Life Insurance 101

Jeff Root Jeff Root Posted in Life Insurance 101
Last updated on May 16, 2019

Would your death cause someone you love a lot of financial stress? If so, you probably need life insurance.

But how much coverage should you buy? What kind of policy do you need? How much will you pay in premiums for your coverage?

Let’s explore the basics of life insurance, from start to finish, so you’ll know how to answer these questions and so you’ll know how to find the best coverage for your life.

What Is Life Insurance and What Does It Do?

couple signing up for a life insurance policyAt its simplest, life insurance has one job: to pay your family a sum of money if you died with the coverage in force.

If you had $1 million in life insurance coverage, for example, your partner or your children — or someone else you’d designated as your beneficiary — could file a claim with your insurance company and receive the $1 million payout, tax free.

No amount of money can replace your life. Your family would still mourn your loss and have to recover from the shock of losing you. But the life insurance payout could make the process of rebuilding a new life easier for your family.

This life insurance payout, which insurers call a “death benefit,” could allow your loved ones to:

  • Pay off your bills: Your family could use the money to pay off the mortgage and other debts you left behind.
  • Replace your income: Without your regular paycheck, your family could use the life insurance money to make ends meet while they recover.
  • Continue saving: Your family could continue saving for your kids’ college or for other important goals without having to spend existing savings on day-to-day expenses.
  • Leave a legacy: If your family already has a stable financial life, your death benefit could fund a scholarship or a foundation.
  • Pay final expenses: Even a smaller amount of life insurance coverage could pay your final expenses such as burial or funeral costs which average about $10,000.

A typical life insurance policy comes with no strings attached. Your beneficiary, whom you’d name when you bought the policy, would get to decide how and when to use the money.

You make all this happen in advance when you buy a life insurance policy and keep the premiums up to date.

How much you pay in premiums will depend a lot on the factors we’re about to discuss.

Do You Really Need Life Insurance?

Obviously, this depends on many factors, such as your personal life, but there are steps you can take to make an informed decision.

In short, if you have a family, you’ll want to buy a life insurance policy.

Should you pass on, the death benefit can be used for everything from final expenses to paying off a mortgage (and much more).

However, even if you don’t have a family, life insurance may still be a good idea.

For instance, you may want a policy to help with final expenses, as you don’t want your extended family to get stuck in a bad spot.

Now, you can buy life insurance on someone else, but remember, there are rules to do it properly (and legally).

Also, some people purchase a policy as a means of leaving something to their favorite charity or organization.

Only you know if you truly need life insurance, but most people find that it’s better to have it than to take a pass.

How Life Insurance Type Affects Cost

At this point, the life insurance discussion always gets a little more convoluted. Life insurance comes in many different flavors and with a lot of different conditions. How much you’ll pay for your coverage depends partly on the type of life insurance policy you buy.

Ultimately, you can categorize policies in one of two ways:

  • Term life: Temporary coverage usually lasting between 10 and 30 years.
  • Whole life: Permanent coverage that can last the rest of your life.

Let’s take a closer look at each type:

Term Life Insurance

Term life policies usually offer more coverage for less money, especially for people who are young and healthy.

Why is term life so much more affordable? For one thing, term coverage expires. The word “term” refers to the length of time the insurance will stay in force before it expires.

Though you can find exceptions, most insurers offer terms of 10, 15, 20, and 30 years. When your term runs out, you will need to renew the coverage at a higher price, convert the coverage to a whole life policy, or let the policy expire.

Many people no longer need as much coverage by the end of their terms. An expiring term policy offers an opportunity to reassess your life insurance needs. Often, shoppers opt for a smaller policy the second time around.

Others with expiring term policies discover they no longer need any life insurance coverage because they’ve saved enough money or they rely on investments for income instead of wages.

Until you reach that point in life, term life coverage provides an affordable solution.

Whole Life Insurance

Whole life insurance is designed to cover you for the rest of your life. Since it can last potentially decades longer than a term policy, you should expect to pay higher premiums for whole life coverage.

And, along with the face value of your life insurance benefit, a whole life policy also includes an additional cash value that grows over time like money in the bank.

