What Is Life Insurance and How Does It Protect Your Family?

Life insurance is more than a policy. It is a financial tool designed to provide money to the people or organizations you choose after your death.

That money can help your family maintain stability during an extremely difficult time. However, life insurance policies are not all alike. Understanding the basic parts of a policy can help you choose coverage that fits your family, budget and long-term goals.

How Does Life Insurance Work?

Life insurance is a contract between a policy owner and an insurance company.

The policy owner pays a premium. If the insured person dies while the policy is active and the claim meets the contract requirements, the insurance company pays a death benefit to the named beneficiary.

Life insurance can provide financial support for loved ones after the insured person dies.

The People Involved in a Life Insurance Policy

Understanding these roles can prevent confusion:

Policy Owner

The policy owner controls the policy. The owner may be responsible for paying premiums and generally has the authority to make permitted changes.

Insured

The insured is the person whose life is covered by the policy.

Beneficiary

The beneficiary is the person, trust, business or organization designated to receive the death benefit.

The owner and insured may be the same person, but they do not have to be. The Consumer Financial Protection Bureau notes that a policyholder is not necessarily the insured.

What Can the Death Benefit Be Used For?

Beneficiaries can generally use life insurance proceeds according to their needs. The money may help cover:

• Mortgage payments or housing expenses
• Funeral and final expenses
• Household bills
• Credit cards and other debts
• Childcare costs
• Education expenses
• Lost income
• Business obligations
• A financial legacy

Life insurance proceeds paid to a beneficiary because of the insured's death are generally not included in the beneficiary's gross income for federal income-tax purposes. However, exceptions can apply, and interest paid on the proceeds is generally taxable.

Consult a qualified tax professional regarding your particular situation.

What Are the Main Types of Life Insurance?

Term Life Insurance

Term life insurance provides coverage for a specified period, such as 10, 20 or 30 years.

It is often used for temporary financial responsibilities, including: Mortgage protection is one common use of term coverage.

• Protecting a mortgage
• Replacing income during working years
• Protecting children until they become independent
• Covering business or personal debts

Term insurance generally has lower initial premiums than permanent coverage, but it does not ordinarily build cash value.

If the term ends while the insured is living, coverage may terminate unless the policy is renewed, converted or replaced. Renewal premiums may be substantially higher.

Whole Life Insurance

Whole life is a form of permanent life insurance. It is designed to remain in force for the insured's lifetime as long as required premiums are paid and policy conditions are satisfied.

Whole life policies generally offer:

• A guaranteed death benefit
• Predictable premiums
• Cash-value accumulation
• The ability to access available cash value through permitted withdrawals or policy loans

Loans and withdrawals can reduce the policy's cash value and death benefit. A policy could lapse if it is not managed properly.

Universal Life Insurance

Universal life is another form of permanent insurance. Depending on the contract, it may offer flexibility in premiums, death benefits and cash-value accumulation.

Universal life requires ongoing monitoring. Changes in credited interest, policy charges, premium payments or withdrawals can affect how long the policy remains active.

Whole life and universal life are both types of cash-value insurance.

What Are Living Benefits?

Some life insurance policies include or offer riders that may allow the insured to access part of the death benefit while living after experiencing a qualifying event, such as a terminal, chronic or critical illness.

The definitions, qualifications and available benefits vary by policy and insurer. Accessing living benefits will generally reduce the amount available to beneficiaries and may have tax or eligibility consequences.

Riders add benefits that are not included in the basic policy, but they may also increase the premium.

Living benefits should be reviewed carefully rather than assumed to be identical across policies. Learn more about living benefits on our Life Insurance Resources page.

How Does Underwriting Affect Coverage?

Underwriting is the process the insurance company uses to evaluate an applicant's risk and determine eligibility, rate classification and premium.

The company may consider:

• Age
• Health history
• Prescription medications
• Height and weight
• Tobacco or nicotine use
• Driving history
• Occupation
• Hobbies
• Family medical history
• Amount of coverage requested

Some policies require a medical examination, while others use health questions, electronic records or simplified underwriting. A no-exam policy does not always mean that no health information will be reviewed. Read our full article on how life insurance underwriting works.

How Much Life Insurance Might You Need?

There is no single amount that is appropriate for everyone.

A useful starting point is the DIME method: Use our DIME Life Insurance Calculator to estimate your family's coverage needs.

• D — Debt: Credit cards, loans and other obligations
• I — Income: Income your family may need replaced
• M — Mortgage: The balance or payments you want protected
• E — Education: Future education expenses for children or dependents

Then subtract assets already available for these needs, including existing personal life insurance and savings designated for family protection.

The result is only an estimate. Your actual need depends on your goals, family responsibilities and budget.

Is Workplace Life Insurance Enough?

Employer-provided coverage can be valuable, but it should be reviewed carefully.

Ask:

• How much coverage do I have?
• Does it cover only me or also my family?
• Can I keep it if I leave or lose the job?
• Will the amount meet my family's actual needs?
• Does the coverage decrease at a certain age?
• Can the employer change or discontinue the benefit?

For many families, workplace coverage can be part of the plan without being the entire plan. Personally owned coverage may provide more control and portability.

What Does Life Insurance Cost?

The premium can be affected by:

• Age
• Health
• Tobacco use
• Coverage amount
• Policy type
• Length of coverage
• Rate classification
• Optional riders

Applying earlier and while healthier may improve the available choices, but approval and pricing are determined by the insurance company.

The least expensive policy is not automatically the best policy. Coverage should be affordable enough to maintain and appropriate for the need it is intended to solve.

Questions to Ask Before Purchasing Coverage

Before choosing a policy, ask:

1. What financial problem is this policy intended to solve?
2. How much coverage do I need?
3. How long should the coverage last?
4. Is the premium guaranteed?
5. Can the premium or policy charges increase?
6. Does the policy include living benefits?
7. Does it build cash value?
8. What happens if I miss a payment?
9. Can the policy be converted or changed?
10. How financially strong is the insurance company?
11. What exclusions or limitations apply?
12. How will the policy be reviewed in the future?

Review Your Coverage Regularly

Life insurance should not be purchased and forgotten.

Review your coverage after major life changes, including:

• Marriage or divorce
• Birth or adoption of a child
• Purchasing or refinancing a home
• Changing jobs
• Starting or selling a business
• Significant income changes
• Retirement
• Changes in health
• Death of a beneficiary

Also make sure your beneficiaries know that coverage exists and where policy information is stored. The NAIC recommends keeping policy information in a safe place and making sure beneficiaries or trusted advisers know the carrier and location of the policy. Visit our Financial Education Glossary for definitions of common life insurance terms.

Education Before the Decision

Life insurance should not begin with a product. It should begin with understanding what needs to be protected.

At Black Apple Group, our approach is to educate first, review your current situation and then help you compare appropriate options. The goal is not simply to purchase a policy. The goal is to create protection that your family can understand, afford and maintain.

Request a Life Insurance Review

Do you know whether your current coverage would accomplish what you want it to do?

We can help you identify your needs, review existing policies and compare options based on your goals, health and budget.

This article is for general educational purposes and does not provide individualized tax, legal or financial advice. Policy features, underwriting requirements, riders and product availability vary by insurer and state. Guarantees depend on the financial strength and claims-paying ability of the issuing insurance company.