# Life Insurance: What It Is, How It Works, and How to Buy a Policy

> **Definition**
>
> Life insurance is a contract between an insurer and the policy owner that guarantees a sum of money to the policy’s named beneficiaries when the insured dies.

## What Is Life Insurance?

Life insurance acts as a financial safety net for your family. If you die while it’s active, your insurance company pays a sum of money to the people you’ve named in your policy. This money, known as the death benefit, can help your beneficiaries replace your lost income and cover expenses like housing, food, and utility bills. [Life insurance](https://www.investopedia.com/the-best-life-insurance-companies-8763666) can also be used to pay for funeral expenses, cover outstanding debts, or leave a legacy for loved ones or charitable organizations.  

### Key Takeaways

*   Life insurance is a type of contract in which you make regular payments to an insurance company. In return, when you die, the company pays a sum of money to your chosen beneficiaries.
*   Term life insurance offers affordable coverage for a specific period, such as 10 or 20 years.
*   Permanent life insurance provides lifelong protection with a cash value component.
*   Life insurance premiums are determined by factors like the policyholder’s age, health, and lifestyle, with younger and healthier individuals paying lower rates.  
    

![Life Insurance](https://www.investopedia.com/thmb/ESBXVspSfaKzFCC9heVqRGHS5Jg=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Life-Insurance-a8aee8e3024145a8b454ea19df030418.png)

*The most common type of life insurance is term life insurance. — Investopedia / Theresa Chiechi*

## How Life Insurance Works

Life insurance may seem complicated, but understanding how it works, who’s involved, and everyone’s responsibilities can help you make informed decisions about your coverage, whether you’re new to life insurance or looking to switch policies or insurers.

### Policyholder and Beneficiary

The policyholder is the person who owns the life insurance policy and is responsible for paying the premiums. The policy usually insures the policyholder, but you can also purchase and manage a policy on behalf of someone else. For example, a business owner might buy a policy on behalf of a high-performing employee, making the company both policyholder and recipient of the death benefit. Similarly, you can take out a policy for a loved one, such as a spouse, while acting as the designated policy owner.

> **Fast Fact**
>
> You can’t buy life insurance for whoever you want. Insurance companies require you to have an insurable interest, meaning you’d face financial hardship if that person died.

The [beneficiary](https://www.investopedia.com/terms/b/beneficiary.asp) is the designated person or entity that will receive the death benefit. A life insurance policy can have multiple beneficiaries, including family members, friends, or even organizations like charities.

### Premiums

Premiums are the [regular payments](https://www.investopedia.com/articles/personal-finance/022316/understanding-life-insurance-premiums.asp) you make to your insurance company to keep the policy active. They're based on factors like age, health, lifestyle, and the amount of coverage you need. For example, a 30-year-old in good health should have significantly lower premiums than a 50-year-old smoker with a history of health issues. The type of policy also matters: Temporary term insurance costs much less than permanent insurance.

### Death Benefit

The [death benefit](https://www.investopedia.com/terms/d/deathbenefit.asp) is the money the beneficiary receives when you die. When submitting a life insurance claim, they can usually choose how they want to receive the money:

*   **Lump sum**: They get the entire amount in a single payment.
*   **Specific income provision**: They can receive the money over time according to a predetermined schedule.
*   **Lifetime income**: Beneficiaries receive guaranteed monthly payments for the rest of their lives. The amount of each payment depends on the total benefit amount as well as the gender and age of the beneficiary at the time of your death.
*   **Interest income option**: The insurance company holds onto the money and only pays the interest earned on it to the beneficiary. When the first beneficiary dies, the original death benefit goes to a secondary beneficiary.

The death benefit can be used for any purpose, such as paying off a mortgage, covering funeral expenses, or funding a child’s education. It’s also generally [tax-free](https://www.investopedia.com/ask/answers/102015/do-beneficiaries-pay-taxes-life-insurance.asp), making it a highly valuable and hassle-free financial resource for beneficiaries.

### Claims Process

To receive the death benefit, your beneficiaries need to file a claim with the insurance company. To initiate the process, they’ll need copies of the death certificate (including a certified copy from the funeral director), the insurance policy, and any other required forms. The insurer will then review the claim. If everything checks out, the company will pay the death benefit to your beneficiaries, usually [within 30 days](https://www.investopedia.com/how-long-does-a-beneficiary-have-to-claim-a-life-insurance-policy-5075605) of when the claim was first submitted.

