Life Insurance: What It Is, How It Works, and How to Purchase a Policy

What is Life Insurance?

Life insurance is a contract between an insurance company and a policyholder in which the insurer promises to pay an amount of money to one or more designated beneficiaries if the insured person dies in return for premiums paid throughout the policyholder’s lifetime. The top life insurance companies have strong financials, a low amount of client complaints, high customer happiness, a variety of policy options, accessible and included riders, and simple applications.


  • Life insurance is a legally binding contract that provides a death benefit to the policyholder if the covered person dies.
  • To keep a life insurance policy in existence, the policyholder must pay either a single payment up front or recurring premiums over time.
  • When the insured dies, the policy’s designated beneficiaries get the face value, also known as the death benefit.
  • Term life insurance plans expire after a certain number of years. Permanent life insurance plans are operative until the insured dies, stops paying payments, or surrenders the policy.
  • A life insurance policy is only as good as the financial stability of the firm that issued it. If the issuer is unable to pay the claim, state guaranty funds may step in.

Types of Life Insurance

Many different forms of life insurance are available to satisfy a wide range of requirements and preferences. Depending on the person’s short- or long-term demands, the key decision of whether to get temporary or permanent life insurance is critical.

Term life insurance.

Term life insurance is meant to last a certain number of years and then expire. When you buy the insurance, you get to select the duration. Common periods include ten, twenty, and thirty years. The finest term life insurance plans combine cost and long-term financial soundness.

  • Decreasing term life insurance is a kind of renewable term life insurance in which coverage decreases throughout the course of the policy at a specified pace.
  • Convertible term life insurance enables customers to convert their term policy into permanent insurance.
  • Renewable term life insurance offers a price for the year the policy is acquired. Premiums rise on an annual basis, and term insurance is often the most affordable at first.

Many term life insurance products enable you to renew the policy on an annual basis after the term expires. This is one option to prolong your life insurance coverage, but since renewal rates are based on your current age, they might climb dramatically each year. Converting your term life insurance policy into a permanent policy is a superior long-term coverage option. This is not available on all term life insurance; if this is essential to you, check into a convertible term policy.

Permanent Life Insurance

Permanent life insurance is more costly than term insurance, but it remains in effect for the insured’s whole life until the policyholder stops paying payments or surrenders the policy. Some plans provide for automatic premium loans when a premium payment is late.

  • Whole life insurance is a sort of permanent life insurance, which means it will last your whole lifetime. It has a monetary value component, akin to a savings account. Cash-value life insurance enables the policyholder to utilize the cash value for a variety of reasons, including loans and policy payments.
  • Universal life (UL) is a form of permanent life insurance that includes an interest-bearing cash value component. Universal life insurance rates are adjustable. Unlike term and whole life insurance, premiums may be changed over time and structured to provide a flat or growing death benefit.
  • Indexed universal life insurance (IUL) allows the policyholder to receive a set or equity-indexed rate of return on the cash value component.
  • Variable universal life (VUL) insurance enables the policyholder to invest the policy’s cash value in a separate account. It also offers adjustable premiums and may be customized with a flat or escalating death benefit.

Top-Rated Companies To Compare

When searching for insurance, consider starting with our list of the finest life insurance providers, some of which are included below.

CompanyAM Best RatingCoverage CapacityMaximum Issue AgePolicies Offered
Nationwide Best Overall Compare Quotes on BestMoneyA+ Over $5 million85Term, whole, UL, IUL, VUL, final expense
Protective Best for Term Compare Quotes on BestMoneyA+Over $5 million85Term, whole, UL, IUL, VUL
MassMutual Best Convertible Term Life Compare Quotes on BestMoneyA++ Over $5 million90Term, whole, UL, VUL
Mutual of Omaha Best Return-of-Premium TermCompare Quotes on BestMoneyA+ Over $5 million85Term, UL, IUL, final expense
Guardian Great Traditional Insurer Compare Quotes on BestMoneyA++ Over $5 million90Term, whole, UL, VUL
USAA Best for Military Compare Quotes on BestMoneyA++Over $5 million85Term, whole, UL
New York Life Best Whole LifeCompare Quotes on BestMoneyA++Over $5 million90Term, whole, UL, VUL

