How does life Insurance work?

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Life insurance pays a lump sum benefit¹ to your loved ones after you pass away.

Many people purchase insurance to help protect their family or beneficiaries from the financial consequences if they die, including debts, lost income and other unexpected expenses.It’s financial confidence for your family’s future – and it’s typically more affordable than many realize.

If a spouse, child, or other loved one depends on your income, you may want to consider getting a life insurance policy to help make sure they are financially taken care of in case you pass away. We’ll cover how life insurance typically works, who may need life insurance, and the difference between the three types of life insurance so you can make an educated decision about whether purchasing a life insurance policy is a good idea for you.

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Life insurance policies work when you need them

When you die, your income disappears – but many of your expenses and debts do not. If you have a spouse, children, or anyone else who is financially dependent on you, they may struggle without your income. And while losing a loved one is hard enough, having to deal with the financial aftermath of losing a major source of income and being left to bear their debts can make it even worse.

So how do life insurance policies work? Essentially, life insurance is a contract between you and an insurance company, providing for payment of a sum of money to a designated beneficiary after you die². Coverage typically can be customized, depending on your income, your age, your health, and how much you can afford to pay per month. Professionals may recommend having enough coverage to help replace the income you now generate for your dependents, help pay off your debts, and offset additional expenses they could incur to replace services you currently provide³. However, you decide how much coverage you purchase and who will be the beneficiaries of your life insurance policy.
While life insurance policies can differ from one another, you’ll likely encounter a few of these terms as you start shopping around⁴:

  • Premium – the payments required to pay for the insurance and keep the policy in effect

  • Beneficiaries – the people who receive proceeds from a life insurance policy. Life insurance beneficiaries are typically spouses, children, or parents, but it isn’t limited to family members – you can choose anyone you’d like. It can all go to a single person or be divided among multiple people and entities.

  • Death benefit – the amount the insurance company agrees to pay the beneficiaries when the covered person dies. You’ll choose this when you buy a policy. It’s often a fixed value.

  • Riders⁵ – these are other optional features you can add to a life insurance policy for an additional cost. For example, you may be able to add a provision that pays your premiums if you’re no longer able to work.
    Some types of insurance are used regularly or more than once, such as dental insurance or medical insurance. However, life insurance is paid out only once, at the time of your death, if you die while covered by an active policy.

Who needs life insurance?

Life insurance is designed to help financially support your spouse, kids, or other dependents after you die. If you have family members who are dependent on you financially, you may need a life insurance policy.

If you are married with children, your life insurance benefits can help to cover the cost of childcare and tuition, along with your mortgage and other bills. Your life insurance payout can also allow your spouse or other beneficiary to spend more time helping your children cope with the loss of a parent, without worrying about finances right away.

If you’re married with no children, your life insurance benefits can help your spouse or dependent maintain the same standard of living and continue paying the mortgage and other bills. It can also help pay your personal debts.

Even if you’re single, life insurance may still be a good idea, especially if you support your parents or want to ease the burden of covering your funeral expenses.

How does term life insurance work differently?

There are three main types of life insurance: term life insurance. whole life insurance and universal life insurance⁶. The main common differences between them are how long they last and how much you’ll pay in premiums⁷.

Whole life insurance covers you until death, as long as you pay your premiums. Whole life insurance is the most well-known type of permanent life insurance. Its guaranteed payouts, potential cash value⁸, and fixed premiums make it an attractive life insurance option but it typically comes at a higher cost than term life insurance⁹.

Universal life cash values and premiums can fluctuate¹⁰. They allow policyholders to change their death benefit if desired or make larger or smaller payments depending on how their policy account performs¹¹.

So how does a term life insurance policy work? Term life insurance lasts for a period of time chosen at purchase, usually 10, 20, or 30 years. If you die during the covered period, the policy will pay your beneficiaries the death benefit amount stated in the policy. If you die after your term is up, no one gets paid. Term life insurance is generally more affordable than permanent life insurance, offering a life insurance payout, called a death benefit at an affordable cost. The average cost of whole life insurance is between five and nine times greater than the average cost of term life insurance, varying by age, sex and coverage type, among other personal factors¹².

Some insurance companies offer convertible policies, which allow you to convert your term life insurance policy into a permanent life insurance policy over time. Others have decreasing term life policies, which have a death benefit that declines over time.

Does life insurance cover suicide?

Many people hesitate to purchase life insurance because they worry their policy won’t be paid out after they die even if they pay their premiums. But life insurance pays out death benefits due to nearly any cause of death. This typically includes suicide, which is a leading cause of death overall in the United States¹³. However, there may be some conditions as to when and how death by suicide is covered, outlined in a suicide clause in your policy.

A life insurance suicide clause typically allows the insurer to refuse to pay if the death occurs within the first 1-2 years (depending on what state you live in) as a result of a self-inflicted injury, to prevent people from purchasing a policy and then taking their own life to give their dependents the payout. But after the first two years, an insurance policy typically pays out for suicidal death unless there’s a provision in the policy that specifically excludes it. Be sure to look over your policy carefully.

Because death by suicide is covered by most life insurance policies, depression and other conditions that put you at higher risk for suicide may cause you to pay higher premiums. Make sure you disclose all health conditions, including mental health conditions, before purchasing a life insurance policy.

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  1. All life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company.

  2., accessed September 2021

  3., accessed September 2021

  4., accessed September 2021

  5. Riders may incur an additional cost or premium. Riders may not be available in all states.

  6. Permanent life insurance consists of two types: whole life and universal life. Cash value grows in a participating whole life policy through dividends, which are declared annually by the company's board of directors and are not guaranteed. Cash value grows in a universal life policy through credited interest and decreased insurance costs. The cash value of both policy types benefits when the policyholder pays an amount above the required premium.

  7., accessed September 2021

  8. Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.

  9., accessed September 2021

  10. Universal Life Insurance may lapse prematurely due to inadequate funding (low or no premium), increase in cost of insurance rates as the insured grows older, and a low interest crediting rate. This does not apply to universal life policies which have a secondary guarantee, but if the secondary guarantee requirements are not met the policy will most likely lapse.

  11., (July 2020), last accessed September 2021

  12., (February 2021), last accessed September 2021

  13., accessed September 2021