How does life insurance work?

Millions of people across the United States carry life insurance. It is an essential part of financial planning and provides a safety net for loved ones in the event of the policyholder’s death. In fact, life insurance can be used to pay off debts, replace lost income, fund children’s education, and more. Although its importance is fairly well-known, many don’t understand how life insurance works.

Read more: Personal Financial Planning and Your Life Insurance Policy

If you’re considering buying life insurance, you’ll need to decide how much coverage you want and what type of policy is right for you. But, first, it’s important to understand how life insurance works in the first place.

So, how does life insurance work? Read through this life insurance guide to cover all the information you need to know about life insurance to make a responsible purchasing decision.

How Life Insurance Works

Life insurance is a type of financial product that provides a death benefit to the beneficiary in the event of the policyholder’s death. It is designed to help protect those financially dependent on the policyholder and provide them with funds to cover expenses such as funeral costs, debts, and lost income.

The primary types of life insurance are term life insurance and permanent life insurance:

• Term life insurance is usually more affordable but only provides coverage for a specific period of time (term).
• Permanent life insurance covers your entire lifetime and typically involves investment features like cash value accumulation and dividends.

When deciding what type of policy is right for you, it’s important to consider factors such as age, medical history, financial goals, and budget.

You should also consult a licensed insurance agent to discuss the various options available and ensure you get the best coverage for your needs. With the correct information and guidance, you can choose the life insurance policy that will give you and your family peace of mind.

Read more: What is evidence of insurability?

Different Types of Life Insurance

Before you buy life insurance, you need to know what type of policy you want. Below, we’ll explain each primary type of life insurance to help you decide.

How Term Life Insurance Works

Term life insurance provides coverage for a set period. This allows the insured to purchase the desired level of coverage without worrying about long-term commitments or financial obligations. It’s often used as a short-term solution to help protect loved ones in the event of an untimely death. However, it can also supplement other forms of permanent life insurance coverage. So how does term life insurance work? (For more information, read our “How to Choose a Term Life Insurance Policy“).

It’s important to understand that term life insurance policies do not accumulate cash value and are designed to pay out only upon death during the policy’s specified term. The insured can choose how long they wish to keep the policy, which can range from five to 30 years and will determine how much coverage is provided.

The amount paid on a term life insurance policy depends on factors such as age, health, and lifestyle, as well as the length and amount of the policy.

It’s important to note that premiums increase as you age, so if you are considering signing up for a term life insurance policy, it’s best to do so when you are younger and in good health.

How Permanent Life Insurance Works

Permanent life insurance is a type of policy that provides lifelong coverage and can build cash value over time. It combines the death benefit protection of term life insurance with an investment component, allowing policyholders to receive dividends on their premiums or access their investment savings.

Permanent life insurance is ideal for long-term financial security, as it guarantees life insurance rates regardless of age and ensures that money will be available to beneficiaries upon the insured’s death.

You have three main options when considering permanent life insurance — whole life, universal life, and variable universal life:

• Whole life insurance offers fixed premiums, benefits, and cash value accumulation over the policy’s lifetime.
• Universal life insurance has adjustable premiums, face amounts, and varying rates of return on the cash value. Learn more about indexed universal life insurance.
• Variable life insurance has adjustable premiums and death benefits, with more opportunities to invest the cash value in the stock market.

Each type of permanent policy offers tax-deferred savings, but whole life generally offers more stability, while universal and variable life allow policyholders to adjust their coverage as needed.

Permanent life insurance is an attractive option for those looking for long-term financial security and peace of mind. It provides guaranteed benefits, the potential for growth through investment opportunities, and flexibility in terms of premiums and death benefit amounts.

Additionally, it can provide a tax-advantaged way to save money or supplement retirement income if appropriately structured. Ultimately, permanent life insurance can be an effective tool for providing financial protection over the long term. ​​Find out if life insurance premiums are tax-deductible.

