Life Insurance 101: Everything You Need to Know About This Essential Protection

 

Life insurance is one of the most important financial products you can buy to protect yourself and your loved ones. It can provide peace of mind, security, and income replacement in case of an unexpected death. Yet, many people are confused, overwhelmed, or underinsured when it comes to life insurance.

According to a 2021 study by LIMRA and Life Happens, only 54% of Americans have some form of life insurance coverage, and among those who do, 25% say they need more. Moreover, 41% of Americans say they would face financial hardship within six months if their primary wage earner died.

If you are one of those who are unsure about life insurance or want to learn more about it, this article is for you. We will explain what life insurance is, how it works, what types are available, how much you need and how much it costs, and how to avoid common mistakes when buying or owning a policy.

What Is Life Insurance and How Does It Work?

Life insurance is a contract between a policyholder and an insurer that pays a death benefit to a beneficiary upon the death of the insured person. The death benefit is a lump-sum payment that can be used for any purpose, such as paying off debts, covering funeral costs, replacing lost income, funding education, or leaving a legacy.

The policyholder pays a premium to the insurer in exchange for the coverage. The premium is the amount of money that the policyholder pays periodically (usually monthly or annually) or as a single payment upfront to keep the policy in force. The premium depends on several factors, such as the type and amount of coverage, the age and health of the insured person, and the duration of the policy.

To buy a life insurance policy, you need to choose a type, amount, and duration of coverage that suits your needs and budget. You also need to compare quotes from different insurers to find the best deal. You can use online tools or work with an agent or broker to help you with this process.

Once you find a policy that you like, you need to fill out an application form and provide some personal information, such as your name, address, date of birth, occupation, income, medical history, etc. Depending on the type and amount of coverage you apply for, you may also need to undergo a medical exam to verify your health status and risk level. The insurer will review your application and decide whether to approve it or not.

If your application is approved, you will receive a policy document that outlines the terms and conditions of your coverage. You will also need to pay your first premium to activate your policy. You will then receive a proof of insurance that confirms your coverage.

If your application is denied or postponed, you may be able to appeal the decision or apply with another insurer. You may also be offered a modified policy with higher premiums or lower benefits.

To make a claim on your life insurance policy, your beneficiary (or someone on their behalf) needs to notify the insurer of your death as soon as possible. They also need to submit a death certificate and provide proof of their identity and relationship to you. The insurer will then review the claim and verify that it meets the policy requirements. If everything is in order, they will pay out the death benefit within a few weeks or months.

What Are the Different Types of Life Insurance?

There are many different types of life insurance available in the market, but they can be broadly classified into two main categories: term life insurance and permanent life insurance.

Term Life Insurance

Term life insurance is designed to last for a specific period of time (the term), such as 10, 20, or 30 years. It only pays out if you die within that term. If you outlive your term, your coverage expires and you get nothing back.

Term life insurance is typically the simplest and cheapest type of life insurance. It is ideal for people who want to protect their family or dependents from financial hardship in case they die prematurely. It can also be used to cover specific debts or obligations that have an end date, such as a mortgage or a student loan.

Some term life insurance policies have additional features that make them more flexible or attractive:

• Renewable term life insurance allows you to renew your policy at the end of each term without having to reapply or take another medical exam. However, your premiums will increase based on your age at renewal.
• Convertible term life insurance allows you to convert your policy into a permanent one without having to reapply or take another medical exam. However, you will have to pay higher premiums for the permanent coverage.
• Level term life insurance keeps your premiums and benefits constant throughout the term. This is the most common type of term life insurance.
• Decreasing term life insurance reduces your benefits over time, usually in line with a debt or obligation that you are paying off. Your premiums may remain constant or decrease as well.
• Increasing term life insurance increases your benefits over time, usually to keep up with inflation or your changing needs. Your premiums will also increase accordingly.

Permanent Life Insurance

Permanent life insurance is designed to last for your entire life, as long as you pay your premiums. It pays out whenever you die, regardless of when that happens. It also has a cash value component that accumulates over time and can be accessed while you are alive.

Permanent life insurance is typically more complex and expensive than term life insurance. It is suitable for people who want to provide lifelong protection for their family or heirs, create an estate or a legacy, or accumulate tax-deferred savings or investments.

There are several subtypes of permanent life insurance, each with its own features and benefits:

• Whole life insurance provides a fixed amount of coverage and a fixed premium for life. It also guarantees a minimum rate of return on the cash value, which grows at a steady pace. You can borrow against the cash value or use it to pay your premiums or buy more coverage. You may also receive dividends from the insurer if they have surplus earnings.
• Universal life insurance provides a flexible amount of coverage and a flexible premium that you can adjust within certain limits. It also offers a variable rate of return on the cash value, which grows based on the performance of the insurer’s investments. You can withdraw or borrow from the cash value or use it to pay your premiums or increase your coverage. You may also receive interest credits from the insurer if they earn more than the minimum guaranteed rate.
• Variable life insurance provides a fixed amount of coverage and a fixed premium for life. It also allows you to invest the cash value in various subaccounts that are similar to mutual funds. You can choose from a range of investment options with different levels of risk and return. You bear the investment risk and reward of the cash value, which can fluctuate depending on the market conditions. You can borrow against the cash value or use it to pay your premiums or buy more coverage.
• Variable universal life insurance combines the features of universal and variable life insurance. It provides a flexible amount of coverage and a flexible premium that you can adjust within certain limits. It also allows you to invest the cash value in various subaccounts that are similar to mutual funds. You can choose from a range of investment options with different levels of risk and return. You bear the investment risk and reward of the cash value, which can fluctuate depending on the market conditions. You can withdraw or borrow from the cash value or use it to pay your premiums or increase your coverage.

