What Is Life Insurance?

Life insurance is an affordable way for people to financially support their loved ones after they’ve passed away. It’s a contract between you and an insurance company where, in exchange for a monthly payment, the insurance company agrees to pay a financial benefit to your loved ones in the event of your death.

How Does Life Insurance Work?

In a traditional life insurance contract, a life insurance company agrees to provide a lump sum payout to your loved ones in the event of your death during a set period of time. In exchange for this payout, you agree to pay monthly installments to the insurance company for the life of the coverage contract.

Life insurance coverage is usually restricted to specific lengths of time, known as terms. For example, you might agree to sign a life insurance policy for a term of 10 years. Your coverage and premium payments would only last for these 10 years, when you would need to decide whether to purchase another life insurance policy.

Here are some common definitions you’ll want to understand while browsing life insurance companies:

• Premium - The amount that you agree to pay to the life insurance provider for coverage, typically on a per-month basis.
• Benefit/Death Benefit/Payout - The coverage amount paid out to your loved ones in the event of your death. Payouts are typically tax-free.
• Beneficiary - The people or entities you name to receive a portion of your policy’s benefit payout. It’s up to you to decide how many people and who exactly will receive the benefit.
• Term - The length of coverage agreed upon by the life insurance company and yourself. Term lengths average anywhere from 10 to 30 years.

What is the Difference Between Term and Whole Life Insurance?

Life insurance providers commonly offer two types of life insurance products.

Term

This is the more popular of the two life insurance products. Term life insurance is a plan that only exists for a set (and predetermined) period of time. While a term is active, you’ll pay monthly premiums in exchange for financial protection in the event of your death. Once the set term has ended, both coverage and premium charges also end.

Term life insurance policies are typically less expensive than whole life insurance policies. That’s because, unlike term, whole life insurance lasts for your entire life. This means that as long as you keep up with the premiums and any other conditions of your policy, the life insurance company is guaranteed to pay out a benefit with a whole life insurance plan. With term life insurance, you’re only buying financial coverage for the period of the term, and at the end of the term, the premiums stay with the insurance company.

On the other hand, term life insurance plans offer a lot more flexibility than whole life insurance; you can choose how long you want coverage for, and they’re pretty straightforward. They’re especially useful for young families, who may be looking for temporary coverage until their children become self-sufficient.

Term plans have no cash value. The premiums paid into a term plan do not accrue in the market, they go straight to the insurance provider. A term plan can usually be canceled, but the premium charges can not be recollected by a customer.

Whole Life

Whole life insurance provides a similar financial protection to term life insurance, but critically, it does not carry a term limit, meaning coverage extends until death (as long as you stay current with premiums).

In addition to the death benefit payout, whole life insurance products carry a cash value accumulation. As customers pay monthly premiums, some of this money is invested into the market, gaining value over time.

Note that under most whole life insurance contracts, the customer’s beneficiaries cannot receive both the death benefit and the cash value accumulation.

Term vs Whole: Which is Better?

It depends! Both term and whole life insurance plans offer a safety net for you to financially support your dependents. To help you decide which type makes the most sense for your financial goals, let’s review the pros and cons of each type:

Term Life Insurance - Pros

• Premium prices are usually much lower than for whole life insurance.
• If timed correctly, the contract term typically ends when a policyholder’s dependents become financially independent, making coverage unnecessary.
• Term life insurance policies can often be transferred into a permanent life insurance policy, if desired.

Term Life Insurance - Cons:

• Coverage may end before the death of the policyholder, leaving beneficiaries with no death benefit.
• Term life insurance does not have or accumulate cash or investment value.

Permanent life Insurance - Pros:

• Coverage lasts for a policyholder’s entire life, meaning a death benefit payout is practically guaranteed.
• Coverage supports a cash-value component that can be used for investments, savings, or borrowing.
• The death benefit is typically tax-free, making permanent life insurance ideal for passing on an inheritance or supporting a trust fund.

Permanent life Insurance - Cons:

• Premiums are expensive, often 12x more expensive per month than term life insurance.
• Policyholders without life-long dependents or heirs may not require coverage in late adulthood.

How to Buy Life Insurance

In order to be considered for life insurance coverage, customers must apply. During the application process, a life insurance company may ask you for personal information, medical records, and other identifying information.

You may also be asked to take a health exam, as traditionally, life insurance companies would require one before offering coverage. Nowadays, life insurance providers have mostly done away with the medical exam requirement—just like many of the companies listed in our chart above.

Do I Need Life Insurance?

The primary goal of life insurance is to provide financial support to the people you cherish most in your life. Most people purchase life insurance as a safety net–in case the unthinkable happens, they want to make sure that their loved ones are protected from debts and able to pursue their goals and dreams.

As beneficiaries can include spouses, children, parents, grandparents, or anyone you choose, the payout from a life insurance policy can support them during their grief to get them back on their feet.

When deciding whether or not to purchase life insurance, here are a few questions to consider:

1. Are you the primary breadwinner for your family?
2. Do you have family members who rely on you for financial support (like paying for assisted living for elderly relatives or helping with college tuition)?
3. Do you have unpaid student loans that are co-signed by a parent or loved one?
4. Are there any debts that could be paid off (like a mortgage or lease, medical debts, or even the future cost of your funeral)?
5. Do you want to supplement your future estate with a tax-free payout?

If the answer is “yes” to any of the above questions, a life insurance policy can help you provide your loved ones with future financial stability.