What Is a Life Insurance Policy and How Does It Work?

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Life insurance is a contract between you and your insurer in which you pay premiums on a regular basis so that your dependents can file an insurance claim and receive payment in the event that you die while your policy is in force. This type of coverage allows you to secure future financial support for loved ones who rely on your income or continue to fund specific causes after you die.

Keep reading to learn more about what life insurance is along with what the different types of life insurance are, what factors impact life insurance prices and how much coverage you may need.

Key Takeaways

  • Life insurance is a type of coverage that can provide a death benefit to your beneficiaries if you die while your policy is in effect.
  • Anyone who has dependents or expects to have dependents at some point should consider life insurance as it can help loved ones cover various expenses including everyday living costs, student loans, mortgage payments, final expenses and more.
  • Term life insurance policies provide low-cost coverage for a limited amount of time, while permanent life insurance policies don’t expire and can accrue cash value that you may be able to access while you are still alive.
  • Some experts recommend maintaining 10 to 30 times your salary in life insurance coverage depending on your age, which means you may need a supplemental policy since work-based plans often provide far less coverage.
  • Life insurance prices can vary drastically depending on factors like your age, sex, health status, family medical history, lifestyle and policy details.

What Is Life Insurance?

Life insurance is an agreement wherein a policyholder makes regular premium payments to an insurance company and, in exchange, the insurance company agrees to pay a predetermined death benefit to the designated beneficiaries of the policy if the insured dies while the policy is active. You can select multiple beneficiaries for your life insurance policy including people, charities and your estate.

What Are the Benefits of Life Insurance?

The main benefit of life insurance is that it allows you to secure an insurance payout that can have many potential uses if you die while others rely on your income on a day-to-day basis. For example, the death benefit can go toward paying off specific major expenses like your mortgage or your children’s student loans. Alternatively, it can broadly take care of your dependents’ financial needs for a set time period such as covering your children until they turn 18 or, if you are the primary wage earner, covering your spouse until your retirement age.

If your dependents’ primary financial needs are already taken care of, then you can instead use life insurance to leave an inheritance for your children or make a final donation to your favorite charitable organization. Conversely, your dependents could simply use the death benefit to pay for your final expenses such as your funeral and your burial or cremation.

Another perk of life insurance is that the death benefit is tax-free in many cases.[1] In addition, certain types of policies accrue cash value that can add to the death benefit or be withdrawn or borrowed against to serve other purposes even before you die.

Who Needs Life Insurance?

Life insurance is generally recommended for anyone who has dependents relying on their income. Even if you don’t have any dependents yet, it may be worthwhile to go ahead and purchase a policy if you plan on getting married or starting a family at some point. This is because life insurance premiums are lower the younger and healthier you are, so it’s often beneficial to lock in low rates by buying life insurance early.

reasons to buy life insurance young

For the most part, the only people who don’t need life insurance at all are those with no dependents who have no intention of ever starting a family and those who already have enough money saved up to cover their dependents’ needs after they die.

How Does Life Insurance Work?

After the insured covered by a life insurance policy dies, the death benefit may be paid out as a lump sum or it may be paid out in installments in a way that mimics the insured’s steady income stream depending on the details of your policy.

If you survive to the end of your policy’s coverage period, then the policy will expire and your beneficiaries will no longer be eligible for a death benefit. However, some insurers allow you to pay extra for a return of premium policy, meaning the insurance carrier will pay back some or all of your premiums if you are still alive at the end of the coverage term.[2]

What Does Life Insurance Cover?

Life insurance broadly covers the insured’s life, meaning most causes of death will lead to a payout for their beneficiaries. In addition, certain life insurance riders allow the insured to personally access the death benefit before they die.

For example, if you have an accidental death and dismemberment (AD&D) rider, then you will receive a payout after an accident that causes you to lose a body part like a limb or otherwise become unable to use a body part. Meanwhile, an accelerated death benefit rider allows you to receive a portion of your death benefit early if you develop a terminal illness.

Once your beneficiaries receive a life insurance payout, they are generally free to spend the money however they please. For example, even if you purchased life insurance to make sure your spouse can finish paying off your mortgage after you die, they are allowed to instead use the death benefit to cover other expenses like credit card debt or everyday living costs.

What Isn’t Covered?

Life insurance policies may come with a set of exclusions, which are scenarios in which your life insurance company won’t pay out a death benefit after you die. For example, most insurers won’t pay out a death benefit if the insured commits suicide within two years of taking out the policy.[3] In addition, the vast majority of states have slayer statutes in place, meaning a beneficiary listed on a life insurance policy legally cannot claim the death benefit if they murder the insured.[4]

What Types of Life Insurance Are There?