Later in life you can use this additional cash value to borrow against or to cash out. Or, with some whole policies, you can invest the cash:

  • Indexed Universal: Indexed Universal life policies connect your additional cash value to a stock index like the S&P 500. Typically, an insurance company will limit your potential gains which also insulates you from losses.
  • Variable Universal: This more hands-on approach allows you to invest your policy’s cash value in more specific securities. You can earn more but also lose more.

These kinds of whole life policies appeal to shoppers because the growing cash value can interact with the death benefit. In fact, some people use the cash value to pay the premiums, reducing out-of-pocket costs later in life.

You may want input from your financial planner before buying these more complex types of life insurance.

How Other Policy Choices Affect Your Cost

After you’ve decided whether to get a term policy that will eventually expire or a whole life policy which can cover you for life, you’ll still have several more decisions to make before buying coverage.

These decisions will also impact your premiums:

  • How Much Coverage: Getting more coverage requires higher premiums.
  • Term Length: With a term policy, longer terms cost more than shorter terms.
  • Whether to Add Extras: Extra features, known as riders, make your coverage more flexible, but they also add money to your premiums.

Let’s look a little closer at these decisions:

Coverage Amount

Among the factors you can control, the size of your policy can have the biggest impact on your premiums. When you’re shopping for insurance on a budget, you may want to choose a smaller coverage amount.

But don’t go too small. You should have enough coverage to help your family survive without your income for seven to 10 years. If you earn $100,000 a year, you’ll want up to $1 million in coverage to replace your income.

Depending on your debts and assets, you may opt for even more coverage. For example, you should consider:

  • Special Plans: If you plan to send your children to a private college, you may want to add an extra $100,000 to $200,000 to your coverage.
  • Extra Debt: If you just bought a vacation home or have recently acquired a second mortgage, consider these large debts as you design your life insurance coverage.
  • A New Reality: If your spouse works but would need extended time off to grieve and build a new life, consider his or her lost wages in your coverage amount.

Your life insurance coverage should match the specifics of your life. Don’t overdo it, though. Paying for more coverage than you need means you’re also overpaying on your premiums. Try to find a coverage amount to fit your family’s exact needs.

Term Length

This just-right advice also applies to your term length when you’re buying a term life policy. You shouldn’t pay more money for a 30-year term, for example, unless you expect to keep the coverage 30 years.

You can save a lot of money buying a 20-year term if you need only 20 years of coverage.

How can you know? You can’t know for sure, but you can make a good guess by imagining your life at the end of your term. If your kids will be grown and financially independent and the house will be paid off in 20 years, a 20-year term policy should be enough.

If you’re interested in a whole life policy, you won’t have to worry about term lengths.

Adding Riders

Insurers use the word “rider” to describe extra features you can add to your coverage. Riders can let you:

  • Keep your coverage without paying for it if you become disabled and can’t work.
  • Receive back all your paid premiums if your term policy expires before you need the coverage.
  • Allow you to claim part of the death benefit while you’re still alive if you’re diagnosed with certain serious illnesses.
  • Pay out double if you’re killed in an accident.
  • Guarantee you’ll be able to renew the policy after the term expires regardless of your medical condition.

You can find dozens of more riders to customize your coverage. Each time you add a rider, you’re adding to your monthly premium bill.

So it’s usually best to avoid the temptation to add a lot of riders.

How Your Life Itself Affects Insurance Costs

When you’ve applied for life insurance coverage, your insurance company will want to know a lot about you. What underwriters find out will help determine whether you get coverage and how much you’ll pay in premiums.

Underwriters will consider:

  • Your Age
  • Your Health
  • Tobacco Status
  • Your Work / Hobbies
  • Your Family Health
  • Your Credit Score
  • Your Driving Record

Let’s take a look at these issues:

Age and Health

Insurance rates tend to be lower for people who are younger and healthier. While you can’t control your age, you can control when you apply for coverage. Getting coverage this year can lock in a lower rate based on your current age. The lower rates will remain in place throughout the life of your policy.

About your health: Traditional life insurance requires you to take a medical exam. You’ll give a blood sample, get a blood pressure reading, and have your weight, and height checked. If you’re in excellent health, expect a lower insurance premium.

