How Does Life Insurance Work?
Life insurance provides financial support for your loved ones after you die. Your life insurance policy is a contract with a life insurance company. You pay a predetermined amount of money in the form of a premium. The insurance company pays your designated beneficiary a set amount of money when you die which you can then use for various purposes including college tuition, housing costs, funeral expenses, and paying off debt. There are unlimited ways in which a beneficiary may use life insurance proceeds.
There are two main types of life insurance.
Term life insurance provides coverage until the “term” of the policy is up. If the insured person dies while the policy is in force, their beneficiaries receive the death benefit. Beneficiaries are designated by the policyholder to receive the life insurance benefit. If the insured person is alive when the policy term expires, then they may renew the policy at a higher premium or convert the policy to a different type of life insurance to maintain coverage. The policyholder can also allow the policy to lapse if they no longer need or want the life insurance coverage.1
Universal life insurance and whole life insurance are two types of permanent life insurance that provide a death benefit throughout the insured person’s life, no matter when they die. Whole life insurance has a savings component that grows at a certain rate. Universal life insurance also has a savings component, but it grows based on market performance.2
You can also get specific life insurance policies to cover burial and funeral expenses. Burial insurance is typically a small whole life policy with a death benefit of $5,000 to $25,000. It’s designed to relieve your loved ones of the financial burden of paying for funeral costs.
How Much Life Insurance Should I Buy?
The amount of life insurance you need depends on your situation and who depends on you for financial support. People who don’t have dependents and who can pay for their own burial and funeral expenses with savings may not need life insurance. They may want life insurance to contribute to a favorite charity or leave an inheritance. Parents of young children who are planning for their financial future may need large life insurance policies to pay off a mortgage and other debts, provide day-to-day living expenses for the family while the children live at home, and provide for their future education needs.
When calculating the amount of life insurance you’ll need, think about the people who depend on you for financial support and those who may be strained financially if you die. Get a quote now.
The IRS doesn’t consider life insurance proceeds taxable income, so your beneficiaries won’t have to worry about receiving less than the face value of the policy due to taxes.3
Can You Have Multiple Life Insurance Policies?
Yes. You may have low-cost or free group life insurance through your employer, your credit union, or another organization. You may also have your own term and whole life policies.
Some people buy several inexpensive term policies that expire at different times as they age. For example, purchasing a 10-year, 20-year, and 30-year term policy at the same time provides the most coverage during the first ten years, when the policyholder may have young children at home or have higher debts. The ladder life insurance strategy allows the policyholder to decrease the amount of money they spend on their term policies over time while maintaining coverage that meets their needs.4
How Long Does Life Insurance Last?
If you choose term life insurance, your coverage lasts for the “term” of the policy. So, a 10-year life insurance policy would pay a death benefit if you die between initiating the policy and the end of its 10-year term. When the term is up, you may be able to choose to keep the policy if you wish to pay a higher premium.
Permanent life insurance, including whole life and variable life policies, never expire. If the policy premiums are paid on time, your beneficiaries receive the death benefit no matter when you die. With a whole life policy, you may be able to add term coverage to boost your death benefit for 10 to 30 years, depending on your needs.
What Does Life Insurance Cover?
Subject to certain exclusions, a life insurance policy typically pays your beneficiaries no matter your cause of death. Whether you died due to an accident or natural causes, so long as your policy is in force, your beneficiaries receive the death benefit.
A permanent life insurance policy has a savings component that builds cash value over time. This type of life insurance policy could help provide funds for any number of things in the form of a loan that you take out against the cash value of the policy. You may also be able to use the savings to pay the insurance premiums if you can’t afford them later in life.5
What Does Life Insurance Not Cover?
If there is an investigation into fraud or criminal activity, a death benefit may be withheld until the problem is resolved. Death by suicide may not be covered if it happens during the first two years of the policy, depending on the insurance company’s requirements.6
In some states, an ex-spouse may not remain as beneficiary. The “revocation-upon-divorce” rule says that after divorce, the spouse should not benefit from a life insurance policy.7 However, in many cases life insurance policies are purchased in order to meet financial obligations as part of a divorce judgment.
What Expenses Does Life Insurance Cover?
Your beneficiaries can use the death benefit in any way they choose. Life insurance money often provides for the basic financial needs of a family with children after a parent dies. It may be used to pay off debts like a mortgage or private student loans.
Does Life Insurance Pay For Funeral Expenses?
While you can certainly use any life insurance benefit to pay for funeral expenses, there are also specific types of insurance that provide money for final expenses. SBLI’s Cherish Life final expense insurance is a senior life insurance solution that can pay off outstanding debt like medical bills in addition to covering burial and funeral expenses.
How much life insurance should I get?
The type and amount of life insurance you need depends entirely on your personal situation. In general, term life insurance is the least-expensive option. It’s popular with young people who are in good health and who need a low premium with a lot of coverage to provide for their family and pay off debts.
Some people find that a combination of term life and whole life is a good choice. This type of blended policy offers coverage for life with a guaranteed death benefit and a premium that stays the same throughout the period you select.
How to Learn More About Life Insurance Options
Life insurance can be a complex topic, so it’s smart to reach out to a trusted advisor with your questions. Work through a few life insurance calculators to get a good idea of how much life insurance you may need.
Some insurance companies require a medical exam to get a life insurance policy, but many reputable companies offer policies up to $750,000 with only a phone interview.
There’s more to life insurance than finding the lowest rates. While it’s important to shop around, be sure to seek out a company with a reputation for taking care of their customers.
This is designed to provide general information on the subjects covered. Pursuant to IRS Circular 230, it is not intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market or recommend any tax plan or arrangement. You are encouraged to consult your personal tax advisor or attorney. Policy form B-52, B-54 & B-40 series. Policy form B-56 series. 21-4173.
Loans will reduce your net cash value and net death benefit, and may be subject to interest charges. Unpaid loans are subject to ordinary income tax and, if taken prior to age 59½, a 10% federal tax penalty.
1 Investopedia.com, Term Life Insurance, Julia Kagan, 2020, accessed 3/1/21.
2 Investopedia.com, Permanent Life Insurance, Julia Kagan, 2021, 3/1/21.
3 IRS.gov, Life Insurance & Disability Insurance Proceeds, Internal Revenue Service, 2021, accessed 3/1/21.
4 Forbes.com, Maximize Life Insurance At The Right Time With A Ladder, Ryan Frailich, 2020, accessed 3/1/21.
5 iii.org, How to choose the right type of life insurance, Insurance Information Institute, accessed 3/1/21.
6 Investopedia.com, Does Life Insurance Cover Suicide?, Kat Tretina, 2021, accessed 3/1/21.
7 PR Newswire.com, 5 Reasons Why Your Life Insurance Claim May Be Denied, And How To Stop It, Jason Turchin, 2020, , 3/1/21.