Read more:

• Understanding Universal Life Insurance Coverage
• Understanding Variable Life Insurance: What is it and how does it work?
• Should you pay life insurance premiums monthly or annually?
• Term vs Permanent Life Insurance: Which is better?
• Term vs Whole Life Insurance: Which is better?
• What is Life Insurance Retirement Plans (LIRPs)?
• Understanding Indexed Whole Life Insurance

How Burial Insurance Works

Burial insurance pays out a lump sum death benefit upon the insured’s passing.

The primary purpose of burial insurance is to provide financial assistance for end-of-life expenses, such as funeral costs, medical bills, and other associated expenses. This can help families avoid taking on additional debt or using up their savings just to cover these costs.

Burial insurance coverage is generally available to those aged 45–85 and does not require any medical tests or questions to obtain coverage.

Policies typically have low premiums and coverage amounts ranging from $2,000 to $25,000. Policies may also include an accelerated death benefit, which allows payment before death if the insured is diagnosed with a terminal illness.

Burial insurance may be an attractive option for those who want to ensure their family is provided for in case of their passing but do not have the means to purchase a more substantial life insurance policy. In addition, it can also provide peace of mind knowing that final expenses will be taken care of without burdening loved ones.

For these reasons, burial insurance is becoming an increasingly popular choice among many individuals and families.

How Survivorship Insurance Works

Survivorship life insurance is a policy that provides coverage for two people simultaneously. Rather than protecting just one individual, this policy covers both individuals in the case of their passing.

The primary benefit of survivorship life insurance is that it offers double coverage with a single premium payment.

In many cases, when each individual takes out a traditional policy, the premiums can add up quickly. However, with survivorship life insurance policies, only one premium payment needs to be made, which can result in significant savings over time.

Additionally, the death benefits from the policy will be paid out regardless of which individual passes away first.

This type of insurance can benefit couples or families who want to provide financial security and stability to their loved ones should anything happen to either person. The death benefits paid out from survivor life insurance can cover expenses that may arise, such as mortgage payments, college tuition, or other debts. (For more information, read our “Tuition Insurance: What is it and should you have it?“).

This policy also benefits couples who want to receive tax-free benefits when one spouse dies. The surviving partner can use the money for long-term care or supplement their income.

Overall, survivorship life insurance is an excellent option for those who want to protect their loved ones if something happens to either person in a relationship. It provides double coverage with just one premium payment. Additionally, tax-free death benefits can be beneficial for surviving spouses.

What Life Insurance Covers

Life insurance is a type of policy that provides financial protection to beneficiaries in the event of an insured individual’s death.

It pays out a lump sum or regular payments depending on the policy, which can be used to cover expenses such as funeral costs, medical bills, debts, mortgage payments, college tuition, and other living expenses.

In addition to providing financial security, life insurance can also provide tax benefits. Depending on the type of policy you have and where you live, proceeds may be exempt from taxation at both state and federal levels.

Furthermore, many life insurance policies offer additional riders, which allow you to customize coverage to fit your needs best. For instance, you may be able to include an accelerated death benefit which allows payment before death if the insured is diagnosed with a terminal illness.

The coverage and features included in a life insurance policy will vary depending on the type of policy you purchase, so it’s important to research different options and consult with an insurance professional to find the best solution for your family’s needs. Learn how bad it is not to have life insurance.

Read more:

• How bad is it to not have life insurance?
• Life Insurance vs Roth IRA: Which is better for retirement?
• What are the tax rules around life insurance?

When it comes to choosing the right life insurance policy type, there are several factors to consider.

The most important factor is the amount of coverage you will need based on your current lifestyle and expected future needs. For example,  suppose you have children or a mortgage. In that case, you may want to opt for a larger amount of coverage, as these expenses can impact your family’s financial security after your passing.

Other factors include the type of policy you choose (term vs. whole life), riders, and other features offered with each policy type. It is also important to consider the cost of premiums and compare providers offering similar policies at different rates.

Finally, it is important to consider how long you need the policy, as some policies may have shorter terms than others. Working with an insurance professional can help you understand the various options to decide which life insurance policy type is right for you. Find out if you can buy life insurance for someone else.

