What is life insurance?

Life insurance pays out a death benefit to your beneficiaries when you die. There are many reasons people may want life insurance:

  • Pay funeral and final expenses
  • Take care of a mortgage
  • Provide money to help a family long-term
  • Pay for future college expenses
  • Leave a legacy for charities

There are various types of life insurance policies. The main types are term life insurance and permanent life insurance insurance. Term life insurance lasts for a specified period of time,  while permanent life insurance policies last your entire life. There are many types of permanent life insurance policies, including whole life, universal life, and indexed universal life insurance. 

Stafford Thompson Jr., senior vice president of life product management for Lincoln Financial Group, says that traditionally, people have purchased life insurance primarily for the protection it offers to families through death benefits. 

"That’s as important today as ever," he says.

However, he says, some types of life insurance policies – such as universal life -- show that life insurance "can also do much more for you." For example, the right policy can provide benefits that assist with financial needs while you are alive, such as providing supplemental retirement income or helping to pay for long-term care expenses.

Permanent life insurance can be complicated due to the various components, such as cash value accumulation, investment options, and different types — each with its own set of rules and benefits. If you’re purchasing a permanent life insurance policy, you should speak with a financial advisor to make sure it works for you.

It’s important to choose the form of coverage that makes the most sense for you while also looking for affordable life insurance.

Life insurance terminology

Life insurance is a complicated topic, but understanding life insurance terminology is essential for making informed decisions and choosing the right policy for your needs. To make it easier, we break down important life insurance terminology below.  

Policyholder: The person who owns the life insurance policy.

Insured: The individual whose life is covered by the life insurance policy. Upon the insured's death, the policy pays out the death benefit to the designated beneficiary. The insured may or may not be the same person as the policyholder.

Premium: The amount you pay for your life insurance policy, typically on a monthly or annual basis.

Beneficiary: The person you name on a life insurance policy who will collect the death benefit when you die. The primary beneficiary receives the death benefit. You can also name a contingent beneficiary, who will only receive a payout if the primary beneficiaries cannot collect the death benefit. A beneficiary can also be an entity, such as a charity.

Death benefit: The money that is paid out to beneficiaries after you die.

Face value: Another term for the death benefit, this is the amount of money the policy will pay out upon the death of the insured.

Underwriting: The process by which an insurance company evaluates the risk of insuring a person and determines the premium.

Rider: An add-on to a life insurance policy that provides additional benefits or coverage, such as a waiver of premium or term conversion rider.

Term life insurance: This type of life insurance remains active for a specified number of years – usually 10 to 40 years – and then expires. It doesn’t include a savings component.

Whole life insurance: This type of insurance remains active for your entire life as long as you continue to pay the premiums. It also offers a savings component, known as the cash value. 

Cash value: A savings component of permanent life insurance policies that builds value over time and can be borrowed against or withdrawn.

Contestability period: A period, typically two years, during which the insurance company can investigate and deny claims based on misrepresentations made by the policyholder.

Lapse: The termination of a life insurance policy due to non-payment of premiums.

When should you buy life insurance?

You should get life insurance if you have financial obligations or dependents relying on your income. For example, if you have a mortgage, student loans, or business loans, life insurance can ensure your loved ones don’t become liable for your debts if you die. Additionally, if you have dependents, such as a spouse, children, or aging parents, life insurance provides a financial safety net, guaranteeing their financial stability and maintaining their standard of living in your absence. 

Who needs life insurance?

Many people – maybe even most – can benefit from a life insurance policy. “However, your life insurance needs can vary significantly depending on your age, stage of life or financial goals,” Stafford says.

You likely need life insurance if you are: 

Starting a family: If you are getting married or planning to have children, life insurance ensures that your family is financially protected in case something happens to you.

Buying a home: A life insurance policy can help cover mortgage payments, ensuring that your family can stay in their home even if you are no longer around.

Experiencing a career milestone: As you advance in your career and your income increases, life insurance can help replace lost income and maintain your family's standard of living.

Taking on debt: If you have significant debts, such as student loans or business loans, life insurance can prevent your loved ones from being burdened with these financial obligations.

Planning for retirement: Purchasing life insurance can be part of a comprehensive retirement plan, providing additional financial security for your spouse or dependents.

Younger and healthier: Buying life insurance when you are young and in good health typically means lower premiums, making it more cost-effective over the long term.

