Life Insurance 101
What is life insurance?
Life insurance is a contract between an insurance company and an insurance buyer. A life insurance policy guarantees that the policyholder’s beneficiaries will receive a lump sum (often known as the death benefit) if he/she were to pass away during the coverage period, in exchange for the policy premiums paid during their lifetime.
You can customize the insurance policy by choosing the policy type, insurance duration, and coverage amount. If you die while your life insurance is in effect, the beneficiary can make a claim, and the tax-free death benefit will be paid to them. If your family is dependent on you, life insurance provides affordable economic protection and unparalleled peace of mind. Your family can use the life insurance payout (the death benefit) to settle long-term financial obligations like mortgages and student loans, pay for their living expenses like rent, grocery, or utility, or even pay for funeral arrangements.
Simply put, life insurance can help you take care of your loved ones by minimizing the financial stress they would suffer upon your passing. A life insurance policy also offers a sense of freedom that comes from knowing that your loved ones will be taken care of irrespective of what happens to you.
A lot of people consider life insurance as something that is only for the healthy and wealthy. That could not be further from the truth! The life insurance industry is broader than most consumers realize, making it possible for almost anyone to find a policy that suits their own unique needs. Getting life insurance when you are young and healthy will help you lock in the best possible rates and quite possibly for less than what you would pay for a large pizza.
Much like everything else in the world of finance, life insurance also comes with its own set of complex jargon that can be confusing for someone just starting their insurance research. Here are a few terms that you will find on almost every policy document in the market:
- Death Benefit - This is the money received by the beneficiary when the insured person passes away. Death benefits are generally not subject to income tax, and the beneficiaries usually receive them in one lump-sum payment.
- Beneficiary - The person(s), entity, or institution(s) that receive the death benefit in the event of death of the insured is known as the beneficiary. It is possible to name one or more persons as the beneficiary when you purchase a policy.
- Insured - The person whose life is covered by the insurance policy is known as the insured. It is usually the person who owns the policy and pays the premiums. However, the policy owner and payor may be someone other than the insured.
- Premium - Premium is the amount paid to keep the insurance policy active. Paying premiums on time is essential to guarantee that your beneficiary will receive the death benefit on your passing. Failure to pay your insurance premiums will cause your policy to lapse.
- Death - Most life insurance policies pay the death benefit, provided the policy is still in force and not lapsed due to missed payments, and the information on your application is accurate. Covered causes of death include Natural Causes like old age or heart attack, Suicide (most policies have a two-year waiting period), Murder (unless the beneficiary played a role in the homicide), and Accidents like a workplace incident or car accident.
The two most common types of life insurance are term life insurance and whole life insurance.
Term life insurance offers coverage for a predefined amount of time known as the coverage period, whereas whole life insurance offers coverage for your entire lifetime. However, this long coverage period of whole life insurance comes at a cost. The average whole life insurance premium is 5-15 times the term life insurance premium for the same coverage amount. Term life insurance is an excellent way to get coverage without breaking the bank.
Whole life insurance offers a cash component that you can borrow from in case of emergencies, but overall, term life insurance is the best bang for your buck when it comes to life insurance. Whole life insurance is recommended only for the extremely rich looking for tax-free investments and those living with permanent health conditions. These specific requirements justify very high premiums.
Term life insurance is the best choice for most people because it offers coverage when they need it the most (such as paying off financial obligations like mortgage or college tuition and raising kids) and comes with comparatively low monthly premiums. If you are very young and healthy while applying for term life insurance, you might even be able to lock in a premium that is less than what you would pay for a car wash without compromising the coverage amount.
The main benefit of having life insurance is that your family will receive a lump sum if you were to die unexpectedly, and you get the reassurance of knowing they will have the resources to help carry on without you.
All life insurance policies can give you confidence that your family will be financially stable even in your absence. But, in general, the more life insurance you have, the more benefits your family will receive when they need it the most. For example, some people get nominal life insurance (about $25,000) through their work. This amount may be better than nothing but often is only enough to cover final expenses and a few mortgage payments. However, with a large life insurance coverage, families can enjoy many benefits, including funding for college education for children, income replacement for years of lost salary, paying off the home mortgage and debts such as car loans, credit cards, and student loans, and supporting other obligations such as caring for older parents.
Deciding how long your life insurance coverage should last is one of the most important decisions you must make while picking a term life insurance plan. Your choice depends on three main factors: How much you need, how much you can afford, and how much you qualify for. The term must be long enough to cover all liabilities and outstanding debts like mortgages and college education for your children. For example, if you have a mortgage with 20 years left on the note, a 20-year term policy may be a good option. A good rule of thumb would be to pick a coverage term that exceeds your last mortgage or loan payment.
Some situations that you might want to consider while selecting a term for your life insurance are:
- You are a parent: If you have just had a child, you will need a policy that will cover you for the amount of time it takes for your children to be financially independent. That may be anywhere from 20-30 years, depending on how old your children are and how long you plan to provide for them.
