What Is Life Insurance?
When someone else depends on the money you earn, you probably need life insurance.
If you died unexpectedly without life insurance, your life partner, your children, and even your business partner could struggle to rebuild a stable life without you.
Life insurance exists to protect the people you care about from this kind of uncertainty.
But with so many kinds of coverage and so many variables to weigh, you’ll need some help finding the right life insurance policy.
So let’s simplify this complex process and then learn where to get the best life insurance quotes.
What is Life Insurance?
Life insurance is an “if, then” exchange contract between you and an insurance company.
If you pay money to an insurance company, then when you die, the insurance company will pay your family money.
When you’re shopping for insurance and coming across complicated insurance jargon, it is easy to forget this simple goal.
For example, here’s that same if-then statement translated into technical insurance-speak:
If you pay premiums to an insurance carrier, then when you die, the carrier will pay your beneficiaries the death benefit (face value) of your in-force policy. In addition, if there is any cash value in the policy when you die, the insurance company will keep it.
Life Insurance 101
If you found words like “beneficiaries” and “in-force” new or confusing, don’t worry: We’ll do a quick “Life Insurance 101” overview.
In addition to looking at the industry terms used, we will also take a quick look at how life insurance works.
By the end of this article, you will have a good foundation to better understand and use life insurance to protect yourself and your family. You’ll also be ready to compare quotes to find the best coverage for you.
Let’s start with a few basic definitions for some commonly used life insurance terms.
- Policy – An insurance agreement and contract in written form.
- Premium – Money you pay to an insurance company for your insurance coverage.
- Carrier – An insurance company.
- Beneficiary – The person (or people) that will receive a lump sum payment in the event of your death.
- Death Benefit – The contracted lump sum payment available to your beneficiaries in the event of your death.
- Face Value – The value of the policy received upon death or if the policy matures before you die.
- Cash Value – The amount of accrued cash available inside a policy for whole life products.
- In Force – Active, i.e., an “In Force” policy is a currently active insurance contract.
- Quote – An estimate from an insurance company that may not precisely reflect your actual premium.
- Underwriting – The process of determining how much you will pay in premiums for your coverage.
- Medically Underwritten – Underwriting that considers specific information about your health and usually requires you to take a medical exam.
Types of Life Insurance
These are the primary different types of life insurance worth knowing about:
Term Life Insurance
Term life insurance is the most common type of life insurance. You pay premiums in exchange for coverage in the form of a death benefit available to your beneficiaries if you died.
The benefit could be paid as a lump sum, monthly payments, or an annuity.
What makes term life so popular? It’s a lot more affordable than other types of policies.
As the name suggests, term life insurance expires at the end of the term, which usually lasts 10, 20, or 30 years. The longer the term you choose, the higher the annual premiums will be.
You could choose a term that provides coverage until your mortgage or other debts are paid off, or your kids are on their own, for example.
When the term expires, your coverage expires. You could renew coverage at a higher premium, convert to a permanent policy, or consider whether you still need coverage.
Permanent Life Insurance
Permanent life insurance policies do not expire — they’ll last as long as you pay any required premiums.
These policies can be helpful for people who need insurance for more than 30 years.
If, for example, you have a child with special needs who will always depend on you for support, you may want permanent life insurance.
These policies can also provide forced savings because your premiums also fund a cash value that grows slowly over time. This cash value is one reason permanent coverage costs more than term life coverage.
The cash value in your policy would work like a tax-deferred savings account from which you can withdraw or borrow funds later in life. (Withdrawals and outstanding loans are subtracted from the death benefit.)
Permanent life insurance (also called “cash value life insurance”) is an umbrella term that covers several kinds of life insurance policies, such as whole life, universal life, variable life, and variable universal life insurance.
Whole Life Insurance
Whole life insurance is the original type of permanent life insurance. You pay a fixed premium every year, have a guaranteed death benefit, and your cash value is guaranteed to grow by at least a certain amount every year.
