How does life insurance work?

There’s one major benefit to buying life insurance: Financial support for your loved ones when you die. As the policyholder, you pay a recurring amount of money — the premium — to an insurance company and if you die while the policy is active, the insurer pays out a tax-free sum  — the death benefit.

The recipients of the death benefit, typically your family members or other dependents, are called beneficiaries. The insurance payout functions as an income replacement so that your beneficiaries can continue to afford housing, food, bills, outstanding debts, and other expenses, even after you’re gone.

There are several different types of life insurance, but term life insurance usually provides the best coverage at the lowest price for most people. The cost of your life insurance policy depends on the amount of coverage; policy length, and how risky you are to insure based on your health, age, and hobbies. 

What does life insurance cover?

Life insurance pays out the death benefit for most causes of death, whether it’s due to an illness, accident, or natural causes. In certain cases, such as suicide within the first two years of holding the policy, a beneficiary murdering the policyholder, application fraud, the insurer may reduce or not pay out the death benefit.

The life insurance death benefit is typically tax-free. Beneficiaries can use it as they see fit.

Do I need life insurance?

....If I’m married?

If your family relies on you for financial support, you need life insurance to help cover expenses after you die. Even if you don’t provide an income for your family, your death may result in extra home or child care, which can end up costing an additional $178,201 annually.

Whether you’re married or in a domestic partnership, you need life insurance, even if you don’t have any kids. Did you cosign your mortgage, credit cards, or auto loan? If you die, your partner will be on the hook for those loan payments and could lose those assets if they become delinquent.

The death benefit also gives your spouse a comfortable standard of living after you’re gone and covers major expenses like end-of-life medical bills and funeral costs.

...If I have children?

For a middle-income family, the cost of raising a child through age 18 in the U.S. can be as high as $233,610, not including any costs thereafter, such as college tuition. Your children rely on you for housing, food, and much more. If you die and are no longer there to provide for them, a life insurance policy can make sure that they’re financially protected and can sustain their standard of living.

Minor children can’t be named as the beneficiaries of your policy without using a complicated loophole in financial law. It’s best to name your spouse or a trusted legal guardian as your policy’s beneficiary who can support your children financially if you die.

...If I’m single?

Just because you’re young or single doesn’t mean you don’t need life insurance. If your plans change and you end up growing your family or taking out a mortgage, you’ll end up needing life insurance later in life, at which point your premiums could be less affordable due to changes in age or health.

Additionally, if you have student loans or you’re a business owner, your debts can still become your family’s responsibility when you’re gone.

Even if you’re not worried about loan payments, the death benefit can pay for funeral costs, which can end up costing your loved ones upwards of $10,000.

→ Learn more about who needs life insurance and who doesn’t

How much life insurance do I need?

You should get enough life insurance coverage to pay for outstanding debts, end-of-life costs, and future day-to-day expenses while having a term length that lasts for the entirety of your longest financial obligation. Policygenius advisers recommend most people carry at least 10-15 times their income in coverage, if not more.

Not getting enough coverage runs the risk that your loved ones will end up liable for your debts or won’t have enough money to sustain their lifestyle.

→ Determine how much life insurance you need

What type of life insurance is right for me?

There are two main types of life insurance: term life insurance, which offers basic coverage for a set period of time, and permanent life insurance, which lasts your entire life and often comes with an investment component.

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. Because term life insurance is the simplest form of coverage, it’s by far the most affordable type of life insurance.

How term life insurance works: If you die during the term, then your beneficiaries receive a death benefit. If you outlive the term, then you and your beneficiaries get nothing from the insurance company.

Permanent life insurance

With permanent life insurance, instead of paying premiums for a set number of years, you pay them for your whole life, and when you die, your beneficiaries receive a death benefit.

Many types of permanent life insurance have a cash value component that earns interest and increases in value as you pay your premiums. Eventually, the cash value component may increase the death benefit amount, and, in rare cases, you may even be paid dividends on the accumulated cash value. You can also withdraw money from the cash value or take out a loan using it as collateral, but this can reduce the death benefit left to your beneficiaries.

How whole life insurance works: the most popular type of permanent life insurance is whole life insurance, in which the cash value grows at a fixed interest rate set by the insurer. 

Other permanent life insurance options include:

• Universal life insurance has a cash value tied to a specific stock index used by the insurer. If the market underperforms, the cash value decreases and you may pay higher premiums to support the same amount of coverage.

• Variable life insurance allows you to choose what kinds of assets you want to invest in and has fixed premiums. If your assets don’t outperform the value of the death benefit, you may not notice any difference in coverage.

• Variable universal life insurance takes the adjustable premiums of universal life insurance and applies them to the diversified assets of variable life insurance. Your premiums can increase or decrease depending on how the investments fare.

→ Compare the different types of life insurance to see which one is right for you 

Life insurance riders

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, an accelerated death benefit rider allows you to get the death benefit early. Many policies include this by default at no extra cost.

Long term care rider

Hybrid life insurance policies add a long-term care rider to your coverage to pay for assisted living costs if you become ill and cannot perform two of the six activities of daily living, which include: eating, bathing, getting dressed, walking from one place to another, using the toilet, or maintaining bowel or bladder continence. If you end up using a long-term care rider, the money is withdrawn from your policy’s death benefit.

