How does life insurance work?

Life insurance is pretty simple: The policyholder pays a recurring amount of money – the premium – to an insurance company. If the policyholder dies while the policy is active, the insurer pays out a tax-free sum of money – the death benefit. The parties that receive the death benefit, typically family members, are called beneficiaries. The death benefit helps the beneficiaries achieve financial goals, like college and homeownership, even if the primary breadwinner is no longer around.

There are several different types of life insurance, and you can choose one that meets your own coverage needs and your financial situation. How much you pay for life insurance depends on how much coverage you purchase, how long you want your life insurance to last, and how much risk you have of dying while you’re covered by the policy.

But even if you know what life insurance is, you can still save money by knowing how it works and still get the benefits and features you need.

Read on to learn more about:

• Who needs life insurance?
• How much life insurance do I need?
• How do I choose a life insurance policy?
• How much does life insurance cost?
• How do I apply for life insurance?
• How do I save money on life insurance?
• How do I make my life insurance policy work for me?
• How do my beneficiaries get paid when I die?

Who needs life insurance?

If you have family who relies on you for financial support, you need life insurance. Life insurance will pay your loved ones a death benefit after you die that could be used to keep paying the bills when you’re not around.

Married people need life insurance even if they don’t have any kids. Do you co-sign your mortgage with your spouse? What about your auto loan? If you die, your spouse will be on the hook for those loan payments and could lose the asset if he or she becomes delinquent.

Even if you’re not worried about loan payments, the death benefit could help pay for funeral costs, which are considerable, or even just a vacation to take away some of the sting of losing a loved one.

If you do have children, they can’t be named as a beneficiary without using a complicated loophole in financial law. But your spouse can use the money to pay for the kids’ education costs.

Single people may still need life insurance, especially if they’re planning on starting a business. You want your business partner to succeed if you die, so you can name him or her as the beneficiary. (This is called having an insurable interest. You can’t just name anyone.)

Say you’re not married, have no kids, and don’t plan on starting a business with anyone any time soon. You may not need life insurance… yet. But what if those plans change? You could need life insurance later in life, but by then you could be ineligible due to a medical condition or find that the premiums have become unaffordable. Life insurance rates increase with age.

How much life insurance do I need?

When you purchase life insurance, you’re basically purchasing a death benefit. If you need a higher death benefit, you’ll pay higher premiums. For that reason, you should calculate how much life insurance you need even before you start looking for quotes by adding up all the expenses you hope to pay for when you die.

Protecting your spouse

Add up the costs of any current debts you share with your loved ones, such as any student loans, co-signed credit cards, or mortgage payments. That’s just the financial obligation side. You’ll also want to give your spouse a comfortable standard of living after you’re gone and provide money for major expenses like end-of-life medical bills and funeral costs.

Taking care of your kids

You also need to factor in the cost of sending your kids to school. Tuition costs are higher than ever, and a death benefit can help pay for all or part of the costs if you’re not around to keep paying for your kids’ education. Additionally, any money leftover can be set aside for your kids until they’re old enough to inherit it.

Keeping your business afloat

If you name your business partner as a beneficiary, you should factor in any outstanding business loans as well as the amount you contribute to grow the business.

Money for charity

You can even name institutions and organizations as beneficiaries. If you intend to leave a $100,000 gift to your alma mater or your favorite charity, make sure your death benefit is large enough to accommodate that.

How do I choose a life insurance policy?

In addition to the amount of coverage you need, you should also figure out what type of life insurance you need. Of the main types of life insurance, the two major differences are

• How long you want your life insurance coverage to last
• Whether you want your death benefit to potentially increase over time

Term life insurance

Term life insurance only covers you for a predetermined number of years, after which you stop paying premiums and the coverage expires. It has no other features, although the coverage can be enhanced with the addition of riders. Because term life insurance is essentially bare-bones coverage, it’s by far the most affordable type of life insurance.

If you die during the term, then your beneficiaries receive a death benefit. But you outlive the term, then you get nothing from the insurance company except the joy of being alive.