You may also receive dividends based on the performance of the insurer’s investments.
Universal Life Insurance
Like a whole life insurance policy, universal life insurance also has a cash value – so the premiums you pay go toward the death benefit, as well as the cash value.
But with universal life insurance, you can change your premium and death benefit amount without taking out a new policy.
However, you need to be careful to monitor the policy — if interest rates end up being lower than expected when you initially bought the policy, you may have to pay additional premiums to keep the policy from lapsing.
Variable Life Insurance
Variable life insurance also has an investment component, but instead of being based on the insurer’s investments or interest rates, you invest the cash value into mutual fund-like sub-accounts that can increase or decrease in value.
Variable Universal Life Insurance
As you may have guessed, this insurance type combines components of variable and universal policies. Your premium and death benefit amounts are adjustable, and you can also invest the cash value in the policy’s sub-accounts.
Simplified Issue Life Insurance
With this insurance type, there’s no medical exam (which is typically something you have to go through when applying for life insurance).
You’re good to go after filling out a health questionnaire instead (if you have no serious health problems).
This option may be ideal for healthy folks who want an insurance policy fast, but coverage amounts won’t be nearly as large as a term life policy’s coverage.
Guaranteed Issue Life Insurance
Not only will you be able to forego the medical exam with guaranteed issue life insurance – but you can also skip the health questionnaire. As long as your premium is paid, the insurer will cover you.
This policy type is best for older people with declining health. If you’re young and healthy, other types of policies will offer much better life insurance coverage at a cheaper cost.
How Do I Shop For Life Insurance?
First, you should determine what type of life insurance you need.
For most millennials and other young adults who have young and growing families, I recommend starting with a term-life policy.
Term life gives you simple coverage for a specific period of time. This simplicity allows for a nice cost efficiency. You can get a lot of coverage for a small amount in premiums.
Of course, there are some very good reasons to pay more for permanent life insurance, and we’ll get into those below.
But for now, let’s look at the steps you’ll need to take to buy a term life policy by exploring some key questions:
How Much Coverage Do I Need?
Many financial advisors recommend buying 7 to 10 times your annual salary in coverage. If you earn $100,000 a year, you’d need at least $700,000 and may need $1 million in life insurance coverage.
These kinds of rules make calculations easy, but they might not reflect your life with enough precision. Be sure to consider your specific needs. For example:
- Do You Have a New Mortgage? If you just bought a new home, make sure your life insurance coverage could pay off the loan.
- What Are Your Future Education Plans? Do you plan to enroll your kids in a private high school or an elite university? Be sure your life insurance coverage could keep your family on track if you died.
- How Will Life Look in 10 Years? If you expect to be earning more money in 10 years, you may want to buy life insurance coverage to replace that income.
Term life policies can offer $2 million or more in life insurance coverage.
But the more coverage you buy, the more you’ll typically pay in premiums, so it’s important to find out how much life insurance your really need.
How Long Should My Term Last?
Whether you buy a 10-year, 20-year, or 30-year term policy will impact the cost of your premiums.
Just like with your coverage amount, you should buy a term that reflects your life.
If you’ve just taken out a 30-year mortgage, consider a 30-year policy to be sure you’re covered while you still owe money on the house.
If you expect all your kids to be financially independent in 20 years, a 20-year policy may be just what you need.
The point is: Get a term to provide coverage for as long as you need the protection in place.
Will I Need a Medical Exam?
Most quality life insurance policies will require you to take a medical exam.
The exam includes a height and weight check, blood and urine tests that will require you to give samples, as well as blood pressure and cholesterol checks.
This exam can be a hassle, but if you’re young and healthy, it’ll pay off in the form of lower premiums.
If you go with a no-exam policy, underwriters will not know much about your health. They will assume you’re not in great health and charge you thousands more in premiums over the life of your policy.