The two main categories of life insurance are term and permanent life insurance. Continue reading for an overview of the main differences between these two types of coverage.

Term Life

Term life insurance is a type of life insurance coverage that remains active for a limited amount of time, usually lasting up to 30 years.[2] Since there is no guarantee that you will die during the coverage period and your insurer may not have to pay out a death benefit at all, term coverage tends to be the most affordable type of life insurance.

If you opt for a level term life insurance policy, then the policy’s death benefit will remain the same throughout the entire coverage term. Conversely, decreasing term life insurance policies lower the death benefit over time, often once per year, meaning your beneficiaries will receive a smaller payout if you die later in the coverage period.[2]

You can have multiple life insurance policies at once and some policyholders opt to maximize their coverage by laddering policies, which involves buying multiple term life policies with different term lengths and coverage amounts so that your premiums will decrease over time as your policies expire.[5] This strategy allows you to maintain a high amount of coverage earlier in your life when you are most likely to need it, while also securing cheap premiums for a lower amount of coverage that will persist later in life.

how laddering works

Permanent Life

As the name suggests, permanent life insurance policies generally don’t expire, meaning your insurer will pay out a death benefit to your beneficiaries regardless of when you die. For this reason, permanent life insurance policies can be far more expensive than term life policies. 

In addition, permanent life insurance policies accrue cash value that you may be able to access while you’re still alive. Depending on the details of your policy, you may be able to put this cash value toward paying your premiums, take out a loan against the cash value, withdraw a portion of the cash value in exchange for lowering the policy’s death benefit or surrender your policy outright in order to claim its cash value.[6]

The main subcategories of permanent life insurance are as follows:

  • Whole life insurance: The most basic and common type of permanent life insurance is whole life insurance.[7] In general, whole life insurance policies have set premiums and death benefits and they accumulate cash value at a guaranteed rate.
  • Universal life insurance: Universal life insurance policies also accrue cash value at a consistent pace but these policies offer you more freedom to adjust your premiums and death benefits if you find that your coverage needs have changed over time.
  • Indexed universal life insurance: While indexed universal life insurance policies can also offer flexible premium payments, their cash value component grows based on the performance of a stock market index such as the S&P 500. There are usually limits on the amount of money you can gain or lose through your policy’s underlying investments.
  • Variable life insurance: Variable life insurance functions similarly to indexed universal life insurance but generally does not set a maximum on the amount of cash value your policy can gain or lose. As a result, variable life insurance is the highest-risk, highest-reward type of permanent life insurance.

How Much Life Insurance Do I Need?

Insurers commonly recommend buying a life insurance policy with a death benefit between 10 and 30 times your annual income depending on how old you are and what expenses you want your policy’s death benefit to cover. For example, if you are in your 30s and make $60,000 a year, you might opt for a policy with $1.8 million worth of coverage. Conversely, if you are in your early 60s and make $100,000 a year, you may instead settle for $1 million worth of coverage.[8]

Keep in mind that employer-sponsored group life insurance plans typically only provide $50,000 to $100,000 worth of coverage.[8] As a result, you will likely want to consider buying a secondary supplemental life insurance policy even if you already have coverage through work.

Which Companies Offer Life Insurance?

There are numerous companies that specialize in selling life insurance including Guardian Life, Lincoln Financial, MassMutual, MetLife, New York Life and Protective Life. You can also get life insurance from companies that specialize in selling supplemental life and health plans like Aflac.

Meanwhile, several insurance carriers that offer a wide range of insurance products such as GEICO, Liberty Mutual, Nationwide, State Farm and USAA include life insurance among their offerings. Some insurers may even offer you a discount if you bundle a life insurance policy with a different type of policy from the same company. For example, State Farm customers may be able to save money by bundling life insurance with auto insurance.[9]

How Much Does Life Insurance Cost?

Life insurance premiums can vary drastically depending on your personal characteristics and policy details. For example, the average cost of a 10-year term life insurance policy for a healthy non-smoker can range from $21.25 to $800 per month depending on their age, sex and coverage amount.[10]

males pay more for life insurance

What Affects Life Insurance Premiums and Costs?