Creating an estate plan: Life insurance can be a valuable tool for estate planning, helping to cover estate taxes and ensuring that your assets are distributed according to your wishes.

Can you buy life insurance on another person?

“You must have an insurable interest when purchasing life insurance,” says Adam Solano, a Chicago-based financial advisor and Life and Annuity Certified Professional (LACP) with WestPoint Financial Group

Insurable interest means you have a good reason to take out a life insurance policy on someone because you would face financial problems if they were to pass away. For example, you might buy life insurance for your spouse, children, or business partner because you rely on them financially. 

“The other person does need to be involved and you do need their consent,” Solano says.

What does life insurance cover?

Life insurance offers a cash benefit to your loved ones after you die. This money can be used to cover many short-term and long-term expenses.

For example, your beneficiaries might immediately use life insurance to cover your funeral costs or pay your bills. Or, they might use it to pay everyday bills, such as food and utility bills.

Life insurance also can cover longer-term expenses, such as mortgage payments or the cost of sending your children or grandchildren to college.

You additionally can use life insurance coverage to leave a sum to a charity, religious organization, or other cause near and dear to you.

How to choose a life insurance policy type

Selecting one option from the best life insurance policies takes time and research. There are many different types of life insurance plans and top life insurance companies offer several options. Choosing the right type of policy depends on your individual needs.

A term life policy makes sense if you think you only will need coverage for a period. Term life policies often run for 10 to 40 years. It tends to be more affordable than whole life, so it can make sense for those focused on staying within a budget.

“Term insurance is good for someone who has an insurance need for only a set number of years,” says Jason Wellmann, senior vice president of life distribution at Allianz Life.

For example, if you have 10 years left on your mortgage, you might want to purchase a term life policy that lasts as long. 

Whole life insurance is a better choice if you want a policy that will last for your lifetime. It also offers cash value account that appeals to those hoping to accumulate a larger pool of savings. Money from a cash value account can be used for financial needs that arise while you’re still alive. 

“Typically, those seeking a permanent life insurance policy are those who are looking for more than just the death benefit,” Wellman says.

You can access the cash value in the form of a loan or withdrawal from the cash value. This money can’t be used after you die and doesn’t pay out with the death benefit.

How much life insurance do you need?

When purchasing life insurance, choosing the right amount can be challenging.

Some experts suggest purchasing a benefit that will pay out 10 to 15 times a policyholder’s annual income. 

Additionally, factor in any outstanding debts, such as a mortgage or a car loan, and  plan for future expenses like your children's college tuition and your spouse’s retirement needs. Don't forget to include the costs associated with end-of-life expenses, such as funeral and burial costs.

Working closely with a life insurance agent can help you determine how much coverage you need for your unique situation.

How much does life insurance cost?

How much you’ll pay for life insurance depends on multiple factors, including:

  • Age. Premiums on a new policy increase as you get older.
  • Gender. Women live longer, so they tend to pay lower premiums.
  • Health history. Healthier people pay lower premiums than those with some medical conditions.
  • Smoking status. You will pay higher premiums if you smoke.
  • Hobbies and lifestyle. People with high-risk hobbies -- such as skydiving -- may pay higher premiums.
  • Occupation. Jobs that involve more physical risks can result in higher premiums.

In addition, some types of coverage just naturally tend to cost more. Term life coverage is usually cheaper than whole life coverage, for example.

How to save on life insurance

Shop around for life insurance to get the best deal for your needs. Start by figuring out how much coverage you need, then get quotes from several companies. Compare the premiums, coverage options, and any extra features. Don’t hesitate to ask questions and consider talking to an independent insurance agent for expert advice.

Make sure you don’t purchase coverage that’s not within your budget. Purchasing life insurance is always a balancing act between getting the coverage you need and finding the best life insurance rates.

Wellmann says the best way to save on life insurance is to make sure you understand your needs.

“Do your research and consider your options,” he says. “Identify what is important to your financial plan and review annually.”

How to get life insurance quotes

You have several options for obtaining life insurance quotes. One method is to narrow a list to several insurers and obtain individual quotes from each of them, either by calling their offices or using their website.

Working with an independent life insurance agent also can help you to gather quotes.

Getting life insurance quotes online is more popular than ever, with many life insurance companies handling the entire application process online as well. You can compare multiple quotes at once and find the best price.

In fact, it’s never been easier to secure a life insurance policy. “Today, it’s possible to apply for a policy and have it delivered completely electronically,” Thompson says.