Term life insurance and permanent life insurance have their own pros and cons, and there is no one-size-fits-all solution for everyone. The best type of life insurance for you depends on your personal situation, goals, budget, and preferences.

Here are some factors to consider when comparing term and permanent life insurance:

• Suitability: Term life insurance is more suitable for people who need temporary protection for a specific period of time, such as until their children are grown up or their debts are paid off. Permanent life insurance is more suitable for people who need lifelong protection for their family or heirs, or who want to build wealth or leave a legacy.
• Affordability: Term life insurance is more affordable than permanent life insurance, especially for younger and healthier people. Permanent life insurance is more expensive than term life insurance, especially for older and less healthy people.
• Flexibility: Term life insurance is less flexible than permanent life insurance, as it has a fixed duration, benefit, and premium (unless it is renewable or convertible). Permanent life insurance is more flexible than term life insurance, as it allows you to adjust your coverage, premium, and cash value (depending on the subtype).
• Investment potential: Term life insurance has no investment potential, as it does not have a cash value component. Permanent life insurance has some investment potential, as it has a cash value component that grows over time and can be accessed while you are alive (depending on the subtype).

Here are some examples of scenarios where each type of life insurance might be appropriate or preferable:

• You are a young parent with two kids and a mortgage. You want to protect your family from financial hardship in case you die before they are independent. You have a tight budget and do not have any savings or investments. You might choose term life insurance because it provides adequate coverage at an affordable cost for a specific period of time.
• You are a middle-aged professional with a high income and a high net worth. You want to provide lifelong protection for your spouse and children, who depend on your income. You also want to create an estate or a legacy for your heirs or charity. You have a large budget and are looking for a tax-efficient way to grow your wealth. You might choose permanent life insurance because it provides lifelong coverage, cash value accumulation, and various investment options.

• You are a senior citizen with no dependents or debts. You want to cover your final expenses and leave a small inheritance for your grandchildren. You have a modest budget and are not interested in investing or saving. You might choose term life insurance because it provides sufficient coverage at a reasonable cost for a limited period of time.

How Much Life Insurance Do You Need and How Much Does It Cost?

One of the most common questions that people have about life insurance is how much coverage they need and how much it will cost them. There is no definitive answer to these questions, as they depend on several factors that vary from person to person.

However, there are some general guidelines and methods that can help you estimate your life insurance needs and costs.

How Much Life Insurance Do You Need?

The amount of life insurance coverage you need depends on your income, expenses, debts, assets, dependents, financial goals, and other factors. The basic idea is to calculate how much money your family or beneficiaries would need to maintain their standard of living and achieve their objectives if you were no longer around.

There are different ways to approach this calculation, but here are some common methods or rules of thumb that you can use:

• Income replacement: This method estimates how much income you would earn over your remaining working years and multiplies it by a factor that accounts for inflation and interest. For example, if you are 40 years old and earn $50,000 per year, and you plan to work until 65, you could multiply your annual income by 10 to get $500,000 as your coverage amount. This is a simple and popular method, but it does not consider your specific expenses or goals.
• Human life value: This method estimates how much economic value you contribute to your family or society over your lifetime and subtracts your personal consumption. For example, if you are 40 years old and earn $50,000 per year, and you spend $20,000 per year on yourself, you could multiply your net income ($30,000) by the number of years you expect to live (say 40) to get $1.2 million as your coverage amount. This is a more comprehensive and realistic method, but it may be difficult to calculate or project.
• DIME (debt, income, mortgage, education): This method adds up your major financial obligations and subtracts your existing assets. For example, if you have $100,000 in debt, $50,000 in annual income for 10 years, $200,000 in mortgage balance, and $100,000 in education costs for your children, you could add these amounts ($450,000) and subtract your savings ($50,000) to get $400,000 as your coverage amount. This is a more detailed and customized method, but it may not account for future changes or contingencies.

These methods are not mutually exclusive or exhaustive; you can use a combination of them or adjust them according to your situation. You can also use online calculators or tools to help you with this process.

How Much Does Life Insurance Cost?

The cost of life insurance depends on several factors that affect the risk of insuring you. The higher the risk, the higher the premium. Some of these factors are:

• Your age: The older you are, the more likely you are to die, and the more expensive your life insurance will be.
• Your health: The healthier you are, the less likely you are to die, and the cheaper your life insurance will be.
• Your lifestyle: The safer and cleaner your habits are, the less likely you are to die, and the cheaper your life insurance will be.
• Your occupation: The less dangerous or stressful your job is, the less likely you are to die, and the cheaper your life insurance will be.
• Your family history: The fewer genetic or hereditary diseases or conditions in your family, the less likely you are to die, and the cheaper your life insurance will be.
• Your type and amount of coverage: The longer and larger your coverage is, the more likely you are to die within the policy term, and the more expensive your life insurance will be.