## Types of Life Insurance

There are two main types of life insurance: term life insurance, which provides coverage for a specific period, and permanent life insurance, which covers you for your entire life and often comes with a savings or investment component.

### Term Life Insurance

[Term life insurance](https://www.investopedia.com/terms/t/termlife.asp) covers you for a specific period, such as 10, 20, or 30 years. Once the period is over, you stop paying premiums and your policy expires. Because of this time limit, term life insurance is generally [the most affordable option](https://www.investopedia.com/most-affordable-life-insurance-5092439), making it ideal for anyone looking for low-cost coverage for a specific timeframe. 

For example, if you’re planning a family, you might consider a 20- or 30-year term policy to ensure your children are supported financially, at least through college graduation. Your premiums stay the same during the entire term. However, the longer the term you pick, the more expensive the initial premiums because you lock in the cost for more time.

### Permanent Life Insurance

With [permanent life insurance](https://www.investopedia.com/terms/p/permanentlife.asp), such as whole life or universal life, you'll pay policy premiums for your entire life rather than a set number of years, providing you and your family with lifelong financial protection (or for as long as you pay premiums). Similar to term life, permanent life policies also pay out a death benefit to your beneficiaries. Permanent life insurance also usually comes with a [cash value](https://www.investopedia.com/terms/c/cash-value-life-insurance.asp) component that can earn interest and grow over time as you continue paying premiums.

A policy’s cash value component can increase your loved one’s benefit amount and, in some cases, can pay you a dividend—financial compensation based on the insurance company’s financial performance. You can also withdraw money from the cash value or take out a loan using it as collateral.

> **Warning**
>
> Any money you withdraw or borrow from your cash value reduces the amount your beneficiaries receive when you die. If you withdraw too much or fail to repay a loan, your policy could lapse, which would end your coverage.

Here are some common types of permanent life insurance:

*   **Whole life insurance**: The most popular type of permanent life insurance offered by insurance companies, [whole life policies](https://www.investopedia.com/terms/w/wholelife.asp) feature a cash value component that grows at a fixed interest rate set by the insurer.
*   **Universal life (UL) insurance**: This is a type of permanent life insurance includes an interest-earning cash value. Unlike term and regular whole life policies, you may be able to adjust your [UL policy](https://www.investopedia.com/terms/u/universallife.asp) premiums over time, potentially accepting less coverage in exchange for lower payments, making it appealing if you want coverage flexibility.
*   **Variable life insurance**: A permanent policy that lets you invest your cash value, usually in mutual funds.
*   **Variable universal life (VUL) insurance**: A [VUL policy](https://www.investopedia.com/terms/v/variableuniversallife.asp) combines the flexible premiums of universal life insurance with the investment options of [variable life insurance](https://www.investopedia.com/ask/answers/08/variable-life-insurance.asp). You can invest your cash value in stocks, bonds, mutual funds, and other market-based assets. These investments can potentially earn immense returns. But market downturns can decrease the cash value and potentially the death benefit. Your premiums can increase or decrease depending on how the investments fare.
*   **Indexed universal life (IUL) insurance**: This type of permanent life insurance ties its cash value growth to a stock market index, such as the S&P 500. However, there’s a cap on the maximum possible return in good years and a limit on potential losses in bad years. Often, there’s a minimum interest rate even when the index loses money. [IUL policies](https://www.investopedia.com/articles/insurance/09/indexed-universal-life-insurance.asp) give you some market exposure but more safety than a VUL. Like its UL counterpart, IUL policies also have adjustable premiums.
*   **Final expense insurance**: This is a type of whole life insurance designed specifically to cover funeral and burial costs. [Final expense insurance](https://www.investopedia.com/final-expense-insurance-4801018) typically offers smaller death benefits, making it more affordable for seniors or those with limited financial resources.
*   **Simplified issue life insurance**: Under simplified issue life insurance, insurers don’t require a medical exam, but premiums are generally higher due to the increased risk to the insurance company. Simplified issue is available for most policy types, including term life, whole life, and universal life insurance in certain cases.
*   **Guaranteed issue life insurance**: Under [guaranteed issue policies](https://www.investopedia.com/terms/g/guaranteed-issue-life-insurance.asp), the insurer doesn’t ask you any health questions, making it an accessible life insurance option for those with health issues. However, these policies come with lower death benefits and higher premiums.

