Advice and Support ›

How Life Insurance Works

(Colin McPherson / Barcroft Image / Barcroft Media via Getty Images)

Why should you consider buying life insurance, and what kind?

Life insurance is a financial product that helps ensure your family is taken care of after you die. This insurance policy will pay out to your children, spouse, partner, or whomever you designate as the beneficiary. Life insurance helps cover important expenses such as housing, education, debt, and funeral costs. It helps replace the income that is lost after someone dies, which is especially valuable when the primary income producer for a family dies unexpectedly.

How does life insurance work?

A life insurance policy is a contract between the life insurance company and the policy holder or insured, who has an interest in providing financially for someone else after they pass away.

The policy holder pays the cost of the policy by paying a premium either monthly or annually. After the insured passes away, the life insurance company pays the death benefit to the designated beneficiary. That's usually a family member, but the decision is up to the insured.

Keep in mind the owner of the life insurance policy, who is responsible for the payment of the premium, does not have to be the insured. Someone else could take out a policy and make the payments for the insured, whose life the policy is based on — though it is much more common that the owner of the policy and the insured are indeed the same person.

The two main types of life insurance policies

 

Term life insurance  

Term life insurance provides coverage for a set period of time, usually 10, 20, or 30 years. It is less expensive than permanent life insurance. This coverage is also called “pure life insurance” as it protects your beneficiary in case of your premature death. The payout and the premium typically do not change during the policy.

Look for term coverage based on when you would be leaving the work force so if the death is premature, the benefit will cover your loss of income. Ideally, you will outlive the term period and by then you will have money saved in retirement accounts, your house may be paid off, your children will be out of the house, and you will not need life insurance.

Whole life insurance 

Whole life insurance is the most common and simple type of permanent life insurance. A whole life policy is more expensive than term life.  

A whole life insurance policy is guaranteed to pay the beneficiary the death benefit whenever you pass. The premium typically stays the same and the cash value of the death benefit will increase. The premium money paid into the policy is invested and will grow the value of the death benefit over time. The gain in the death benefit on the policy is tax-deferred so you won’t have to pay taxes on the increase.

Keep in mind that a healthy lifestyle is a factor in how much you will pay in premiums for a policy. A person who smokes or has serious health issues could pay three times more in premiums or be denied life insurance.

Finally, it is recommended that you discuss all your life insurance options with a reputable insurance broker

Read more:

How to Pay for a Funeral
How to Find the Best Burial Insurance Policy
How and Why to Make a Charitable Bequest