How does life insurance work?

If your family were to lose your entire income today because you passed away in an accident, who would cover the mortgage or keep food on the table?

This is where life insurance can help you protect your family and your loved ones.

Is life insurance worth it? Life insurance works to protect your loved ones from a total loss of income if you pass away.

Monthly life insurance rates are often less expensive than you’d imagine. This guide will help you to understand how life insurance works and whether you can have multiple life insurance policies.

What is life insurance?

Life insurance is a type of insurance plan that financially safeguards and supports designated beneficiaries in the event of the policyholder’s passing.

Life insurance beneficiaries are typically members of the policyholder’s immediate family. Health care, funeral, housing, and debt repayment costs are all things a life insurance policy can help cover.

Read more: Can you have multiple life insurance policies?

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How does life insurance work?

There is a procedure for applying for life insurance that can involve a medical exam or answering health-related questions. Your age and lifestyle will influence your level of risk and how much you pay for coverage.

Once your application is approved, and the terms of the policy are established with your insurance company, you will pay a monthly or yearly premium to maintain life insurance coverage. Your insurer is generally not allowed to stop providing coverage after a policy is issued, even if your health changes gradually while you’re still alive.

However, your life insurance company may reject claims if you haven’t paid your premiums on time or your insurer finds out you’ve given them false information about your health.

Additionally, some insurance companies might have additional exclusions, such as when a beneficiary kills you or your death results from a high-risk activity.

Read more: Should you pay life insurance premiums monthly or annually?

What does life insurance cover?

Life insurance covers you in the event of:

• Homicide or murder
• A fatal accident
• A deadly disease, illness, or virus
• Suicide

Read more: How To Negotiate a Bodily Injury Settlement

What does life insurance not cover?

Suicide may be explicitly excluded from your life insurance coverage, so read your policy carefully. In most cases, life insurance policies come with a two-year contestability clause, which means the company won’t pay out if the insured commits suicide within two years of taking out the policy.

Other contestable circumstances include misrepresentation of facts when creating the life insurance policy or dying while committing an illegal act during the contestability period. Here are 10 other reasons why life insurance won’t pay out.

Different Kinds of Life Insurance by Definition

There are two kinds of life insurance: term life and permanent life insurance. Each one has its own applications and benefits.

Term Life Insurance

How does term life insurance work? Term life insurance provides coverage for a certain number of years, typically between 10 and 30.

With term life insurance, you decide how long you anticipate needing the coverage — for example, until the mortgage is paid off, until the kids graduate from college, or until you retire — and select a term that corresponds to that length of time.

A term life insurance policy might cover your working years to protect your beneficiaries until you retire. The life insurance death benefit is paid to your beneficiaries to help with debts if you pass away before the coverage period expires. Typically, term life insurance benefits are tax-free unless you pay your premiums with pre-tax dollars. Find out how to buy term life insurance.

At its rudimentary level, term life is a contract between the policyholder and their insurance company, where the insurer offers to pay a particular death benefit in cash to the listed beneficiaries if the named insured dies within the terms of the policy.

To maintain coverage, the policyholder must make regular life insurance payments over the policy’s term. Your term life insurance rates will be lower the younger you are when you apply. (For more information, read our “How To Find a Lower Term Life Insurance Premium“).

For instance, insurance companies view policyholders between the ages of 18-54 as generally the most active and healthy. Likewise, dangerous occupational environments, such as working on an oil rig or construction worker, may raise your rates.

Depending on the type of term life insurance policy, you can renew it for another term without a new medical exam or convertible to a permanent life policy.

Read more: What is the waiting period for life insurance?

Permanent Life Insurance

A permanent life insurance policy, also called whole life insurance, offers more lasting benefits. It will cover you for your entire life and pay beneficiaries after you pass away.

Whole life insurance costs more than term life but offers exclusive advantages not available with term policies, including an investment portion where part of your annual premiums is invested in a separate account.

With each payment you make, the total cash amount in your life insurance account also rises. Some insurance companies allow compound interest and dividends to be earned as well. While alive, you might also be allowed to take out loans against your policy or eventually cash it out entirely.