Term vs Permanent Life Insurance

Term life insurance varies from permanent life insurance in various respects, but it often meets the requirements of most consumers seeking cheap life insurance coverage. Term life insurance is only valid for a certain amount of time and provides a death benefit if the policyholder dies before the term expires. This is in contrast to permanent life insurance, which remains in force as long as the policyholder pays the payment. Another important distinction is the cost of premiums—term life is often substantially less costly than permanent life since it does not need the accumulation of capital.

Before applying for life insurance, you should assess your financial condition and calculate how much money is needed to maintain your dependents’ level of living or satisfy the requirement for which you are acquiring a policy. Consider how long you will need coverage.

For example, if you are the main caregiver and have two and four-year-old children, you should have adequate insurance to fulfill your custodial duties until your children reach adulthood and can support themselves.

You may look at the expense of hiring a nanny and a maid, or employing commercial child care and cleaning services, and then budget for schooling. Incorporate any outstanding mortgage and retirement expenses for your spouse into your life insurance calculation, particularly if the spouse earns much less or is a stay-at-home parent. Add up the payments over the following 16 years, plus inflation, and that’s the death benefit you may wish to purchase—if you can afford it.

What Determines Your Life Insurance Premiums and Costs?

Many variables influence the cost of life insurance premiums. Certain factors may be beyond your control, but others may be handled to possibly reduce the cost before (or even after) applying. Your health and age are the most essential variables in determining cost, so purchasing life insurance as soon as you need it is frequently the best option.

After being accepted for an insurance policy, if your health has improved and you have made good lifestyle adjustments, you may request that your risk class be changed. Even if it is discovered that you are in lower health than at the time of underwriting, your rates will not increase. If you’re deemed to be in better health, your rates may be reduced. You may also be able to get more coverage at a cheaper cost than you first paid.

Life Insurance Purchasing Guide

Step 1: Determine the amount you need.

Consider what expenditures will need to be addressed in the case of your death. Consider house payments, college tuition, and other bills, not to mention burial costs. Furthermore, income replacement is an important consideration if your spouse or loved ones need cash flow but are unable to offer it on their own.

There are useful tools available online for calculating the lump payment required to cover any prospective expenditures.

Step 2: Prepare your application.

In most cases, life insurance applications involve personal and family medical history, as well as beneficiary information. You may be required to have a medical examination and reveal any prior medical issues, a history of traffic offenses, DUIs, and any risky hobbies, such as vehicle racing or skydiving. The following are essential components of most life insurance applications:

  • Age is the most essential aspect since life expectancy is the largest risk factor for the insurance business.
  • Gender: Because women live longer, they tend to pay lower rates than men their age.
  • Smoking: Smoking puts a person at risk for a variety of health concerns, which may shorten life and raise risk-based premiums.Health: Most plans include medical tests to screen for health issues such as heart disease, diabetes, and cancer, as well as other medical metrics that might suggest risk.
  • Lifestyle: Dangerous lifestyles may increase premiums significantly.
  • Family medical history: If you have a history of serious illness in your immediate family, your chances of having certain disorders are much increased.
  • Driving record: A history of traffic offenses or drunk driving may significantly boost insurance prices.

Before a policy can be established, you will also need to provide standard kinds of identification, such as your Social Security card, driver’s license, or United States passport.

Step 3: Compare policy quotes.

After gathering all of the relevant information, you may do research to get numerous life insurance quotes from various companies. Prices might vary greatly from company to business, so it is critical to make an attempt to locate the greatest combination of policy, company rating, and premium price. Because life insurance premiums are likely to be paid monthly for decades, selecting the right coverage to meet your requirements might result in significant savings.