Whole life insurance

Whole life insurance is a form of permanent life insurance. Rather than pay premiums for a set number of years, you pay them for your whole life, and when you die, your beneficiaries receive a death benefit.

As with other types of permanent life insurance, whole life has a cash-value component that increases in value as you pay your premiums. Eventually, the cash-value component may increase the death benefit, and, in rare cases, you may even be paid dividends on the accumulated cash value. You can also withdraw money the cash value or take out a loan using it as collateral, but this could reduce the death benefit and leave your beneficiaries with nothing.

If you don’t want to pay premiums forever, there is paid-up whole life insurance. This lets you pay increased premiums for a set number of years, after which you’re covered for the rest of your life.

Universal life insurance

Universal life insurance is another permanent life insurance policy. However, unlike whole life, the cash value of universal life is tied to a specific stock index used by the insurer. If the market underperforms, then the cash value can decrease, which means that you may have to pay higher premiums to keep supporting the same amount of coverage.

Variable life insurance

Variable life is also tied to market trends. But, unlike universal life, you can choose what kinds of assets you want to invest in. Premiums under variable life are fixed, but if your assets don’t outperform the value of the death benefit, you may not notice any difference in coverage.

Variable universal life insurance

As a combination of variable life insurance and universal life insurance, variable universal life insurance takes the adjustable premiums of universal life and applies them to the diversified assets of variable life. That means your premiums could increase or decrease depending on how the investments fare, but they must be enough to keep supporting the death benefit.

Choosing the type of life insurance you need

Most people who need life insurance only need term, especially if they’re investing their money in traditional savings accounts. With term life insurance, you pay a low amount of money for the peace of mind that comes with having life insurance. But if you purchase a more expensive policy, you run the risk of falling behind on your payments, and the policy could lapse.

But if you’re the kind of person who makes the maximum contribution to their retirement account each year, you may find that the cash-value component allows you to grow even more of your money. For that reason, wealthier people may prefer a permanent life insurance policy such as whole life.

How much does life insurance cost?

The cost of life insurance depends on how much coverage you need and how much risk you pose. Healthier people pay less for life insurance; so do people who live a less risky or dangerous lifestyle. If you’re less healthy or enjoy hobbies like skydiving, you can make life insurance more affordable if you purchase smaller amounts of coverage or choose a shorter term.

State governments regulate life insurance premiums. According to each insurer’s actuarial tables, someone with your same characteristics and health history will likely be quoted similar if not the very same rates as you.

On average, a person between the ages of 35 and 39 will pay about $26.20 per month for a 20-year term life insurance policy with a $500,000 death benefit. By comparison, a 30-year-old will pay $99.14 per month for a whole life insurance policy that is paid up at age 99.

Contestability period

Note that lying about your health to get a better rate could hurt you in the long run. During the first two years that your policy is in force, it’s considered contestable; the life insurance company reserves the right to contest any claim made by your beneficiaries after your death. If it finds that you misrepresented your health, the carrier could reduce the death benefit or cancel the policy outright, leaving your beneficiaries with nothing but a refund of your premiums. After this two-year period ends, your coverage becomes incontestable, except in the case of fraud.

How do I apply for life insurance?

The life insurance application is pretty straightforward, but the process can take some time. It all starts with getting quotes. Policygenius makes it easier than ever to compare quotes online, and you can start your application right then and there with a licensed representative to help you along the way.

1. Fill out the application.

The application will include basic information about your health, your family health history, your hobbies, and how much coverage you need. The application will include information about your beneficiaries, including whom you want to be the primary beneficiary, and whom you want to be the contingent beneficiaries, who will receive the death benefit if the primary beneficiary dies before you or can’t be contacted.

2. The phone interview.

After your application is complete, a representative from the carrier will call you to discuss the information you submitted. This will confirm some of the details and allow you to schedule the medical exam.

3. Take a paramedical exam.

A medical tech will come to you and do a basic health checkup, similar to the one you get from your doctor. (You can also go to the lab yourself.) In addition to examining the severity of any health conditions you mentioned in your application, the medical tech could discover any medical concerns that weren’t mentioned on the application. You could have to take a blood or urine test, which will confirm whether you use illicit substances.