However, this would affect any payout to beneficiaries someday, as all interest and loans would have to be repaid, or the total life insurance payout would be reduced. Learn more about universal whole life insurance and how it can impact your investments.

How to Pick the Best Type of Life Insurance Policy

The best life insurance policy protects and matches your current assets, net worth, long-term financial obligations, and earning power over a set period of time. The most important thing to remember is you shouldn’t wait too long to open a policy if you think you need one.

You can always cancel a life insurance policy but can’t open one retroactively.

Read More: Is life insurance an asset?

How to Pick a Coverage Amount for Life Insurance

Although you can’t predict the future or account for every price your family might incur while you’re away, there are a few easy ways to begin calculating your number:

• Multiply your income between the ages of 18 and 40 by 30
• Multiply your income between the ages of 41 and 50 by 20
• Multiply your income between the ages of 51 and 60 by 15
• Multiply your income between the ages of 61 and 65 by 10

After the age of 65, coverage is determined by net worth rather than income.

Remember, the more coverage you choose, the more expensive your life insurance rates will be. So compare how much term life insurance you can buy to permanent coverage, and shop around with multiple companies to find the most affordable rates for the kind of policy you need.

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How much is life insurance?

Life insurance costs typically go up as you age. You’ll get the lowest life insurance rates if you buy a policy before you turn 40. However, you can lock in payment and pricing structures with certain types of permanent policies to eventually stop paying but retain the full payout and benefit amount.

A whole life insurance policy typically costs between $200 and $400 per month, depending on your age. Term life insurance is much less expensive at around $20-$50 per month.

This table compares life insurance rates by age, gender, and smoker status.

Life Insurance Monthly Rates by Age, Gender & Smoker Status

As you can see, life insurance rates will increase if you are a smoker.

What about life insurance for older adults? It’s important to remember that once you are above 60, buying life insurance will be difficult and more expensive as many insurance companies are unwilling to take on the risk. If you wait too long, companies might refuse to create a life insurance policy for you.

Read more: Can you reduce the coverage amount on your term life insurance policy?

How to Get Life Insurance Quotes

You can quickly and easily get free life insurance quotes with our comparison tool below. We search by ZIP code and will connect you with the cheapest life insurance companies near you.

Enter your ZIP code and click on “Get Free Quotes.” Answer the follow-up questions to receive life insurance quotes online from local companies.

What is considered high-risk for life insurance?

The insurance company will determine how much of a risk you are before issuing you a policy. The life insurance underwriting procedure will assess your health, often with a medical exam, and the company will ask you about your job, hobbies, and medical history.

How does life insurance work if you participate in extreme sports? Some pastimes, like scuba diving, skydiving, bungee jumping, or wingsuit gliding, are considered hazardous to your health and will increase your rates. (For more information, read our “Life Insurance for Extreme Sports“).

Read more: life insurance for high-risk individuals.

What is the contestability period for life insurance?

A brief time after a policy is opened is known as the “life insurance contestability period.” The life insurance company can look into (and potentially reject) claims during this time. The contestability term is normally between one and two years, depending on your state.

For example, life insurance coverage may not apply to certain deaths during this period, including suicides or death due to criminal behavior. The company may launch an investigation if you pass away during the contestability period. This doesn’t mean your beneficiaries will not receive what’s due, but the company does have the choice to look more closely if it chooses to.

However, if you’re unhappy with the total payout or suspect insurance company malfeasance, seeking an attorney could be useful to receive maximum benefits in the event of a dispute.

Read more: How Life Insurance Payouts Work

Life Insurance Basics

Life insurance doesn’t have to be overly complicated. Here we discuss some of the basic life insurance terms used when creating a life insurance policy:

• Premiums. The payments you make to the insurance provider are called premiums. These cover the price of your insurance and administrative charges for term life policies. Additionally, you’ll be able to deposit funds into a cash-value account with a permanent policy.
• Beneficiaries. What are life insurance beneficiaries? These are the individuals who get money upon the insured party’s death. A crucial step in determining the impact of your life insurance is selecting the beneficiaries. Beneficiaries are typically spouses, kids, or parents. However, anybody can be chosen.
• Death Benefit. The sum of money that will be given to the beneficiaries upon the insured person’s demise is referred to as the death benefit. When you purchase a policy, you choose the face value of the life insurance, which is occasionally but not always a fixed number.
• Insurance Riders. You can customize your policy by adding life insurance riders. If you can no longer work, you might want your premiums paid for or add a child to your insurance. You can add these features with different riders.

