteed interest rate. Premiums and death benefit amounts can't be changed during the policy term.
- Universal life insurance offers more options than whole life. Its cash value typically grows at a money market interest rate. Once you build up enough cash value, you may have the flexibility to adjust your premiums and coverage amount.
- Variable life insurance doesn't guarantee cash value returns. Instead, it lets you choose different investment options for the cash part of your policy. You could see higher returns than whole life or universal life, but you could also lose money. Poor investment choices may even reduce your death benefit.
- Variable universal life insurance lets you choose investment options, just as variable life insurance does. It also allows you to change your death benefit and premium amounts, like universal life insurance.
- Final expense insurance, also called funeral insurance or burial insurance, is permanent life insurance designed to pay end-of-life expenses, although the payout can be used for any purpose. This insurance is generally easy to get and rarely requires a medical exam. Death benefits usually range from $5,000 to $20,000.
How Much Does Life Insurance Cost?
The cost of life insurance depends on several factors, including:
- Your age: In general, younger people pay lower life insurance premiums than older people.
- Your gender: Because women have a longer life expectancy, they typically pay less for life insurance than men.
- Your health and family health history: You may pay more for life insurance if you're in poor health or have a family history of health issues such as diabetes, high blood pressure or cancer.
- Your occupation and lifestyle: A dangerous job, such as firefighting, or risky hobby, such as mountain climbing, may mean higher life insurance premiums.
- The amount of life insurance you buy: The larger your death benefit, the more you can expect to pay.
- The type of life insurance you buy: Permanent life insurance costs up to 10 times more than term life insurance.
Learn more >> How to Save Money on Life Insurance
How to Get Life Insurance
Ready to buy life insurance? Here's what to do.
1. Decide How Much Coverage You Need
Add up the expenses your insurance payout needs to cover, such as your loved ones' current living expenses, your funeral expenses and your debts. Also consider future expenses, such as a child's college education. Next, add up any assets your loved ones would receive when you die, such as savings, retirement funds or Social Security benefits.
Buy enough life insurance to cover the difference between your family's financial needs and these assets. Some experts advise purchasing life insurance worth 10 to 30 times your income as a good rule of thumb.
2. Check Insurance Company Ratings
Make sure any insurer you're considering is financially stable and provides excellent customer service. Check insurance company ratings from independent agencies such as A.M. Best and review the National Association of Insurance Commissioners' complaint index.
3. Compare Life Insurance Quotes
You can get life insurance quotes on insurance companies' websites, by phone or by visiting life insurance comparison sites that gather quotes from several companies at once. Life insurance can be complex. You may want to work with an independent insurance agent who sells policies from multiple insurers and can help you find the right policy for your needs.
4. Complete Life Insurance Applications
Once you've got some quotes in hand, fill out an application for the policy that's the best fit. This typically includes questions about your lifestyle, hobbies, medical history and family health. You may also have to go through a phone interview and a medical exam. Be sure to answer questions honestly, or your insurance policy could be invalidated when your family needs it most.
5. Purchase a Policy
If your life insurance application is accepted, you'll need to accept the policy terms and pay your premium to activate coverage.
Learn more >> How to Buy Life Insurance
Do I Need Life Insurance?
Life insurance protects loved ones who depend on you to provide for them. It can also be worthwhile for other reasons. For example, life insurance can:
- Ensure your family's financial needs are met after your death
- Pay for child care, housekeeping and cooking services to replace the work done by a stay-at-home parent
- Pay for funerals, debts, taxes and medical bills
- Leave money to friends, family members, charities or organizations you support
- Supplement retirement income
Frequently Asked Questions
Life insurance helps provide financial security for your loved ones after your death. It pays a death benefit that can help replace your income or pay for services you provided in life for your family, such as child care or housekeeping.
A life insurance settlement can help pay any debts you leave behind, such as a mortgage, medical bills or credit card debt. You can also use life insurance to pass wealth on to your heirs or donate to a charitable cause or other organization.
Some life insurance has cash value you can tap into during your lifetime to supplement retirement income, pay premiums or buy more insurance.
Although you can buy life insurance at almost any age, you generally pay less if you purchase life insurance when you're young and healthy. Your age and health are critical factors in the cost of life insurance. Since life insurance premiums typically stay the same throughout the policy term, buying coverage early can lock in lower premiums. Getting married, having children or taking on the financial support of an aging parent can also motivate you to buy life insurance.
Choose the beneficiary you want your insurance payout to provide for or the person who is best able to carry out your wishes for the money. These may not be the same person. If you fear your spouse or partner won't manage the payout wisely, you could designate another trusted person to be beneficiary and handle the finances for them.
You can also name a trust, business, charity or other organization as your beneficiary. Since beneficiary designations supersede any instructions in your will, be sure to update your insurance policy beneficiaries after any major life change, such as getting divorced or having children.
The Bottom Line
Fitting one more expense into your budget may be a challenge, but life insurance is essential if loved ones rely on your income or support. Losing weight, quitting smoking or giving up risky hobbies can help lower your life insurance premiums.
Improving your credit score could also save you money on life insurance. In most states, insurers can review your credit-based insurance scores when setting your rates. Although these scores differ from consumer credit scores, they're calculated using many of the same factors. Actions that can improve your consumer credit score, such as paying bills on time and paying down debt, could boost your credit-based insurance scores, which may mean lower life insurance premiums.