What is life insurance and how does it work?

Life insurance pays a sum of money to the people you name when you die, in exchange for the premiums you pay while you’re alive. Your family can spend that money on anything, but most use it for the mortgage, everyday bills and raising the kids.

You choose the payout amount and the type of policy, and the insurer sets your price based on your age, health and how long you want coverage. Term coverage lasts a set number of years and costs the least, while permanent coverage lasts your whole life and costs considerably more.

Buy a policy while you’re young and healthy and you lock that price in for the life of the contract. Wait, and every year of age and every new diagnosis in your medical file raises what you’ll pay for the same protection.

How does life insurance work?

You apply, answer health questions, the insurer evaluates your health and lifestyle choices, and the insurer quotes you a price. Pay that premium and the company owes your beneficiaries the death benefit if you die while the policy is active.

The payout replaces the income your family would lose. The death benefit can pay off the mortgage, cover childcare so your spouse can keep working and pay for college, which means your kids stay in the same house and the same school.

To get the death benefit, your beneficiaries file a claim with a death certificate and the insurer sends the money, usually as a lump sum. They owe no federal income tax on the payout, though interest the company adds while processing the claim counts as taxable income.

Answer every health and tobacco question honestly. Insurers verify your answers against prescriptions and medical records, and false statements can reduce or cancel your coverage, leaving your family with a denial after years of paid premiums.

What are the main types of life insurance?

Life insurance splits into two categories — temporary coverage that expires and permanent coverage that lasts until you die.

Term life insurance costs less and expires on a set date, while whole life insurance costs more and pays out whenever you die. Term fits most families, because a mortgage gets paid off and children grow up.

Term life is the best option for most people because it is significantly cheaper than other types of coverage. If you’re considering a more expensive permanent policy, we recommend getting term and investing the price difference. Work with a certified financial planner to make the best financial choice for your situation.

• Term life insurance covers you for 10, 20, or 30 years. It pays only if you die during that window, builds no savings and costs the least of any coverage, which is why most families buy it.
• Whole life insurance covers you for life and builds cash value. Premiums stay level and a portion goes into an account you can borrow against, and you pay several times the term price for the same death benefit.
• Universal life insurance covers you for life with adjustable premiums. You can raise or lower what you pay within limits, but underfunding the policy can collapse it years later.
• Final expense insurance covers funeral costs with a small death benefit. Payouts typically run $5,000 to $25,000 with easy approval, and the price per dollar of coverage is high.
• Group life insurance comes through your employer. It usually pays less than you need and won’t follow you to your next job, so treat it as a supplement to your own policy.

How much life insurance do you need?

Your life insurance payout should cover what your household would still owe and still spend once your income stops. Add up these numbers, then subtract what you already have.

• Your mortgage balance and any debt someone co-signed. Clearing these means a surviving partner keeps the house on one income.
• Several years of your salary. Multiply your annual pay by the number of years until your youngest child supports themselves.
• Childcare, tuition and the unpaid work you do at home. A surviving parent who has to buy full-time childcare adds a five-figure expense in the first year alone.
• What your savings and workplace policy already cover. If your job insures you for $100,000 and you need $700,000, buy a $600,000 policy of your own.

Buy for the life you’re about to have if you rent and have no children yet. A 28-year-old planning to buy a house in three years should size the policy around that future mortgage, because applying at 28 instead of 33 locks a lower rate on coverage that has to last into their 40s.

What can you use the life insurance death benefit for?

Your beneficiaries can spend the death benefit on anything. Most families put it toward the expenses that would otherwise force them to sell the house or drain their savings.

• The mortgage and other debt. Paying off the loan removes the biggest monthly bill from a household now running on one income.
• Everyday living costs. Groceries, utilities, car payments, and insurance premiums keep coming, and the payout replaces the paycheck that covered them.
• Childcare and college. A surviving parent can keep working instead of cutting hours, and tuition stays funded.
• Funeral and burial costs. A funeral runs several thousand dollars and comes due within days, long before an estate settles.
• Medical bills and estate taxes. Hospital balances and tax bills land on the estate, and the payout covers them so heirs keep the property instead of selling it.
• Your surviving spouse’s retirement. Money that goes into an IRA or brokerage account replaces the years of savings your income would have produced.

How much does life insurance cost?

Life insurance costs a 35-year-old woman in good health $290 a year for $500,000 of 20-year term coverage and a 35-year-old man $343, based on our data for nonsmokers. Permanent coverage runs several times those prices.