Life Insurance Rates

The cost of life insurance varies based on the type of policy you choose, the amount of coverage you need, and your age. Generally speaking, your premiums will be lower the younger and healthier you are.

Term life insurance policies tend to be more affordable than whole life policies as they do not offer a cash value component. However, term policies typically have shorter terms (e.g., 10-20 years) than permanent coverage, which lasts your entire life.

Average Monthly Term Life Insurance Rates by Age, Policy Length, and Policy Amount

The cost of premiums can also vary from one insurer to another, so it’s important to compare quotes from different providers before choosing a policy. Additionally, many companies offer discounts for purchasing multiple policies or taking out a policy with a higher coverage amount.

How to Get Life Insurance Quotes

Once you’ve decided on the type of life insurance policy you want, your next step is to compare life insurance quotes from different providers. You can get free life insurance quotes online with our comparison tool below. We compare quotes from local life insurance companies to get you the lowest rates. Find the best life insurance companies that offer 30-year terms.

When comparing life insurance rates, be sure to look at more than just the cost of the premium. Compare the coverage amounts, any additional riders available, and the insurer’s financial rating to make sure you are getting a policy that meets your needs at a competitive rate.

Read more: How much does a $500000 life insurance policy cost?

How to Choose the Right Beneficiary

Choosing the right beneficiary is an important step when taking out a life insurance policy. You’ll need to determine who should receive the death benefit in case of your passing.

Usually, this would be your spouse or close family member, but it could also be a friend, charity, or trust fund. It’s important to make sure that your beneficiary is aware of the policy and understands how it works, so they can claim the death benefit should you pass away.

Be sure to regularly update your beneficiaries as needed in order to keep your life insurance policy up-to-date with any changes in your personal situation.

If you have any questions about the right beneficiary, a representative can help explain what you should look for and how life insurance is paid out to beneficiaries.

Read more:

• Understanding Your Life Insurance Policy: Terms and Riders Explained
• What are life insurance riders?

Case Studies: Illustrating the Benefits of Life Insurance

Case Study 1: John’s Story

John, a 35-year-old father of two, wanted to ensure the financial security of his family in case of his untimely death. He decided to purchase a term life insurance policy with a coverage term of 20 years and a death benefit of $500,000.

Unfortunately, John passed away in a car accident five years after purchasing the policy. His wife and children received the full death benefit, which helped cover funeral expenses, pay off outstanding debts, and provide financial stability for the future.

Case Study 2: Sarah’s Story

Sarah, a 50-year-old business owner, wanted to secure her family’s financial future and provide for her grandchildren’s education. She opted for a permanent life insurance policy, specifically a whole life insurance policy with a death benefit of $1 million. Sarah paid premiums into the policy for 20 years and accumulated a significant cash value.

When she turned 70, Sarah decided to retire and used a portion of the cash value to supplement her retirement income. Upon her passing, her beneficiaries received the remaining death benefit, which helped fund her grandchildren’s education and provided financial support for her spouse.

Read more: Best Life Insurance Policies When You Have Grandchildren

Case Study 3: Mark and Lisa’s Story

Mark and Lisa, a married couple in their early 60s, wanted to protect their estate and ensure their beneficiaries would receive an inheritance even after they were gone. They opted for survivorship life insurance, also known as second-to-die insurance.

They purchased a policy with a death benefit of $2 million, which would be paid out after both of them passed away. The policy provided them peace of mind, knowing that their children would receive a significant inheritance and be financially secure. Additionally, the policy offered tax advantages for their estate planning.

Read more: What are the benefits of having life insurance?

Find the Right Life Insurance for Your Needs Today

Life insurance is an important part of many financial plans, as it provides financial protection for your loved ones in case of your passing.

When choosing the right life insurance policy type, consider the amount of coverage you need, the cost and duration of premiums, and any additional riders or features offered by your life insurance company.

When comparing quotes from different insurers, make sure to consider their financial rating, coverage amounts, and any additional features or riders available.

With the right policy in place, you can provide financial security for your loved ones even after you’re gone. Learn how to get instant life insurance.