## Common Life Insurance Riders

Riders are extra features you can add to your life insurance policy to better suit your needs. Here are some of the most common types of life insurance riders:

*   **Accidental death benefit (ADB) rider**: An [ADB rider](https://www.investopedia.com/terms/a/accidental-death-benefit.asp) provides beneficiaries with an additional payout if you die due to an accident.
*   **Waiver of premium rider**: [Waives premium payments](https://www.investopedia.com/terms/w/waiver_of_premium.asp) if you become disabled and are subsequently unable to work.
*   **Long-term care rider**: Allows you to use the death benefit to cover [long-term care expenses](https://www.investopedia.com/long-term-care-rider-4802409).
*   **Guaranteed insurability rider**: Lets you purchase additional coverage in the future [without needing a medical exam](https://www.investopedia.com/guaranteed-insurability-rider-5095038).
*   **Child term rider**: Provides coverage for your children—usually until they reach a certain age. This can be a cost-effective way to provide a financial safety net in case your child dies.
*   **Return of premium rider**: If you outlive your term policy, this rider [refunds all or a portion of the premiums](https://www.investopedia.com/articles/pf/08/return-of-premium.asp) you paid. While this can be appealing, it often comes with significantly higher premiums.
*   **Chronic illness rider**: Allows you to access a portion of the death benefit if you’re diagnosed with a [chronic illness](https://www.investopedia.com/terms/c/catastrophic-illness-insurance.asp) that requires long-term care. This can help cover medical expenses without depleting your savings.

While the above riders can enhance your policy’s flexibility, they usually come at an additional cost. Be sure to weigh the benefits against the added expense.

## How to Buy Life Insurance

When you [buy life insurance](https://www.investopedia.com/how-to-buy-term-life-insurance-7151709), you’re making a major financial decision that impacts the people you love. It’s critical to choose a policy that meets both their current and future needs, in addition to one that gives you the peace of mind that they’ll be taken care of after you die.

By following the steps below, you’ll be better positioned to navigate the process quickly and confidently.

### Step 1: Assess Your Financial Needs

Before diving into policy options, evaluate your financial situation and [determine how much coverage you need](https://www.investopedia.com/do-i-need-life-insurance-how-to-decide-11729298). Consider the following factors:

*   **Income replacement**: Calculate how much money your family would need to maintain their standard of living if you were no longer there to provide for them. A common rule of thumb is to aim for 60% to 80% of your individual post-tax income, but this can vary based on your specific circumstances.
*   **Debts and liabilities**: Include outstanding debts like mortgages, car loans, student loans, or credit card balances your family would need to pay off.
*   **Future expenses**: Factor in long-term costs like [college tuition](https://www.investopedia.com/articles/pf/08/affordable-college-education.asp) for your children, wedding expenses, or retirement savings for your spouse.
*   **Final expenses**: Account for funeral and burial costs, which can range from $7,000 to $12,000 on average.

Using an online life insurance calculator or speaking with a licensed financial advisor could prove valuable in helping you estimate the right amount of coverage or a more tailored assessment of your needs.

### Step 2: Compare Policies and Insurers

Once you know how much coverage you need, it’s time to shop around. Comparing policies from multiple insurers is crucial to finding the best coverage for your budget and goals. Here’s how to properly compare life insurance policies:

*   **Get multiple quotes**: Request quotes from at least three to five [top life insurance companies](https://www.investopedia.com/the-best-life-insurance-companies-8763666) to compare premiums, coverage options, and policy features. Many insurers offer self-service online quote tools to help you quickly compare and choose a policy yourself, especially for simpler term life insurance policies. But if you have more complex life or financial planning needs, an experienced independent agent or fee-based financial advisor could help you narrow down what policy types or coverages work best for your situation.
*   **Check insurer ratings**: Look for companies with strong financial stability, as rated by agencies like [AM Best](https://www.investopedia.com/terms/a/a-m-best.asp), Moody’s, or Standard & Poor’s. A financially stable insurer is more likely to honor claims and remain solvent over the long haul.
*   **Read customer reviews**: Research customer satisfaction ratings and reviews from third-party companies to gauge the insurer’s reputation for customer service and claims handling. Organizations like the Better Business Bureau (BBB) and J.D. Power can be helpful resources.
*   **Consider policy features**: Beyond the death benefit, look for the availability of additional features like riders (e.g., accelerated death benefits, waiver of premium, etc.), flexibility in premium payments, or other policy perks.