He adds that you can sometimes have a policy in place within 24 hours.

Life insurance FAQs

How do you choose a beneficiary?

Your beneficiary should be someone you trust to use your death benefit in accordance with your wishes. For most people, it's a spouse or significant other.

Also, remember to keep your beneficiary up to date if life circumstances change -- such as after a divorce -- and consider naming backup (or contingent) beneficiaries.

How do my beneficiaries get paid after I die?

Your beneficiaries should have the option for how they would like to receive the policy's death benefit.

Options may include:

  • A lump sum: All of the death benefits arrive in a single payment.
  • Monthly installments: Some beneficiaries find it easier to get the money gradually over a period.
  • Retained asset account: Some insurers may allow a beneficiary to keep the death benefit in an interest-bearing account. Beneficiaries can then write checks against the money in the account.
  • Annuity: Beneficiaries may have the option of receiving guaranteed payments monthly for life. Unless the annuity is established for a set period, any remaining death benefit remaining when the beneficiary dies will return to the insurance company.

How does a beneficiary make a claim?

The process for filing a lice insurance claim differs by company. In most cases, the beneficiary will need to contact the company directly to request the correct forms, and then fill them out and provide any required documentation, like a death certificate.

Does life insurance cover suicide?

Typically, a life insurance policy will payout for any cause, even in the event of a suicide.

However, many policies have a contestability window that begins when you take out a policy. During that period, companies may investigate your death before deciding whether or not to pay out the benefit. In the case of a suicide, there is a good chance the death benefit would be denied during that period.

Is life insurance taxable?

Life insurance death benefits aren’t typically taxable to a beneficiary. The IRS says these benefits generally don’t have to be reported on a tax return.

However, a beneficiary must report any interest that’s received as taxable income. If you’re a beneficiary and unsure of whether you owe taxes, speak with a qualified tax professional.

What happens when a whole life insurance policy matures?

A whole life insurance policy remains in effect as long as the policyholder pays the premiums. However, there may be an age at which the life insurance policy "matures." For example, the policy might mature when the policyholder turns 100 or older.

When this happens, the insurer typically will pay out the full cash value of the policy to the policyholder and close the policy. Some insurers might offer an extension to the policyholder if he or she continues to pay premiums.

Can you cash out a whole life policy?

If you have a whole life policy and have built up cash value, you can withdraw this money to pay for expenses. However, if you withdraw the full amount of the cash value, you have essentially "surrendered" the policy. At this point, your life insurance will lapse and you will no longer have coverage.

If this occurs, you also may owe surrender fees and taxes on the money that you receive.

Another option for cashing out your policy is known as a life settlement, in which you sell the policy to a third-party investor and receive cash in return.

How do you withdraw money from a whole life policy?

If you have built up cash value in your whole life insurance policy, you typically can withdraw a limited amount of this money to use for your own purposes. Most withdrawals up to the amount of premiums you’ve paid into the policy will not trigger a taxable event. Withdrawals over that amount will be subject to taxes, however.

It’s also important to remember that the amount of money you withdraw from your cash basis will reduce your death benefit. And if you withdraw the full amount of cash value, your policy will expire.

Instead of withdrawal, you may decide to take a loan. But the loan itself will not be against the cash value. Instead, you will borrow from the issuer, and your policy will be used as collateral. You might owe interest payments on these funds.

Can you get life insurance with a pre-existing health condition?

Many people assume that a pre-existing health condition will preclude them from getting life insurance. But can you still get a policy even if you have such an issue?

In many cases, the answer is “yes,” says Heather Milligan, senior vice president and head of life insurance underwriting and new business and business innovation life solutions for Lincoln Financial Group.

"While underwriting guidelines will vary from life insurance company to life insurance company, generally speaking, it is possible to get life insurance with pre-existing conditions," she says.

Milligan notes that 90% or more of current Lincoln applicants qualify for some level of life insurance coverage. Policyholders may include people with hepatitis C, diabetes and coronary artery disease and those with a history of certain types of treated cancer.

It’s important to note that having a pre-existing condition might raise the price you pay for coverage. That can be true even for common conditions, such as:

  • High blood pressure
  • High cholesterol
  • Obesity
  • Anxiety
  • Heart disease
  • Gastroesophageal reflux disease

In some cases, you can get life insurance without a medical exam. But this coverage may not be as comprehensive as you would find in other policies, and it will be more expensive than a policy with a medical exam.