Term conversion rider

After your policy term expires, you may still need life insurance coverage. A term conversion rider, usually available at no additional cost, converts your term policy into a permanent life insurance policy using the same information you submitted when you first applied (and with no additional underwriting).

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How much does life insurance cost?

The cost of life insurance depends on how much coverage you need and how risky you are to insure — if your health, hobbies, and age make it more likely that you’ll die during the term of your policy, you’re going to get a higher premium. 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 coverage term.

What if I lie about my health to get better life insurance rates?

Lying about your health (or anything else relating to your life insurance application) to save money on premiums could hurt you in the long run. The first two years your policy is in force, it’s in the contestability period; the life insurance company can contest any claim made by your beneficiaries after your death. If it finds that you misrepresented your health, the insurer could reduce the death benefit or cancel the policy outright, leaving your beneficiaries with nothing but a refund of your premiums. Even after this two-year period ends, your insurer can refuse to pay out the death benefit if you’ve committed fraud.

How do I apply for life insurance?

The life insurance application is pretty straightforward. It all starts with getting quotes from a licensed agent or broker, like Policygenius. Getting a life insurance policy can be done in five easy steps.

1. Fill out the application and complete the phone interview

The application and subsequent phone interview collect and confirm basic information about your health, your family health history, your hobbies, and your coverage needs. You’ll also designate your policy’s beneficiaries when you apply.

2. Take the medical exam

Unless you can qualify for instant decision or no-medical exam life insurance, a medical technician will come to your home or place of work and do a basic health checkup called a paramedical exam, which is similar to the one you get from your doctor. They may perform blood or urine tests to confirm the health information from your application.

3. 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 prognoses.

4. Go through underwriting

The underwriter will assess the risk of insuring you based on information from your application, your driving history, your credit score, and your information in the Medical Information Bureau, to calculate how much your premiums will cost.

5. 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 your premiums. You may need to share payment information with your agent or broker by phone for the initial payment or to organize recurring payments.

How long does it take for life insurance coverage to kick in?

Your life insurance policy’s effective date, or the day your coverage kicks in, is the day you sign your final policy documents and pay your first premium. Once the insurer approves your application and sends over the paperwork, the day your coverage goes in force is up to you. You usually have about six months to sign your policy paperwork until you have to reapply for life insurance.

How do I save money on life insurance?

Is price your number one priority? There are a lot of ways to get affordable life insurance:

Buy early

The cost of life insurance gets more expensive as you age, so if you buy when you’re younger and healthier, 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 in your golden years.

Here’s how much you can expect to pay for a 20-year term life insurance coverage at different ages:

Methodology: Sample premiums are for male and female non-smokers with a Preferred health rating based in Ohio; Life insurance averages are based on a composite of policies offered by Policygenius from AIG, Banner, Brighthouse, Lincoln, Mutual of Omaha, Pacific Life, Principal, Protective, Prudential, SBLI, and Transamerica and may vary by insurer, term, coverage amount, health class, and state. Not all policies are available in all states. Rate illustration valid as of 3/16/2021.

Get the right amount of coverage

On paper, it sounds reassuring to know that your beneficiaries could get a $1 million payout when you die but if you can’t afford the premiums and end up missing payments, a larger policy will be of no use. Instead, get the coverage you can fit into your budget.

Shop around for quotes

Every insurer evaluates your risk differently. For example, some may offer costlier premiums for marijuana smokers, while others are more forgiving. Using an independent broker like Policygenius to shop around for quotes from multiple life insurance companies can get you coverage at the lowest possible price.

Get healthy before you apply

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

If your body mass index (BMI) is 25 or higher, the CDC defines this as overweight. Most life insurance companies use BMI to help calculate premium rates, so losing weight before you apply could net you a more favorable premium. But as with quitting tobacco, you’ll need to maintain a lower weight for a year or more before an insurer will decrease your premiums. Someone with a BMI between 18.5 and 24.9, the CDC’s “healthy” range, will receive the most affordable pricing.

Even if you’re not in the best health now, you shouldn’t delay getting coverage. After your policy is in force for a year or two, you can always apply for a rate reconsideration. This process requires you to go through underwriting again to demonstrate your improved health to your insurer for lower premiums. And worry not — they can never come back with higher life insurance premiums.

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How do my beneficiaries get paid when I die?

When you die, it could take the insurer up to two months to pay out your death benefit. For expediency, your beneficiary should file a claim with the life insurance company. It’s important to leave behind written records with a financial adviser or beneficiary so they can find the policy (and be notified that the life insurance exists in the first place)! They 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.

Your beneficiary can choose whether to receive the death benefit as a one-time tax-free lump sum or in installments over time in an annuity. Most people choose to get the death benefit as a lump sum because receiving it in an annuity can incur penalties if you need to withdraw more than what’s disbursed in the allotted installment.

(If you’re unsure if you’re the beneficiary on a life insurance policy, you can use the National Association of Insurance Commissioners (NAIC) policy locator to find out.)

Is life insurance worth it?

When you die, life insurance replaces the financial support you provided to your dependents. It's an important income replacement, and without it, your loved ones may no longer be able to afford everyday expenses. It can also cover outstanding debts, such as a mortgage, and ensures that your family doesn't lose their livelihood if you die prematurely.

Because of the financial security it provides, life insurance is a worthwhile risk management tool to protect your loved ones from financial suffering. By working with an independent broker like Policygenius, you can get a policy with optimal coverage at competitive rates.