### Step 3: Complete the Application Process

Once you’ve identified a policy that meets your needs, the next step is to apply. The [life insurance application](https://www.investopedia.com/articles/pf/08/what-to-expect-insurance-application.asp) process typically involves the following:

*   **Medical exam**: Most traditional life insurance policies require a medical exam to assess your health as part of the [underwriting process](https://www.investopedia.com/terms/u/underwriting.asp). This may include blood tests, urine samples, and a review of your medical history. The results of these tests could influence how much you pay for life insurance, so it’s best to be in good health or take steps to improve your health before applying. Many insurance companies offer healthy applicants accelerated underwriting, which uses data to assess health risks without a medical exam.
*   **Health and lifestyle questions**: Be prepared to answer detailed questions about your health, lifestyle, and family medical history. Honesty is critical—misrepresenting your health could lead the insurance company to deny your beneficiary’s claim in the future.
*   **No-exam policies**: If you prefer to avoid a medical exam, consider simplified issue or guaranteed issue policies. Keep in mind that while these options are more accessible and convenient compared to traditional options, they often come with higher premiums and lower death benefits.

### Step 4: Review and Finalize Your Policy

After the insurance company approves your application, carefully review the policy before finalizing it. Here’s what to look for:

*   **Policy details**: Ensure the death benefit, premiums, and term length (if applicable) match what you discussed with your agent.
*   **Riders and add-ons**: If you’ve opted for riders like an accidental death benefit or long-term care rider, confirm that they’re included and you understand how they work.
*   **Fine print**: Pay attention to exclusions (things the company says they won’t cover), such as clauses for certain medical conditions or restrictions on high-risk activities like skydiving. If anything is unclear, ask your insurance agent or advisor for clarification.
*   **Beneficiary designation**: Double-check that your beneficiaries are correctly listed and that you’ve provided their full legal names and contact information.

### Step 5: Regularly Review and Update Your Policy

As your life circumstances change—such as getting married, having children, buying a home, or retiring—so too may your life insurance needs. Here’s how to stay on top of your coverage and whatever else life throws your way:

*   **Annual reviews**: Reassess your policy annually to ensure it still aligns with your financial goals. For example, you may need less coverage if you’ve paid off your mortgage or your children have become financially independent.
*   **Life events**: Major life events like marriage, divorce, or the birth of a child should prompt you to review your policy. You may need to update your beneficiaries or adjust your coverage amount. Life insurance beneficiary designations apply even if you name someone different in your [will](https://www.investopedia.com/terms/w/will.asp) to inherit the money.
*   **Health improvements**: If you’ve made significant improvements to your health, such as quitting smoking or losing weight, you may qualify for lower premiums. Consider reapplying for a new policy to take advantage of these savings.

### Additional Tips for Buying Life Insurance

*   **Work with a financial advisor**: A [financial advisor](https://www.investopedia.com/articles/fa-profession/092316/why-financial-advisors-sell-life-insurance.asp) can help you [navigate the complexities of life insurance](https://www.investopedia.com/fa-one-thing-life-insurance-8706370) and ensure your policy aligns with your broader financial goals.
*   **Understand the tax implications**: While death benefits are generally tax-free, there may be tax implications for cash value withdrawals or loans. Consult an accountant or tax professional to understand how your policy fits into your overall tax strategy.
*   **Don’t delay**: The [younger and healthier](https://www.investopedia.com/articles/investing/072816/what-best-age-get-life-insurance.asp) you are, the lower your premiums will be. Waiting too long to purchase a policy could result in higher costs or even denial of coverage down the road.