As you shop for life insurance, remember that the following factors will have an impact on the amount you have to pay for coverage:

  • Age: Age is one of the biggest factors affecting life insurance prices. Younger people get to pay less for coverage since they are likely to live longer, meaning they can spend more time paying premiums and are less likely to die at all during the coverage period of a term life insurance policy.
  • Sex: Since women live longer than men on average, they generally get to pay less for life insurance coverage.[11]
  • Medical history: If you have a pre-existing health condition or multiple family members who have died of heart disease, cancer or some other serious illness, life insurance companies may view you as riskier to insure and charge you more for coverage.
  • Lifestyle: When assessing the likelihood that you will die while your policy is active, insurers will also pay attention to your lifestyle. As a result, you could face higher premiums if you smoke, have a poor driving record or participate in dangerous hobbies like extreme sports.
  • Occupation: Similarly, if you work in a high-risk industry like fishing or logging, your insurance provider could charge you higher premiums.
  • Policy details: Naturally, the type of policy you take out will also affect your premiums. Relevant factors include whether you get a term or permanent life insurance policy, how high the death benefit is and, if you opt for term life insurance coverage, how long the coverage period is.
  • Riders: You may be able to enhance your coverage by purchasing various riders, although you should note that any riders you add to your policy will likely cause your premiums to go up.

How To Qualify for Life Insurance

To qualify for life insurance, you may have to undergo a full underwriting process that involves passing a medical examination and answering detailed questions about your lifestyle and family medical history. However, some insurers offer no-exam life insurance that may be appealing to individuals with health problems that could disqualify them from fully underwritten coverage.

You may encounter the following underwriting methods as you shop for no-exam life insurance:

  • Simplified issue: When you apply for simplified issue life insurance, you will only have to fill out a health questionnaire rather than going through a full medical exam. However, you should note that these policies can be more expensive than fully underwritten policies since your insurer will account for the lack of complete medical information needed to accurately assess the risk of covering you.
  • Accelerated underwriting: Accelerated underwriting can create a slightly more detailed risk profile than simplified issue underwriting since it involves algorithmically analyzing data from various external resources including your medical records, prescription drug history, credit report and motor vehicle records.
  • Guaranteed issue: You don’t need to undergo any sort of risk assessment to qualify for guaranteed issue life insurance, meaning you can receive coverage regardless of your health status. However, this is only possible because guaranteed issue policies are often very expensive relative to the amount of coverage they provide. Burial insurance, a type of whole life insurance that is commonly guaranteed issue, generally only provides a large enough death benefit to take care of expenses like your funeral and burial.

How To Buy Life Insurance

To find the best life insurance policy for your situation, it’s recommended that you compare quotes from at least three to five insurance companies. You’ll need to share your contact information and potentially provide preliminary information about your health status and medical history. This can drag out the life insurance shopping process if you try to contact insurers one by one.

Instead, let us help you streamline the process. If you fill out a simple online questionnaire through SmartFinancial, we’ll match you up with agents who can help you find a policy that meets your needs at the best price available. Click here if you’re interested in receiving no-cost life insurance quotes today.

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Do I need life insurance if I don’t have dependents?

You may want to go ahead and purchase life insurance if you don’t have dependents now but think you will at some point in the future. However, life insurance likely isn’t necessary for you if you don’t plan on starting a family or otherwise having any dependents.

Is life insurance required?

Life insurance isn’t required by law but is still advised for anyone who has dependents relying on their income.

How is life insurance paid out?

Your life insurance company may pay out your policy’s death benefit to your beneficiaries in installments or as a lump sum depending on the details of your policy.


  1. Internal Revenue Service. “Life Insurance & Disability Insurance Proceeds.” Accessed March 5, 2024.
  2. Insurance Information Institute. “What Are the Principal Types of Life Insurance?” Accessed March 5, 2024.
  3. Guardian Life. “How To Read Your Life Insurance Policy.” Accessed March 5, 2024.
  4. Ohio Northern University Law Review. “Consequences of Heirs’ Misconduct: Moving From Rules to Discretion,” Page 979-980. Accessed March 5, 2024.
  5. Guardian Life. “Can You Have Multiple Life Insurance Policies?” Accessed March 5, 2024.
  6. Allstate. “What Is Cash Value Life Insurance?” Accessed March 5, 2024.
  7. Insurance Information Institute. “What Are the Different Types of Permanent Life Insurance Policies?” Accessed March 5, 2024.
  8. Guardian Life. “Is the Life Insurance You Have Through Work Enough?” Accessed March 5, 2024.
  9. State Farm. “Can You Really Save if You Bundle Insurance?” Accessed March 5, 2024.
  10. Aflac. “Term Life Insurance Rates by Age.” Accessed March 5, 2024.
  11. State Farm. “What Determines the Cost of Life Insurance?” Accessed March 5, 2024.

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