Benefits of Life Insurance

There are several advantages to obtaining life insurance. The following are some of the most essential benefits and safeguards provided by life insurance plans.

Most individuals purchase life insurance to give money to dependents who would face financial difficulty if the insured died. However, for affluent people, the tax advantages of life insurance, such as tax-deferred cash value growth, tax-free dividends, and tax-free death payouts, may open up new strategic alternatives.

Avoiding Taxes

The death payout from a life insurance policy is typically tax-free.
It may be susceptible to inheritance taxes, but this is why affluent people sometimes get perpetual life insurance via a trust. The trust allows them to avoid inheritance taxes while still preserving the estate’s worth for future generations.

Tax avoidance is a lawful approach for reducing one’s tax bill, not tax evasion, which is criminal.

Who needs life insurance?

Life insurance offers financial assistance to surviving dependents or other beneficiaries after the death of an insured policyholder. Here are some instances of individuals who may need life insurance:

  • Parents have minor children. If a parent dies, the loss of their income or caring abilities may result in financial difficulty. Life insurance may ensure that the children have the necessary financial resources until they are able to sustain themselves.
  • Parents with adult children who have special needs. Life insurance may ensure that children who need lifetime care and will never be self-sufficient are provided for when their parents die. The death benefit may be used to finance a special needs trust, which will be managed by a trustee for the benefit of the adult child.
  • Adults who hold property jointly. Married or not, if the death of one adult would result in the other being unable to make loan payments, property maintenance, and taxes, life insurance may be beneficial. One example is an engaged couple who get a combined mortgage to purchase their first home.
  • Seniors who wish to leave money to their adult offspring who care for them. Many adult children spend time at work to care for an older parent who need assistance. This assistance may also entail direct cash support. When a parent dies, life insurance may assist pay for the adult child’s expenses.
  • Young people whose parents owed private student loans or cosigned a loan for them. Young individuals without dependents seldom need life insurance, but if a parent will be liable for a kid’s debt after death, the child may choose to carry adequate life insurance to cover that burden.
  • Children or young people want to lock in cheap rates. The younger and healthier you are, the cheaper your insurance rates. A 20-something adult may get a policy even if they do not have dependents or anticipate to have them in the future.
  • Stay-at-home wives. Stay-at-home spouses should obtain life insurance since their employment at home provides considerable economic value. According to, a stay-at-home parent’s economic worth in 2018 would have been similar to an annual wage of $162,581.
  • Wealthy families who anticipate to pay estate taxes. Life insurance may give cash to meet taxes while preserving the entire value of the estate.
  • Families unable to pay burial and funeral expenditures. A modest life insurance policy might offer monies to commemorate a loved one’s death.
  • Companies having essential staff. If the death of a prominent person, such as a CEO, would cause a significant financial hardship for a company, the company may have an insurable interest, allowing it to obtain a life insurance policy on that individual.
  • Married pensioners. Instead of deciding between a pension payment that includes a spousal benefit and one that does not, seniors may take their whole pension and spend part of it to purchase life insurance for their spouse. This method is known as pension maximization.
  • Individuals having preexisting conditions. Examples include cancer, diabetes, and smoking. However, some insurers may refuse to cover such persons or impose exorbitant premiums.

What to do before buying life insurance.

Research Policy Options and Company Reviews

Because life insurance plans are a significant expenditure and commitment, it is vital to do adequate due diligence to ensure that the firm you pick has a strong track record and financial soundness, especially because your heirs may not get any death benefits for many decades. Investopedia has analyzed dozens of organizations that provide various forms of insurance and ranked the best in multiple areas.

Consider How Much Death Benefit You Need.