Read more: How to Talk About Life Insurance With Someone Who Doesn’t Want To Discuss It

Consider your premiums, death benefits, and any riders you might need as you shop for life insurance. For instance, riders will increase your rates, while choosing a smaller death benefit will lower your rates. (For more information, read our “How To Find a Lower Term Life Insurance Premium“).

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How to Choose a Life Insurance Beneficiary

Figuring out how to choose a life insurance beneficiary is one of the most important steps.

You can assign anyone you please to be the paid beneficiary of your life insurance policy — most of the time, people choose their immediate family members. Just remember to choose wisely and with the long term in mind, as loyalties and allegiances can change over time.

How to File a Life Insurance Claim

As soon as the policyholder passes away, beneficiaries should obtain the death certificate and call the insurance company. The insurance company will arrange payment, and beneficiaries can take care of expenses and set themselves up to avoid financial issues as soon as possible.

While an insurance company may pay in as little as two weeks, it could create an issue for beneficiaries if it takes longer.

Case Study 1: John’s Financial Protection for His Family

John, a 35-year-old married individual with two children, recognized the importance of providing financial security for his family in the event of his untimely death. He decided to purchase a term life insurance policy for a period of 20 years to ensure that his family would be financially protected during their most vulnerable years.

The policy offered a death benefit that would cover the mortgage, education expenses, and daily living costs for his family. Unfortunately, John passed away unexpectedly after five years of having the policy. Thanks to the life insurance payout, his family was able to maintain their lifestyle and cover their financial obligations during this difficult time.

Case Study 2: Sarah’s Peace of Mind for the Future

Sarah, a 45-year-old single woman, had been putting off purchasing life insurance for years. However, after witnessing the financial struggles of a friend’s family following their unexpected loss, she realized the importance of having a safety net in place.

Sarah decided to opt for a permanent life insurance policy that would provide coverage for her entire lifetime. She chose a policy with a death benefit that would not only cover funeral expenses but also leave a legacy for her nieces and nephews.

As Sarah continued to pay her premiums over the years, the cash value of her policy grew, offering her the flexibility to borrow against it if needed. Sarah found peace of mind knowing that her loved ones would be taken care of financially after her passing.

Case Study 3: David’s Business Succession Planning

David, a 50-year-old entrepreneur, was the sole owner of a successful small business. He realized that without him, the future of his business and the financial security of his employees would be at risk.

To ensure a smooth transition in the event of his death, David purchased a combination of term and permanent life insurance. The term life insurance policy provided coverage for a specified period, during which David planned to groom a successor and ensure the continuity of his business.

The permanent life insurance policy would offer a death benefit that could be used to settle any outstanding debts and provide financial support to his family. With this comprehensive life insurance plan, David was confident that his business and loved ones would be protected in the face of unexpected circumstances.

The Bottom Line on How Life Insurance Works

Life insurance policies provide financial protection for your loved ones after your death. If you buy life insurance, the company will pay a death benefit to your beneficiaries to cover funeral expenses and burial costs, replace lost income, and more.

You can choose between term and permanent life insurance, but remember that term life insurance only lasts for a set number of years. Permanent policies last your whole life but come with higher monthly rates.

The kind of life insurance you need is based on your financial situation, familial responsibilities, lifetime earning potential, and the level of protection required including life insurance for non-working spouses to meet your current obligations and circumstances.

The Insurance Information Institute reports that 106 million American adults don’t have life insurance or adequate protection. While many Americans have switched to annuities, even more households are completely unprepared to recoup a major loss of income.

Fortunately, most life insurance policies will pay out, so start shopping for coverage today. Take advantage of our free comparison tool below to get life insurance quotes from local companies. Then, compare different policies with multiple insurers to find the best rates.

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