A couple of new insurers, including Haven Life and Bestow, have created an exception to this rule. They offer no-exam coverage at affordable rates by checking medical and pharmaceutical databases to find details about your health.
How Do I Find a Good Insurance Company?
You should always compare quotes before applying for life insurance, but how do you know whether a company provides quality coverage?
Some people simply go with insurance companies they’ve heard of, but there’s a better way.
Several independent agencies take an inside look at insurance companies to determine the health of each company.
These agencies issue grades every couple of years. Agencies include A.M. Best, Moody’s, Standard & Poor’s, and Fitch.
These agencies have different grading scales, but they work a lot like grades in school. A’s are better than B’s or C’s. Usually, a company with an AAA rating or A++ is best positioned to pay your claim in the coming years.
Check at least two ratings agencies grades about the insurance company you’re considering before buying your coverage.
Or check out my best life insurance providers here, all of which grade really well with independent ratings agencies.
How Do I Compare Life Insurance Quotes?
Life insurance quotes give you insight into how much you’ll be paying for your coverage.
It’s easy to get quotes and start your application for coverage online.
Quotes are just estimates. After you apply and go through the underwriting process, your actual premium may be higher (or lower) than your quote.
Here’s What Goes Into a Life Insurance Premium:
Life insurance companies base your premiums, in part, on the following:
- Credit score
- Family’s health history
These kinds of factors work together to help the insurance company learn your risk of dying with the policy in force.
Tips to Save on Life Insurance
If you’d like to benefit from lower premiums, you can:
- Drive More Safely: If you’ve had a couple moving violations such as speeding tickets or reckless driving charges, your life insurance company will likely consider you a higher risk.
- Lose Weight and Exercise: Your medical exam will tell your insurer a lot about your health. If you can lose a few pounds or shave a few numbers off your cholesterol readings, you can save on premiums in the long run.
- Pay Your Bills On Time: Life insurance isn’t a loan, so your credit score shouldn’t matter, right? Insurance underwriters don’t agree. They’ve noticed this trend: People with lower credit scores tend to file more claims. Nobody knows exactly why this is true. It could be taking more financial risks correlates with taking other kinds of risks. No matter the case, if you can improve your credit score, you could save on premiums.
- Apply Sooner Rather than Later: Younger people usually access the best life insurance rates. You can’t change your age, but you can apply this year instead of waiting for a few years. Waiting can lead to higher premiums later. Unless, of course, you’re getting significantly more healthy while you wait.
- Quit Using Tobacco & Similar Products: Smoking, vaping, chewing, dipping — these habits will inflate your life insurance premiums. Sometimes you’ll pay 5 or 6 times more!
You can’t control every aspect of your life. If a certain kind of serious illness has affected several generations of your family, your chances of developing the same condition will be higher. Your insurance rates could be higher as a result.
People with dangerous jobs like roofing, high-rise construction, and deep-sea angling tend to pay noticeably more for life insurance as well.
How Risky Are You?
All the factors above — and several others depending on your insurer — will tell underwriters how you live, how healthy you are, and how much of a risk your policy would present to the insurance company’s bottom line.
Your quote will not reflect many of these variables, though many quotes do consider your age, general health, and tobacco status.
So as you compare online quotes, keep this in mind. Quotes are a great tool for comparing carriers, but quotes do not reflect guaranteed rates.
If you have a specific condition that is preventing you from getting life insurance, you should talk to an independent life insurance agent.
These agents work with a lot of different insurers and often know nuances that can help connect you with the best company for your condition, whether it’s a health condition like diabetes or a lifestyle choice such as smoking marijuana.
Should I Always Tell the Truth on Life Insurance Applications?
Since your health, occupation, and hobbies can lead to higher insurance premiums, couldn’t you just omit those details from your application?
It can be tempting for some applicants, but please don’t go there.
I won’t preach about the morality of lying. However, I will point out that you’d be committing insurance fraud and undermining the very reason you’re spending so much time shopping for coverage.
