Life insurance is an agreement between a policy owner and an insurance company. In exchange for the required premium payments and compliance with the contract, the insurer agrees to pay the applicable death benefit when the insured person dies under circumstances covered by the policy.

The primary purpose is financial protection for people or organizations that could be affected by the insured person’s death.

A life insurance benefit might help survivors:

Life insurance is not an investment account simply because some policies contain a cash-value component. Its primary function remains insurance against the financial consequences of death.

The basic process can be understood in several steps.

Exact requirements differ by policy. Reading the contract is important because premiums, guarantees, exclusions, cash values, riders, and lapse provisions can vary substantially.

Several roles are involved in a life insurance contract, and they are not always held by the same person.

The death benefit is the amount payable under the policy to eligible beneficiaries after the insured person’s death, subject to the contract.

For example, a person might purchase a policy with a $500,000 death benefit because the family wants financial protection for income replacement, mortgage obligations, and other future expenses.

The death benefit should not automatically be viewed as the amount a household “should” buy. The appropriate amount depends on the financial problem the policy is intended to solve.

Policy loans, withdrawals, certain riders, policy changes, or other contractual provisions can affect the amount ultimately payable under some policies.

Term life insurance provides coverage for a specified period. Depending on the product, coverage might last for a set number of years or until a specified age.

If the insured dies while qualifying term coverage is in force, the beneficiary can file a claim for the applicable death benefit.

If the insured outlives the term, ordinary term insurance generally ends without paying a death benefit unless the policy provides renewal, conversion, or another option.

Why People Choose Term Life

Term life can be useful when the financial need exists primarily for a limited period.

Examples include:

• Replacing income while children are financially dependent.
• Protecting against a mortgage obligation.
• Providing coverage during working years.
• Addressing debts expected to decline over time.
• Providing a larger death benefit within a limited insurance budget.

Term insurance generally has lower premiums in its early years than comparable permanent insurance because it does not normally build cash value and covers a limited period.

Permanent life insurance is designed differently from term coverage. Depending on the contract and whether required premiums or other funding requirements are satisfied, permanent coverage can potentially remain in force throughout the insured person’s lifetime.

Permanent policies commonly include a cash-value component in addition to the death benefit.

Major categories can include:

Permanent policies can be useful in appropriate situations, but they are generally more complex than term insurance. Costs, guarantees, investment risk, surrender charges, and funding assumptions should be reviewed carefully before purchase.

Neither category is automatically better. The right choice depends on how long you need protection, how much death benefit you need, what you can afford, and whether permanent-policy features are important to your financial plan.

Cash value is a feature available in certain permanent life insurance policies. Part of the policy’s financial structure can create value that the owner may be able to access under the contract.

Depending on the policy, the owner may have options such as:

• Taking a policy loan.
• Making certain withdrawals.
• Using available value in other ways permitted by the contract.
• Surrendering the policy for its available cash surrender value.

Accessing cash value is not the same as receiving free money. Loans and withdrawals can reduce the cash value and death benefit, may affect policy performance, and can create tax consequences in some circumstances.

A policy can also lapse if it does not have enough value to support required charges or premiums. Consumers considering cash-value insurance should understand the policy illustration, guarantees, non-guaranteed assumptions, charges, and lapse risks.

A premium is the amount required to maintain the insurance according to the policy’s terms. Insurers determine pricing through underwriting and other actuarial factors.

Factors can include:

Different insurers can evaluate the same applicant differently, so comparing equivalent policies from multiple companies can be useful.

Not every life insurance policy requires a traditional medical examination. Underwriting approaches vary by insurer and product.

An insurer may evaluate information from an application and other permitted underwriting sources. Some applicants may qualify through accelerated or simplified underwriting, while other applications can require medical information or an exam.

Policies advertised as requiring no medical exam can still ask health questions or use other underwriting information. They may also differ in available coverage amounts, pricing, or policy terms.

When comparing policies, look beyond whether an exam is required and compare the actual death benefit, premiums, guarantees, exclusions, and coverage duration.

There is no universal death-benefit amount that every household should buy. The goal is to estimate the financial effect your death could have on the people who depend on you.