It’s possible to skip the paramedical exam if you don’t need as much life insurance coverage and your health is excellent. Talk to the life insurance company about simplified-issue life insurance or other types of no-medical-exam coverage.

4. Wait for the attending physician’s statement.

If you have any serious or chronic illnesses, the insurer may ask your doctor to submit an attending physician’s statement (APS), which lists the conditions you’re being treated for and your prognosis.

5. Go through underwriting.

During underwriting, the insurer will take all the information it gleaned about you during the application process and calculate how much your premiums will cost. The underwriter will also look at such evidence of risk as your driving history, your credit score, and any information about you in the Medical Information Bureau, which tracks what information you’ve submitted in previous insurance applications and whether you’ve been declined in the past.

6. Pay your first premium.

Once you’ve received your policy, it won’t be in force until you pay your first premium. This is the time to set up a payment plan for paying your premiums. Payments can be made with credit card, debit card, or as a direct withdrawal from your bank. You may also be able to mail a check.

How do I save money on life insurance?

Don’t like how much you have to pay? There are a lot of ways to save on life insurance.

Buy early

Buy when you’re younger and healthier, and you’ll save on premiums over the lifetime of the policy. That’s because you can lock in your rates, so the amount you pay when you’re a fresh-faced 25-year-old will be the same amount you pay when you’re old and frail.

Get the right amount of coverage

It sounds awesome to know that your beneficiaries could get a $1,000,000 payout when you die. But can you afford to pay for $1,000,000 in coverage while you’re alive? Maybe $500,000 or $750,000 in coverage will be more affordable, but always be sure you’re purchasing enough.

Shop around for quotes

By getting quotes from multiple carriers, you can always go with the lowest rate you’re offered. Make sure you read over the policy before you sign to make sure that the low price doesn’t come with lackluster coverage.

Get healthy before you apply

If you get assigned tobacco or nicotine rates when you apply, you’ll pay much higher premiums than someone with your characteristics who doesn’t smoke. While quitting smoking before you apply can lower your rates, you’ll have to show that you’ve been tobacco-free for at least two years before your rates will budge, and it needs to be at least five years if you want the best rates.

Losing weight can also help. Life insurance carriers assign higher rates to people with higher a body mass index, so getting in shape before you apply could net you a more favorable premium. But hit the gym soon! Your rates will go up slightly with every passing year.

Purchase group life insurance

Your employer may offer life insurance coverage as a benefit. While it may be more affordable than buying individually, group life insurance may also only offer small coverage amounts.

How do I make my life insurance policy work for me?

You can customize your life insurance coverage by adding riders, which give you additional benefits. Some common riders include:

Accelerated death benefit rider

If you need end-of-life care because of a terminal or critical illness, you can start receiving the death benefit early.

Family income benefit rider

Having the family income benefit rider means that, when you die, your beneficiaries will not only receive the death benefit but also a monthly payout. You can choose how long you want the payments to continue.

Term conversion rider

After your term expires, you may still need life insurance coverage. If you have the term conversion rider, you have the option to convert policy into a permanent life insurance policy using the same information you submitted all those years ago when you first applied.

You’ll pay less for a converted permanent life insurance policy than you would if you bought one new at that age, but note that your premiums will be higher than you were used to paying for term life insurance.

How do my beneficiaries get paid when I die?

When you die, the beneficiary will file a claim with the life insurance company. Make sure he or she knows how to find the policy. (And even that the life insurance exists in the first place!) He or she will have to submit a death certificate, proof of identity, and a claim form that thoroughly details all the information surrounding the death and the beneficiary’s claim.

If the insurer doesn’t contest the claim and no fraud or illegal activity was involved, then all that’s left is to get paid.

Your beneficiary can choose whether to receive the death benefit as a lump sum, which is paid all at once, tax-free. He or she can also convert the death benefit into an annuity, meaning that he or she will get smaller annual payments that could eventually exceed the death benefit if the beneficiary lives long enough.