As you can imagine, a life insurance company doesn’t pay out $1 million or more as a death benefit without asking a few questions first.
If it comes to light you weren’t upfront in your application, the company could void your policy, leaving your beneficiaries with nothing.
Why Do I Need Life Insurance?
It does not matter if you are single, married, or divorced before you die; you need to have a plan in place to meet the needs of those you leave behind.
Compared to other options, life insurance is often the most cost-effective way to do this.
The other options include self-insurance (having enough money saved up to cover these needs already) or relying on someone else to pick up the slack.
So, unless or until you have a large stash of cash to cover your obligations and responsibilities – yes, it is worth getting life insurance.
Everyone has different needs and wants, but people often need money to cover:
- Daily Living Expenses
- Mortgage/Rent Payments
- Retirement Savings
- Education Savings
- Personal Debts
- Small Business Obligations
- Estate Taxes
- Final Expenses (funeral expenses)
- Charitable Giving
The death benefit lump sum payout will help your loved ones to cover some or all of these areas.
Life Insurance for Retirement Income
Another way to use life insurance is for a tax-advantaged retirement income.
Permanent insurance solutions such as Whole Life and Indexed Universal Life may have a cash value component built into the policy.
As a result, you can structure your policy to accumulate cash at a rate that will help you supplement your retirement income.
When you pull money out of your retirement accounts, there are different rules for taxation based on the account.
If you are an investor who has already exhausted funding accounts with tax-free withdrawals (like your Roth IRA), then putting money into your life insurance cash value will give you another tax-advantaged option.
Money withdrawn from your indexed universal or whole life policy is considered a loan and is thus not taxed like regular income.
Of course, there are fees (like the cost of insurance) to consider when using life insurance as an investment vehicle. You need to do your research and talk to experts to make informed decisions.
Life Insurance for Long-Term Care Funds
Besides being a source of funds for final expenses and legacy gifts, many life insurance policies are now offering Long-Term Care Riders.
These riders offer access to the face value (death benefit) of the policy before you die if you need the money for a qualifying event. (These riders are sometimes called Chronic Illness or Living Benefit Riders.)
Nursing home expenses and chronic illness expenses are two examples of events that may allow access to funds. These funds are pulled from the death benefit.
As a result, if you use them all up before you die, then you will not leave any death benefit money for your beneficiaries.
You could also consider getting an insurance policy specifically for long-term care if you’re worried about these costs.
When Should I Get Life Insurance?
If you are lucky to be healthy enough to qualify for life insurance, then you should get something in place now.
Even if you are single, with no dependents and maybe even no debts, you should still consider what is available to you and what you could use it for. Insurance gets pricier the older you are and the more health concerns you have.
If you are not yet convinced or think insurance is not in your budget, then keep reading why you need life insurance here.
Before you buy, you need to consider why you want life insurance, both now and in the future. Your reason should greatly influence where you buy your insurance and what policies you consider.
Life insurance companies tailor their life products differently to meet different needs. Some products are designed to offer more cash value and growth, while others are priced to provide the most death benefit value for the premium dollar.
A Case Study: The Savvy Millennial Investor Uses Life Insurance
As an example, let’s say you are a financially savvy 30-year-old who is on your way to financial independence at an earlier age than is typical.
You are married with no children but know kids are in your near future. You also have no major health problems and qualify for the good, non-smoking life insurance rates.
Your goals are to provide for your family’s needs and future children’s education – both while alive and if you unexpectedly pass.
First, you decide you need the policy to cover living expenses/education expenses while you are working and raising your future kids.
Then, by age 50 or 55, your financial plan says you will have enough in savings to let go of this insurance safety net.
However, by this time, you have other needs arising. These needs include tax-advantaged ways to access cash in retirement and a need for long-term care funds.
What Insurance Do You Need?