The cost of life insurance also varies by insurer, as each one has its own underwriting criteria, pricing models, and discounts. Therefore, it is important to compare quotes from different insurers before buying a policy.

To give you an idea of how much life insurance costs, here are some average annual premiums for a 20-year term policy with a $500,000 face value for a healthy non-smoker in 2021, according to Policygenius:

Age	Male	Female
30	$228	$193
40	$341	$289
50	$842	$654
60	$2,191	$1,558

As you can see, the cost of life insurance increases significantly with age and gender. However, these are only averages and may not reflect your actual situation or options.

How to Find Affordable Life Insurance?

Life insurance is a valuable and necessary product, but it does not have to break the bank. There are some ways to find affordable life insurance that meets your needs and budget. Here are some tips or strategies that you can follow:

• Shop around: Compare quotes from different insurers and use online tools or brokers to help you find the best deal. You may be surprised by how much prices can vary for the same type of coverage.
• Buy early: The younger and healthier you are, the cheaper your life insurance will be. Buying early can also lock in your rate and avoid future increases due to age or health issues.
• Choose term over permanent (if suitable): Term life insurance is usually much cheaper than permanent life insurance for the same amount of coverage. If you only need temporary protection for a specific period of time, term life insurance may be a better option for you.
• Improve your health and habits: The healthier and safer you are, the cheaper your life insurance will be. You can lower your premiums by quitting smoking, losing weight, exercising regularly, eating well, managing your stress, and avoiding risky activities.
• Bundle with other policies (if available): Some insurers may offer discounts or incentives if you buy more than one policy from them, such as life, home, auto, or health insurance. This can save you money and simplify your payments and claims.
• Review your coverage periodically: Your life insurance needs and costs may change over time due to life events, such as marriage, divorce, birth, death, retirement, etc. You should review your coverage periodically and adjust it accordingly to avoid paying for too much or too little.

What Are Some Common Life Insurance Mistakes and How to Avoid Them?

Life insurance is a complex and important product that requires careful planning and decision-making. However, many people make mistakes when buying or owning a life insurance policy that can cost them money, time, or peace of mind. Here are some common pitfalls or errors that you should avoid or correct:

• Buying too little or too much coverage: If you buy too little coverage, you may leave your family or beneficiaries financially vulnerable in case of your death. If you buy too much coverage, you may waste money on premiums that you do not need. You should assess your needs regularly and use reliable methods or tools to calculate your coverage amount.
• Choosing the wrong type or duration of coverage: If you choose the wrong type of coverage, you may end up paying more than you need or getting less than you expect. For example, if you choose term life insurance when you need permanent protection, you may outlive your policy and lose your coverage. If you choose permanent life insurance when you only need temporary protection, you may pay more than necessary for features that you do not use. You should compare the pros and cons of different types of coverage and choose the one that matches your goals and budget.
• Naming the wrong beneficiary or not updating it regularly: If you name the wrong beneficiary or forget to update it after a life event, you may cause confusion, delays, disputes, or taxes when making a claim. For example, if you name your ex-spouse as your beneficiary and do not change it after a divorce, they may still receive the death benefit instead of your current spouse or children. You should name your beneficiary carefully and review it periodically to ensure that it reflects your current wishes.
• Skipping or delaying payments: If you skip or delay your premium payments, you may risk losing your coverage or paying more than you should. For example, if you miss a payment deadline by more than 30 days (the grace period), your policy may lapse and terminate. If you reinstate your policy later, you may have to pay back premiums, interest, fees, or undergo a new medical exam. You should pay your premiums on time and set up automatic payments or reminders to avoid missing them.
• Not reviewing or updating the policy periodically: If you do not review or update your policy periodically, you may miss out on opportunities to improve your coverage or save money. For example, if your health improves or your lifestyle changes, you may qualify for lower premiums or better terms. If your needs or goals change, you may want to increase or decrease your coverage or switch to a different type of policy. You should review your policy at least once a year and update it as needed to keep it relevant and optimal.

Conclusion

Life insurance is a vital and valuable product that can protect you and your loved ones from financial hardship in case of your death. It can also help you achieve your financial goals and leave a legacy for your heirs or charity.

However, life insurance is not a one-size-fits-all solution that you can buy and forget. It requires careful planning, comparison, and maintenance to ensure that you get the best coverage for your needs and budget.

In this article, we have explained what life insurance is, how it works, what types are available, how much you need and how much it costs, and how to avoid common mistakes when buying or owning a policy. We hope that this guide has helped you understand the basics of life insurance and inspired you to take action.

If you are ready to buy a life insurance policy or review your existing one, we recommend that you compare quotes from different insurers and use online tools or brokers to help you find the best deal. You can also consult a professional if you need more guidance or advice.

Remember, life is unpredictable and precious. Don’t wait until it’s too late to protect yourself and your loved ones with life insurance.