What is life insurance?
Life insurance is an agreement that says that in exchange for money from you while you’re alive, the life insurance company will pay out a sum of money to the people you choose when you die.
Those people, called your beneficiaries, can then use that money to cover funeral expenses, mortgage payments, credit card debt, or anything else they need.
Simplifying life insurance
At its core, a life insurance policy is a product. You buy it just like any other product, but the money you pay toward it is called a premium. While you can pay a bunch of money upfront to buy life insurance (that’s called single-premium life insurance), most people make a small monthly payment toward the cost of their policy.
When you buy life insurance, you get to choose a few things:
The size of the death benefit, or sum of money, you leave behind (although insurance companies will cap it to ensure it aligns with your income level, meaning this isn’t a way to get your family rich overnight)
The beneficiaries you want to receive your death benefit, like your partner or your business partner
The type of life insurance you want (more on that next)
As long as you keep paying your premiums, your policy stays active. And if you die while your policy is active, your life insurance company has to hold up their end of the contract. That means that they distribute a sum of money in the amount of your death benefit to your beneficiaries.
Types of life insurance
Permanent life insurance
As the name suggests, this is life insurance that lasts permanently for you. That means that as long as you keep paying your premiums, your beneficiaries will get the death benefit, no matter when you die.
Most types of permanent life insurance, including whole life insurance, come with a cash value component. This is sort of like a savings account for you within the policy. A portion of your premiums go into that account and grow over time. The way they grow depends on the type of permanent life insurance you chose.
Permanent life insurance can give you a lot of peace of mind because it lasts your lifetime, essentially guaranteeing that your loved ones will get your death benefit. But it costs a significant amount more than the other type of life insurance, term life insurance.
Term life insurance
The much more affordable type of life insurance, term insurance lays out a specific term during which the policy will stay active. You can buy insurance for a 20-year term or a 30-year one, for example.
If you outlive the term, the policy expires. You can let it expire, meaning you’ll get nothing in return for the premiums you’ve paid during your term. But in many cases, you’ll have the option to convert a term policy into a permanent one.
Buying life insurance
Most life insurance companies require a medical exam before they’ll issue you a policy. This is their way of minimizing risk. If you die just a few years into paying your premiums, they have to pay out your death benefit with very little to show for it.
To avoid that scenario, life insurance medical exams check for the main markers of longevity. They’ll look at things like your blood pressure levels and family health history. They’ll also test you for drugs and nicotine in your system.
Once they have an idea of how healthy you are, your life insurance company sets your premiums. Generally, healthier, younger people pay less. Older folks, those with health conditions, and smokers get charged more.
In some cases, your medical exam could result in the life insurance company denying you coverage altogether. If that happens to you, don’t panic. You can explore no-medical-exam and guaranteed-issue life insurance. It will be a little bit more expensive, but it should give you a route to get the policy you need.
Life insurance cost
Two key things affect the cost of your life insurance policy: how healthy you are and the policy type you choose. If you’re healthier and younger, you’ll pay less. And if you choose a term policy, you’ll pay less.
If you have a diagnosed health condition that could shorten your lifespan or you want permanent life insurance, be prepared to pay more for your policy.
Say a healthy 40-year-old male wants a $500,000 term life policy. We found that the average man that age will pay about $40 per month for coverage. Because women live longer, they tend to pay less. The average healthy 40-year-old woman will pay $32 for a $500,000 policy, for example.
To reiterate, your overall health matters. We found that a 40-year-old male smoker will pay $137 for the same policy, while a 40-year-old female smoker will pay $107.
If you want a policy that won’t expire, the cost increases by a fair margin. Going back to our review of policy averages, we found that the average 40-year-old nonsmoker pays nearly $200 per month for a permanent life insurance policy.
Who needs life insurance?
People choose to buy life insurance because they want to set people in their lives up for financial success after they’re gone. You may decide you need life insurance if your family relies on your income or if you have shared debts like a mortgage. Business partners may also choose life insurance to protect their company and help their partners maintain operations should they die unexpectedly.
Because it’s so much cheaper, many people choose term life insurance to safeguard the people they care about for a certain season of life. If you just got a 30-year mortgage with your partner, for example, a 30-year term policy can ensure they’re not left with payments they can’t afford if you pass away prematurely.
Permanent life insurance, on the other hand, can be a key piece of estate planning. If you know you want to leave certain people or entities (like a charity) a lump sum of money, a permanent life insurance policy can ensure that part of your legacy.