Most people expect a much bigger number. Healthy adults aged 18 to 30 priced a $250,000 20-year policy at 10 to 12 times what it actually costs, according to LIMRA and Life Happens, so get a quote before you rule out the premium.

The chart below lists average annual premiums for 20-year term policies at $500,000, $750,000 and $1 million, by age and gender, for nonsmokers in good health.

Average annual premiums for 20-year term policies

$500,000

Age	Gender	$500,000
25	Female	$242
25	Male	$299
30	Female	$254
30	Male	$314
35	Female	$290
35	Male	$343
40	Female	$386
40	Male	$470
45	Female	$564
45	Male	$723
50	Female	$845
50	Male	$1,111
55	Female	$1,275
55	Male	$1,768
60	Female	$2,180
60	Male	$3,067
65	Female	$4,166
65	Male	$5,918

$750,000

Age	Gender	$750,000
25	Female	$329
25	Male	$414
30	Female	$345
30	Male	$439
35	Female	$399
35	Male	$479
40	Female	$547
40	Male	$670
45	Female	$809
45	Male	$1,046
50	Female	$1,232
50	Male	$1,630
55	Female	$1,869
55	Male	$2,616
60	Female	$3,231
60	Male	$4,580
65	Female	$6,216
65	Male	$8,843

$1,000,000

Age	Gender	$1 million
25	Female	$389
25	Male	$519
30	Female	$424
30	Male	$545
35	Female	$496
35	Male	$607
40	Female	$690
40	Male	$849
45	Female	$1,025
45	Male	$1,337
50	Female	$1,539
50	Male	$2,086
55	Female	$2,443
55	Male	$3,369
60	Female	$4,152
60	Male	$5,967
65	Female	$7,863
65	Male	$11,259

Tip. Get quotes from at least three insurers for the same payout and term length. Each company weighs conditions like high blood pressure differently, so the same 45-year-old man can be quoted $723 by one insurer and several hundred dollars more by another for identical coverage.

What affects your life insurance rates?

Your age, health, tobacco use, family medical history, job and coverage amount set your life insurance rate. Insurers price the odds of paying your claim.

• Age moves the price the most. A 40-year-old woman in good health pays $386 a year for $500,000 of term coverage, and that number climbs every year she waits.
• Health conditions cost you the best rate. High blood pressure, a high body mass index or a cancer history all move you into a higher-priced classification.
• Nicotine use puts you in a smoker rate class. Cigarettes, cigars, vaping, and chew all count, and smoker rates run several times higher than nonsmoker rates at the same age.
• Family history counts when your own record is clean. A parent or sibling diagnosed with heart disease or cancer before 60 can drop you a classification.
• Your job and hobbies show up in the quote. Skydiving, private flying, a DUI or commercial roofing work all raise what you pay.

How do you buy a life insurance policy?

Compare quotes for the same payout and term length from several insurers, because each company weighs your health differently and prices vary widely for identical coverage. Work with an independent agent if you have a health condition, since they know which insurers price your situation best.

Expect an application with detailed health questions and, in sometimes, a medical exam, though no-exam coverage is becoming a lot more prevalent with comparable prices. The insurer then pulls your prescription history, motor vehicle record and medical records.

How does a life insurance payout work?

Your beneficiary contacts the insurer, submits a certified death certificate and a claim form, and the company pays out the claim. Most families take the money as a lump sum, though insurers also offer installments or an interest-bearing account.

Deaths in the first two years get a closer look. During that contestability period, the insurer can review your original application, and a misstatement it finds can reduce or void the payout.

Beneficiaries pay no federal income tax on the death benefit. A large payout can still count toward estate tax if you owned the policy, which is why some families put coverage in a trust.

What to do before you buy a life insurance policy

Get the agent’s answers in writing on how the policy behaves after you sign it, then set up the paperwork so the money reaches the right person.

• Confirm whether the rate stays guaranteed for the full term. Some policies lock the price for only the first few years and then reprice you, which turns a $290 premium into a much larger one halfway through.
• Confirm the conversion deadline and which permanent policies you can convert into. That window usually closes years before a term policy ends, and missing it costs you the option to keep coverage without a new medical exam.
• Confirm what happens if a payment arrives late. Coverage ends once you pass the grace period, and buying it back means paying at your current age and health.
• Put the premium on autopay and revisit the policy after a birth, marriage, divorce or job change. You can update beneficiaries at no cost, and an outdated form sends the money to the wrong person regardless of what your will says.

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