The NAIC recommends considering questions such as how much family income you provide, who depends on you financially, and how survivors would handle debts and final expenses.

A practical needs analysis can include:

• Income your family may need to replace.
• Mortgage and other debts.
• Funeral and final expenses.
• Future education costs you want to fund.
• Childcare needs.
• Financial support for a spouse or dependent.
• Existing savings and investments.
• Existing individual or employer life insurance.
• Other financial resources available to survivors.

Subtracting resources already available to your household from the financial obligations you want to cover can provide a more useful starting point than relying only on a simple salary multiple.

Suppose a household estimates that it wants life insurance to address the following hypothetical needs if one income earner dies:

If the household already has $125,000 in financial resources specifically available for these needs, a simplified calculation could look like this:

This example is illustrative rather than a recommendation. Actual needs can change with household income, taxes, investment assumptions, inflation, debts, Social Security survivor benefits, existing insurance, and other financial resources.

A beneficiary is the person or organization designated to receive eligible life insurance proceeds after the insured dies.

You may be able to name:

• A spouse.
• Adult children.
• Other relatives.
• A trust.
• A charitable organization.
• Multiple beneficiaries.

Policies generally allow you to designate primary beneficiaries and may also allow contingent beneficiaries. A contingent beneficiary can receive proceeds if the primary beneficiary cannot.

Review beneficiary designations after major life changes such as marriage, divorce, births, deaths, or changes in estate planning.

Special care may be appropriate when considering a minor child, a person receiving means-tested government benefits, a trust, or an estate as beneficiary because legal and financial consequences can be more complex.

Life insurance is not normally paid automatically the moment the insured dies. A beneficiary or representative generally needs to notify the insurance company and begin the claim process.

A typical process can include:

Claims involving particular circumstances can require additional review. State law and the policy’s contestability, exclusion, and other provisions can affect the process.

For U.S. federal income tax purposes, life insurance proceeds received by a beneficiary because of the insured person’s death are generally not included in gross income.

However, that general rule has exceptions. For example, interest paid on life insurance proceeds can be taxable, and transferred policies or other circumstances can create different tax results.

Cash-value withdrawals, policy loans, surrender of a permanent policy, ownership arrangements, and estate-planning strategies can also have tax consequences that depend on the circumstances.

The existence of a policy does not guarantee that every claim or every expected dollar will be paid regardless of circumstances.

Issues can include:

Review the policy periodically and contact the insurer before making changes that could affect guarantees, coverage duration, or the death benefit.

A rider is an optional policy provision that adds, changes, or expands certain benefits. Riders differ by insurer and can involve additional cost.

Examples offered in the marketplace can include:

• Accelerated death benefit riders.
• Waiver-of-premium provisions.
• Child or family-related riders.
• Additional coverage options.
• Other policy-specific benefits.

A rider should be evaluated based on its actual contract language rather than its name. Eligibility requirements, exclusions, waiting periods, limits, and costs can vary.

Employer-provided group life insurance can be valuable, but it should not automatically be treated as a complete replacement for personally owned coverage.

Review:

• The actual death benefit.
• Whether coverage depends on remaining employed.
• What happens if you change jobs.
• Whether conversion or portability options exist.
• Whether the amount is enough for your household’s needs.
• Whether supplemental coverage is available.

If your household would face a large financial gap after your death, relying only on an employer benefit without reviewing its amount and continuation rules could leave you underinsured.

Life insurance needs change as your finances and family change. Review coverage after major events such as:

If replacing an existing policy, do not cancel the old coverage until the new policy has been issued and you have reviewed it. A new application can involve new underwriting, costs, contestability provisions, and other contractual terms.

Comparing life insurance only by monthly premium can be misleading because policies can provide very different guarantees and features.

Compare:

• Death benefit amount.
• Term length or expected coverage duration.
• Premium structure.
• Whether premiums are guaranteed.
• Renewal provisions.
• Conversion options for term policies.
• Cash-value guarantees and assumptions for permanent policies.
• Policy charges.
• Riders.
• Surrender provisions.
• Company financial strength and complaint information.

For permanent insurance, review both guaranteed and non-guaranteed elements of any illustration. A projection based on assumptions is not the same as a contractual guarantee.