- You are a homeowner: If you have just bought a house, you might want to consider a term at least slightly longer than your mortgage. Even if you have taken out a 15-year mortgage, you may want a cushion in case you refinance and circumstances change.
- You have cosigned a loan: Whether it is a car loan for your spouse, a student loan for your child, or a small business loan with a partner, you will need a term that will outlast these debts so that your co-signers will not be in trouble in the event of your death.
You can’t know exactly how much life insurance you should buy. If you assess your current financial situation and estimate what your loved ones may need over the next few years, you can develop a decent estimate. In general, you should calculate how much life insurance you need by subtracting your assets from your long-term financial needs.
Several rules of thumb will help you decide on a good life insurance coverage amount. Some of the more popular ones are:
Several rules of thumb will help you decide on a good life insurance coverage amount. Some of the more popular ones are:
- Buy 10-15 times your current income plus $100,000 per child for college expenses. Education expenses are an important component of your life insurance if you have kids and plan to help them pay for college. This rule is best used only for a starting estimate as it still does not take a deep look at all of your family’s needs, assets, or any life insurance coverage already in place.
- The DIME formula: This formula provides a more accurate figure by encouraging you to take a more detailed look at your finances. DIME stands for debt, income, mortgage, and education, four areas you should account for when calculating your life insurance needs.
- Debt and final expenses: Draw up a list of your debts, except for your mortgage, but include an estimate of your funeral expenses.
- Income: Determine the number of years your family will require support and multiply your annual income by that number.
- Mortgage: Determine the amount required to pay off your mortgage.
- Education: Estimate the cost of sending your children to school and college.
The cost of life insurance is different for everyone and depends on your specific situation. The following are the most important factors that can influence your premium:
*Based on internal actuarial rate tables for male and female non-smokers in excellent health for 20-year term lengths from two life insurance carriers in the InsurAware™ marketplace. Current as of June 28, 2021.
- Your age: Young people are more likely to have lower insurance premiums.
- Your health: Healthier people typically get lower rates.
- Your gender: Men usually pay more than women for comparable policies.
- Your tobacco use: Life insurance is generally more expensive for smokers.
- The type of policy you choose: Whole life policies tend to cost more than term life policies because they last throughout your life and have a cash value component.
- Your term length and coverage amount: Term life insurance with less coverage and short term lengths tend to be less expensive when compared to whole life insurance, which costs more owing to its unlimited term length.
- The type of underwriting experience you want: Simplified and guaranteed issue policies are more expensive because they do not require full underwriting or a medical exam.
| Age, Gender | $250k coverage amount | $500k coverage amount |
|---|---|---|
| 25 Female | $11.24 | $16.32 |
| 25 Male | $12.80 | $19.29 |
| 35 Female | $11.94 | $17.88 |
| 35 Male | $13.76 | $21.64 |
| 45 Female | $22.10 | $37.82 |
| 45 Male | $27.32 | $47.40 |
| 55 Female | $48.87 | $84.99 |
| 55 Male | $62.47 | $117.29 |
Now that you are an expert on all things life insurance, you can start your coverage journey with confidence.
Shopping for life insurance is no different from buying something online, and the most important rule is to ensure that you get the best possible coverage for the least amount of money. You can do this by comparing quotes from different insurers across the country. We have made it easier for you to do so by streamlining the whole thing.
You can now complete the entire process in one place. You can go from being uninsured to living a carefree life in just 7 simple steps.
Shopping for life insurance is no different from buying something online, and the most important rule is to ensure that you get the best possible coverage for the least amount of money. You can do this by comparing quotes from different insurers across the country. We have made it easier for you to do so by streamlining the whole thing.
You can now complete the entire process in one place. You can go from being uninsured to living a carefree life in just 7 simple steps.
- Generate a free life insurance quote: Compare quotes from the nation’s top insurers to ensure that you get the best policy that suits your unique needs. InsurAware™ generates multiple quotes from a variety of insurers to help you find the perfect coverage.
- Choose a life insurance policy: Once you decide on a coverage amount and duration, you can choose any one of the quotes displayed in the InsurAware™ quote calculator.
- Fill out an application: You can fill out your application online or call a licensed expert to get help. All you need to do is answer a few questions related to your health, and you will be all set for the next step.
- Take a medical exam: You might have to take a medical exam depending on the type of policy you choose. Life insurance policies that require you to take a medical exam are often cheaper than ones that don’t, since the insurer can ensure that you are in perfect health before issuing the policy. The exam is free, and a technician will come to your home or workplace on your schedule.
- Complete a phone interview: An insurance agent will ask you a few simple questions about your health and hobbies.
- Wait for approval: An insurance underwriter will use the information you provide to decide on a final premium rate that will be similar to the one you picked. This process can take up to six to eight weeks, but some companies offer instant decision policies that can help you get coverage in just a few hours.
- Sign your policy: As soon as you sign your policy document and complete the first premium payment, your coverage will be active. Congratulations on putting your family and loved ones first!