Life insurance may be a wise financial instrument for hedging your chances and protecting your loved ones in the event of your death while the policy is in effect. However, it makes less sense in some instances, such as when you purchase too much or cover individuals whose income does not need to be replaced. So the following points must be considered.

What bills could not be covered if you died? If your spouse has a large salary and you do not have any children, it may not be necessary. It is still critical to assess the effect of your probable death on your spouse, including how much financial help they would need to mourn without having to return to work before they are ready. However, if both couples’ income is required to maintain a chosen lifestyle or satisfy financial obligations, they may need separate life insurance policies.

Know Why You’re Buying Life Insurance.

If you’re purchasing a life insurance policy for another family member, you should consider what you’re seeking to cover. Children and seniors may not have a significant income to replace, but funeral expenditures may need to be met in the case of death. Aside from funeral costs, a parent may desire to preserve their child’s future insurability by getting a moderate-sized insurance when they are young. This permits the parent to guarantee that their kid can financially support their future family. Parents may only get life insurance for their children for up to 25% of the amount they have in their own policy.

Could investing the money spent on permanent insurance premiums throughout the course of a policy provide a higher return over time? Consistent saving and investing, such as self-insurance, may make more sense as a buffer against uncertainty in certain situations, particularly if a major income does not need to be replaced if policy investment returns on cash value are unduly cautious.

How life insurance works

A life insurance policy has two major components: a death payout and a premium. Term life insurance contains these two components, but permanent or whole life insurance plans also include a cash value component.

  • Death Benefit. The death benefit, also known as the face value, is the amount of money guaranteed by the insurance company to the policyholder’s designated dependents when the insured dies. For example, the insured may be a parent and the beneficiaries their children. The insured will choose the intended death benefit amount based on the beneficiaries’ anticipated future requirements. The insurance company will examine if there is an insurable interest and whether the potential insured meets the firm’s underwriting standards for age, health, and participation in any hazardous activities.
  • Premium. Premiums are the money that a policyholder pays for insurance. If the policyholder pays the requisite premiums, the insurer must pay the death benefit when the insured dies. Premiums are decided in part by the insurer’s likelihood of having to pay the policy’s death benefit based on the insured’s life expectancy. Life expectancy is influenced by the insured’s age, gender, medical history, work dangers, and high-risk hobbies. A portion of the premium also goes toward the insurance company’s running costs. Premiums are greater for plans with bigger death benefits, high-risk clients, and permanent policies that accrue cash value.
  • Cash value. The cash value of permanent life insurance fulfills two functions. It is a savings account that the policyholder may access throughout the insured’s lifetime; the cash builds tax-deferred. Some regulations limit withdrawals based on how the money is to be utilized. For example, the policyholder may take out a loan against the policy’s cash value and be required to pay interest on the loan principle. The policyholder may also use the cash value to pay premiums or buy more insurance. The cash value is a living benefit that passes to the insurance company when the insured dies. Any outstanding loans against the cash value diminish the policy’s death benefit.

Life Insurance Riders and Policy Changes

Many insurance firms allow clients to tailor their plans to meet their specific requirements. Riders are the most popular method that policyholders may alter or adjust their coverage. There are several riders, but their availability is determined by the supplier. The policyholder will normally pay an extra premium or a cost to exercise each rider, while some plans include certain riders in the main premium.

  • The accidental death benefit rider adds extra life insurance coverage in the event that the policyholder dies by accident.
  • The waiver of premium rider relieves the policyholder of the need to pay premiums if the insured becomes incapacitated and unable to work.
  • The disability income rider provides a monthly income if the policyholder is unable to work for many months or more due to a major sickness or accident.The expedited death benefit rider enables the insured to obtain a part or the whole death benefit after being diagnosed with a terminal disease.
  • The long-term care rider is a form of accelerated death benefit that may be used to pay for nursing home, assisted living, or in-home care when the insured needs assistance with everyday tasks such as washing, eating, and using the restroom.
  • A guaranteed insurability rider allows the policyholder to purchase extra insurance at a later date without undergoing a medical exam.