If you’re overweight or have high blood pressure or high cholesterol, for example, you’ll likely face higher, but still affordable, premiums. If you have a serious illness, you may not qualify for traditional coverage or you may not be able to afford the premiums if you do qualify.

You may want to look into no-exam coverage which we’ll get into below. Or, you can also benefit from the expertise of an independent life insurance agent specializing in high risk coverage.

Tobacco Status

Smokers pay more for life insurance. Sometimes they pay 5 to 10 times more. If you smoke or use another tobacco product, consider quitting before shopping for insurance.

Different companies have different requirements for how long you’ll need to be tobacco free before qualifying for non-tobacco rates.

Work and Hobbies

By now you’ve probably noticed a trend: people with higher risk factors pay more for life insurance. People who are older, who smoke, or who have health issues present a higher risk to the insurance company’s bottom line. In response, the company requires higher premiums.

The same goes for people who work dangerous jobs or take more risks in their personal lives. Roofers, loggers, commercial anglers — these are some of the most dangerous jobs according to the Bureau of Labor Statistics.

As for hobbies, skydivers, scuba divers, rock climbers, and extreme sport athletes can expect to pay more for life insurance, especially compared to cello players, painters, and gamers.

Family Health History

Expect your insurance company to ask about your extended family’s health history. If you’re genetically predisposed to developing a serious illness, your insurance company could respond by raising your rate.

Credit and Driving History

More and more insurers rely on electronic records to paint a picture of your tolerance for taking risks. Your credit score, for example, can tell insurers about your tendency to take financial risks. Research shows a correlation between financial and lifestyle risks.

Your driving record works the same way. If you’ve had a couple moving violations in the past three years, your insurance company may want to charge higher premiums for your life insurance coverage. By their thinking, someone who drives recklessly will more likely take other risks in life.

No Exam Coverage: A More Expensive Alternative

All this scrutiny worries a lot of life insurance shoppers, especially shoppers who value their privacy and don’t want strangers poking around in their health and financial data.

In these cases, no exam life insurance sounds like a reasonable alternative because underwriters have more relaxed guidelines:

  • Simplified Issue: This kind of no-exam coverage requires you to submit a thorough questionnaire, and underwriters will check your credit score, driving record, and your prescription drug history. Some companies offer up to $350,000 in simplified issue coverage.
  • Guaranteed Issue: As the name implies, just about everyone can get guaranteed issue coverage. You will have to answer a few health questions, and you’ll probably have to wait a couple years before the coverage is fully available to your family. Typical policies top out at $25,000 to $35,000 in coverage.

While convenient and necessary for some people who can’t qualify for other kinds of coverage, no-exam policies cost more and offer less coverage. Since underwriters don’t know as much about your life, they assume you’re a higher-risk applicant and will charge premiums accordingly.

If you are young and healthy, the hassle of traditional underwriting should pay off by unlocking robust coverage at affordable rates.

Scrutinizing Your Insurance Company

There’s no doubt: your life will be under the insurance company’s microscope when you apply for traditional life insurance coverage.

But what about your insurance company’s health? You’ll want to partner with a company with decades or even centuries of financial stability. If the insurance company no longer exists or can’t afford to pay the claim when needed, your policy won’t help your family.

Fortunately, independent life insurance ratings agencies regularly investigate insurers and issue grades, usually ranging from A to F. Before buying a policy, check with A.M. Best, Moody’s, Standard & Poor’s, or Fitch for your company’s ratings.

Check with more than one ratings agency since they all use different criteria. If you’d like some suggestions for the best life insurance companies, check out our top 10 list.

Bottom Line: Leveraging ‘Just in Case’

Once you have life insurance, your premium will seem like just another monthly bill. But each time you pay the premium — month after month and year after year — you’re leveraging a much larger amount of money for “just in case.”

Few of us enjoy thinking about the unexpected. By any standard, your untimely death would cause unimaginable stress and upheaval for your family. Your life insurance coverage wouldn’t fix that, but it could make the rebuilding process easier for your loved ones.

When you have the right amount of life insurance coverage in place, you can worry less about how your family would handle the unexpected.

Advice On Purchasing Life Insurance In Different Situations

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