## Benefits of Life Insurance

Life insurance provides you and your loved ones [several invaluable benefits](https://www.investopedia.com/5-top-benefits-of-life-insurance-5105062), including:

*   **Financial security**: Life insurance provides peace of mind that your loved ones will be taken care of, even in your absence.
*   **Tax advantages**: Death benefits are often tax-free, while cash value growth is tax-deferred, making it a potentially valuable estate planning tool.
*   **Coverage flexibility**: Policies can be customized with riders like accelerated death benefits, which allow you to access a portion of the death benefit if you’re diagnosed with a terminal illness.
*   **Creditor protection**: In many states, life insurance policies are protected from creditors, meaning the death benefit cannot be seized to pay off debts. This can provide an added layer of security for your beneficiaries.
*   **Charitable giving**: Life insurance can be used to make a [charitable contribution](https://www.investopedia.com/terms/c/charitabledonation.asp) to an organization of your choosing. By naming a charity as one of your beneficiaries, you can leave a legacy in support of a cause you care deeply about.
*   **Supplemental income**: If you’re retired, the cash value component of a permanent life insurance policy can be a valuable source of supplemental income. It can be particularly useful for covering unexpected expenses or funding travel and leisure activities in retirement.

## Who Needs Life Insurance?

Life insurance is for more than just breadwinners. People of all income levels and portfolio sizes often [need life insurance](https://www.investopedia.com/who-needs-life-insurance-the-most-5075437) for many of the same reasons.

*   [**Parents or guardians**](https://www.investopedia.com/the-best-life-insurance-for-parents-11713483): To ensure your children are financially supported until they can support themselves.
*   **Homeowners or renters**: To help cover your mortgage or rent payments and avoid a potential [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp) or [eviction](https://www.investopedia.com/terms/e/eviction.asp) if the primary source of bills and mortgage payments dies unexpectedly.
*   **Business owners**: To protect against the loss of one of your key employees.
*   **Seniors**: To leave a legacy, cover final expenses, or provide for your surviving spouse.
*   **Stay-at-home parents**: Even if you don’t earn an income as a stay-at-home parent, you may still provide valuable services to your family, such as child care and household maintenance. Life insurance can help cover the cost of replacing these services if the stay-at-home parent dies.
*   **Single individuals**: While you might not have dependents as a single individual, you may still have financial obligations like student loans or co-signed debts. Life insurance can ensure these debts are paid off, preventing a burden on your surviving family members.
*   **High-net-worth individuals**: For those with significant assets, life insurance can be a tool for estate planning, ensure a tax-free wealth transfer.

## What Happens if a Person Dies Without Life Insurance?

Should you pass away without a life insurance policy in place, then the responsibility of paying your funeral costs and outstanding debts will likely fall on your loved ones. Additionally, anyone who depends on your income will have to figure out how to cover their living expenses without your financial support.

Fortunately, your assets will still be passed on to your next of kin, so they may not have to rely entirely on your death benefit. However, depending on the complexity of your estate, whether or not you have a will, and your outstanding debts, it can be months before your loved ones get their inheritance, or they may receive less than they need to survive. A life insurance policy, meanwhile, is typically paid out within 30 days of a claim being submitted, and you can ensure your policy's payout will be sufficient to replace your income.

## What Is the Best Age to Get Life Insurance?

The best age to get a life insurance policy can depend on multiple factors, so there's no right answer for everyone. For example, a younger person will most likely pay lower premiums; as such, getting coverage early in life may be wise. However, if you have no beneficiaries who could receive your death benefit, then you may not need life insurance until you're older and have someone in your life who relies on your income.

## How Long After a Person Dies Do You Have to Collect the Life Insurance?

Most life insurance companies don't have a deadline for when a policy has to be collected. However, it typically takes 30 days after submitting a claim for a death benefit to be paid out, so waiting to file may mean you won't receive the funds by the time you need them.

Additionally, states have laws in place that require uncollected policies be sent to their respective unclaimed property offices after a certain number of years. You can still claim the death benefit if this happens, but it will likely complicate the process (and, therefore, further delay the payout).

## The Bottom Line

Life insurance is a crucial tool for protecting your loved ones and securing their financial future. It can help protect your family, assist with estate planning, or ensure your business can continue operating if you die. By understanding the different types of policies, comparing quotes, and working with a trusted advisor, you can make an informed decision that aligns with your financial goals and provides lasting protection for those you care about

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>     
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> 12.  Experian. "[What Happens if You Die Without Life Insurance?](https://www.experian.com/blogs/ask-experian/what-happens-if-you-die-without-life-insurance/)"
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