Borrowing money. Most permanent life insurance policies develop cash value that may be borrowed against. Technically, you are borrowing money from the insurance company and pledging your cash worth as security. Unlike with other forms of loans, the policyholder’s credit score is not considered. Repayment periods are variable, and the loan interest is credited to the policyholder’s cash value account. If you do not repay policy debts, the death benefit of the insurance will be reduced.

Saving for retirement. Policies with cash value or investment components might offer retirement income. This opportunity may only be suitable for persons who have exhausted all other tax-advantaged savings and investing accounts because to its high costs and lesser death benefit. Another option to finance retirement with life insurance is via the pension maximization technique mentioned above.

Qualify for Life Insurance

Insurers analyze each life insurance application on an individual basis, and with hundreds of insurers to choose from, practically anybody can find an inexpensive policy that fits at least some of their requirements. The Insurance Information Institute reported that the United States has 841 life insurance and annuity businesses in 2018.

Furthermore, many life insurance firms provide a wide range of policy types and sizes, with some specializing in satisfying specialized requirements, such as coverage for persons with chronic illnesses. There are also brokers that specialize in life insurance and understand what various firms provide. Applicants may engage with a broker free of charge to get the insurance they need. This implies that practically everyone may get some form of life insurance coverage if they seek hard enough and are ready to pay a high enough premium or accept a potentially less-than-optimal death payout.

Insurance is not just for the healthy and rich, and since the insurance market is considerably larger than many customers know, obtaining life insurance may be feasible and inexpensive even if past applications have been declined or bids have been too expensive.

In general, the younger and healthier you are, the simpler it is to qualify for life insurance, but the older and less healthy you are, the more difficult it is. Certain lifestyle choices, such as smoking or partaking in dangerous activities like skydiving, make it more difficult to qualify or result in higher premiums.

Who needs life insurance?

You need life insurance if you want to protect your spouse, children, or other family members in the case of your death. Life insurance death benefits, depending on the policy amount, might assist beneficiaries in paying down a mortgage, covering college tuition, or funding retirement. Permanent life insurance also includes a cash value component that accrues over time.

What Determines Your Life Insurance Premiums?

  • Age (life insurance is cheaper)
  • Gender (female is usually less costly)
  • Smoking (increases premiums)
  • Health (Poor health might increase premiums)
  • Lifestyle (risky behaviors may boost premiums)
  • Family medical history (chronic sickness with relatives may boost rates)
  • Driving record (good drivers save money on premiums).

What are the benefits of life insurance?

  • The payouts are tax-free. Life insurance death benefits are paid in one lump amount and are not subject to federal income tax since they are not considered income by recipients.
  • Dependents are not responsible for their own living expenditures. Most insurance calculators propose a seven to ten-year multiple of your gross income to cover key obligations like as mortgages and college tuition without requiring the surviving spouse or children to take out loans.
  • Final expenditures may be reimbursed. Funeral costs might be high, but they can be avoided with a burial policy, as well as ordinary term or permanent life insurance.
  • Policies might help augment retirement savings. Permanent life plans, such as whole, universal, and variable life insurance, may provide cash value in addition to death payments, allowing you to supplement your retirement funds.

How Do You Qualify for Life Insurance?
To be eligible for life insurance, you must submit an application. However, life insurance is accessible to practically everybody. However, the cost or premium amount varies significantly depending on your age, health, and lifestyle. Some forms of life insurance do not need medical information, but they often have substantially higher premiums and a waiting time before the death benefit becomes accessible.

How does life insurance work?
Life insurance works by offering a death benefit in return for paying premiums. One common sort of life insurance is term life insurance, which lasts for a specified period of time, such as 10 or 20 years. Permanent life insurance likewise provides a death benefit, but it lasts the policyholder’s whole life as long as premiums are paid.

Similar Posts