In this case study, as the financially savvy 30-year-old, there are a few ways you could meet your insurance needs.
Let’s look at one effective plan. (As a disclaimer, this is just an example and not a recommendation for everyone.)
Assuming you believe your income will grow modestly each year, we would research insurance companies that have term policies with conversion options. On top of that, we would research companies that offer Long-Term Care Riders on their products.
Here Is Our Insurance Solution:
- Death Benefit: After deciding how much cash your family would need upon your death (typically 7 to 10 times your annual income), we would take out a 30-year term policy that has conversion privileges (that usually extend for the first 20 years of the policy.)
- Retirement Income: At age 40, we would convert part of the term policy to an IUL (Indexed Universal Life) policy with a Long-Term Care Rider. After paying the premiums for at least 15 years (20 would be better), then you could use the cash value in the policy as a source of tax-advantaged income in retirement.
- Long-Term Care: On top of that, the Long-Term Care Rider would allow you to use the death benefit value for long-term care needs or for chronic illnesses.
- Legacy: As a bonus, if you did not deplete the face value (death benefit) of the policy for long-term care needs, then you would have money to leave your family or your causes as a legacy.
How Does My Beneficiary Get The Money?
No matter what kind of coverage or how many riders your policy offers, your policy will need a beneficiary. Your beneficiary could file a claim and receive your coverage if you died with the policy in force.
Typically you’d name your spouse or grown children as beneficiary. You could also name a business partner or even a lender if you’re using life insurance as collateral for a loan.
To file a claim, your beneficiary would need to submit a copy of your death certificate. Most policies have a two-year contestability period which means your insurance company will look closely at the cause and nature of your death to make sure the coverage applies.
And most policies have exemptions which could prevent your beneficiary from receiving the money. Suicide, for example, tends to be an exclusion for most carriers within the first two years of coverage.
Most of the time, insurance companies want to pay out your policy’s coverage. Companies must pay interest on unpaid benefits.
What Can Your Beneficiary Do with the Money?
The money your beneficiary would receive is tax free and has no strings attached. Your beneficiary would use the money on living expenses, to pay off the house, pay off all the credit cards, or to save for the future.
Ultimately the money should replace the earnings you would have made over the next five to 10 years, especially if you’re young and healthy and depend on your earnings from work for your family’s survival.
One of the best things about life insurance is its flexibility. Your beneficiary could use the money as needed. You could even leave directions in a will or estate plan.
How Do Life Insurers Make Money?
People often ask: How can life insurance afford to pay millions of dollars in benefits? How can they keep making money and offering policies?
Not all life insurance companies make a profit. A company with the word “mutual” in its name may divide profits among policyholders.
But most life insurance companies do seek profit. Insurers make money by investing the premiums you pay and by limiting their likelihood of paying out a huge benefit through responsible underwriting.
Insurers also make money if someone stops paying on a policy which entirely eliminates the company’s obligation to pay the death benefit.
And, they make money on term policies when the term expires before the policyholder dies.
Where Did Life Insurance Come From?
In the context of the insurance industry, life insurance is unique. Unlike a car or a home, you can’t measure the monetary value of a life and insure against that value.
Historians can trace the idea of life insurance to Ancient Rome. Roman citizens could join a burial club whose fees helped pay other club members’ funeral expenses.
How does this ancient practice connect with you as you shop for life insurance in the 21st century?
Ultimately you still have the same goal: To pay a small amount of money in exchange for access to a much larger amount of money that could help your loved ones if you died.
You owe it to yourself and your family to find the best coverage — the policy from the company that can offer you affordable coverage, modern features, and reliability.
What is Life Insurance To You?
Now that you know the basics of life insurance and how it works, you need to decide – what is life insurance to you?
Considering your life goals and needs, you can now make more informed decisions on how to use life insurance to protect you and your loved ones, both now and in the future.
You can get started by comparing quotes with one of the best online life insurance aggregators on the market right now!