Once you’ve reached certain milestones in your life — like getting married, buying your first home, or welcoming your first child, for instance — it’s time to consider the not-so-fun topic of how your family or other dependents may fare upon your passing. Life insurance guarantees your loved ones a safety net in the event you die, which is especially important if anyone is financially dependent on you.
Let’s explore the basics of life insurance, including how it works, common types of life insurance and more.
Life insurance guide — table of contents:
- What is life insurance?
- How does life insurance work?
- What are the different types of life insurance?
- How much is life insurance?
- Is life insurance taxable?
- Why life insurance is important
What is life insurance?
Life insurance is a contract between you and an insurance company that promises a monetary payout, commonly called a death benefit, to designated beneficiaries — typically family members — after you pass away. As long as you’ve paid your premiums and the policy is active upon your death, the death benefit will be paid out.
Visit our guide to life insurance for more definitions and information.
How life insurance works
In order to obtain life insurance, you must qualify by submitting an initial application. The process typically includes a phone screening and a medical examination to determine your health status, including any chronic or pre-existing conditions. Your health information is a major contributing factor to your life insurance premium. Once you finalize how much life insurance you need and your rate, you must keep paying your premium to keep the coverage in place.
After you pass away, your beneficiary must file a claim with the life insurance company and submit relevant documentation, such as a death certificate. The beneficiary may choose how the death benefit will be paid out to them — either via lump sum or annual payments. Each life insurance payment option is paid out tax-free.
What does life insurance cover?
Most causes of death are covered by life insurance, including natural causes, accidents, and illness. There may be stipulations around suicide, however, and life insurance may consider it exempt from coverage within the first number of years of having the policy. Fraud is the most common reason for denial of life insurance claims, and life insurance companies can also deny coverage in cases where a beneficiary murders the policyholder.
Many people are concerned about being denied life insurance coverage due to pre-existing conditions. While there are many conditions that can impact your chance to get coverage, many individuals with pre-existing conditions can still find coverage in some instances. Coverage availability and limits for higher-risk individuals will differ from company to company. If you have a pre-existing condition, the best thing to do is to shop around to see what type of coverage you can receive.
Start by getting a quote from Ethos, which offers life insurance coverage for people with many different pre-existing conditions.
Types of life insurance policies
Another factor to consider — aside from how much insurance you need — is what type of life insurance is best for you and your family members. The two primary differences between these types of life insurance policies are the length of coverage over your lifetime and the potential to increase your death benefit over time via cash value.
These differences are explained below.
Term life insurance
A term life insurance policy only covers you for a set number of years and is considered the most basic level of life insurance coverage you can buy. If you’re lucky enough to still be alive once the term policy expires, you must renew to keep the coverage in place and guarantee your beneficiary gets your death benefit once you do pass. Term life policies tend to be the cheapest type of life insurance.
Whole life insurance
Considered a form of permanent life insurance, you must pay premiums for the duration of your life if you have a whole life policy. Whole life insurance may also be known as cash value life insurance; this is because a percentage of every premium payment you make is diverted as tax-deferred cash value that accrues interest at the rate specified on your policy.
This cash value amount of your permanent policy is separate from the death benefit and is meant to be used while the policyholder is still living. Beneficiaries should not expect to receive both in the event of the policyholder’s death. Think of it as a savings account built into your whole life policy.
Benefits of cash value include:
- It can be withdrawn tax-free as long as you keep paying for your policy and don’t surrender it.
- It can be used to take out a low-interest loan against your own policy. Like other loans, you must pay interest until it’s paid off if you access cash value this way. Any remaining amount owed after you pass will be deducted from your death benefit.
- It can be paid out if you surrender your life insurance policy. However, many life insurance companies charge a fee for this, and it may not be worth it if your policy is only a few years old — most of the growth in cash value happens the longer your whole life insurance policy matures, generally beyond 10 years old.
Another key benefit of a whole life insurance policy is that your premium will typically remain unchanged through the years as you age. Learn more about the differences between term and whole life insurance policies.
Universal life insurance
Universal life insurance is another type of permanent policy. The main difference between universal and whole life policies is that the cash value is associated with a specific stock index instead of a fixed percentage. This leaves the cash value vulnerable to decline if the market underperforms.
Top factors that impact life insurance premiums
Insurance companies will assess who you are, including the condition of your health and details about your lifestyle and your past. Factors affecting life insurance rates include:
- Age: One of the most important rating factors is your age. Unlike auto insurance, the younger you are, the cheaper your premium will be. This is because younger people are generally healthier and thus, less likely to die soon.
- Gender: On average, women live longer than men. Insurers use this data to help price premiums. Insurance companies charge higher rates for men since they calculate premiums based on mortality risk.
- Personal health history: As previously mentioned, a medical exam of your mental and physical health is routine when you enroll in life insurance. This is another significant indicator of your mortality risk: those in poor health may pay higher rates than those who are in good health.
- Smoking: You will face a higher rate if tobacco use is part of your lifestyle. Smokers are considered high-risk clients due to the myriad illnesses exacerbated by smoking.
- Family health history: Insurers will inquire about your immediate family’s history of illnesses to get an idea of what direction your health will take over time.
- Career, lifestyle, and hobbies: Some jobs are riskier than others — but the same applies to how you like to spend your leisure time as well. If you’re a pilot with a passion for skydiving and free climbing, your premium may reflect the elevated risks posed by your lifestyle.
- Driving, criminal, and credit records: Although these personal factors affect your premium to a lesser extent than the above, these are still used as risk indicators. For instance, you could be charged a pricier rate if you have a history of getting into car collisions. From the eyes of a life insurance provider, a bad driving record is associated with the heightened risk of the policyholder suffering an accidental death.
Is life insurance tax-deductible?
Life insurance premiums are generally not tax-deductible. One of the rare exceptions is business owners, who can deduct life insurance premiums paid for employees. However, this comes with a few more provisions; for example, you cannot deduct premiums if you own the business with your spouse and the business must not be named as a beneficiary on the policy.
Learn more about life insurance and taxes.
Are death benefits taxable?
The death benefits payout beneficiaries receive is not considered taxable income. If your family is expected a death benefit of $1 million after you pass, they can expect the full amount. Many policyholders strategically plan to pay future family expenses tax-free — including college tuition or mortgage payments — by enrolling in life insurance.
Do I need life insurance?
If anyone is financially dependent on you, life insurance is always recommended — the earlier the better. It’s also worth it if you have assets, debt, or a business. Death benefits can be used by beneficiaries to pay for just about anything following the passing of the policyholder, including funeral expenses, childcare, mortgage payments, business debt, student loan debt, and inheritance or estate taxes. The cash value component can even be used to fund part of your retirement.
Life insurance could be a smart long-term investment for those who are:
- The sole financial provider in a household
- Parents, including stay-at-home partners, divorced or single parents, and parents of a special-needs child
- Homeowners with a mortgage
- Business owners
- High net-worth individuals
- Those paying off debt
- Those concerned about funeral costs
- Those looking to provide an inheritance
Ethos is a life insurance company that offers whole and term life insurance policies and an easy, seamless online experience. Get a free Ethos quote in just 10 minutes.
Evaluating your life insurance needs, understanding your options, and shopping around for life insurance quotes is the most effective way to find affordable rates. Having this important coverage is one of the best ways to ensure some financial security for your beneficiaries if anything should befall you — whether that be 50 years down the line or five.