Life insurance is a type of insurance policy that can provide the policyholder with something almost priceless: the reassurance that loved ones will have the financial support they need after the insured person passes away. More technically, it is a contract between the policyholder and the company providing the insurance coverage.
Whichever way you define it, it’s an important tool that can protect those who depend upon you most if you weren’t here to financially care for them.
Let’s take a closer look at what it’s all about and how it can help give your loved ones a financial safety net — and give you peace of mind.
What Is Life Insurance?
Let’s give you an overview of this important product:
• Life insurance is a kind of a contract between a policyholder and the company issuing the insurance. Specifically, that policy guarantees that the beneficiaries who are named will receive, upon the death of the insured, a sum of money known as a death benefit.
• For this kind of coverage, the policyholder pays premiums during their lifetime. They must also disclose details like their health status and some facets of their lifestyle to be insured.
• Life insurance comes in two main varieties: term insurance, which covers you for a specific time period (or term), and permanent insurance, which covers you for however long you live, even if that’s 110!
Life insurance comes in many different forms and with an array of features. But at its core, it can be thought of as a way of making sure that your loved ones have a financial cushion when you aren’t here. Consider these scenarios:
• Let’s say you have a non-working spouse: Life insurance will mean they are covered so housing, food, and other expenses are provided for.
• Perhaps you have toddlers and want to know that, no matter what, their college tuition will be paid.
• Maybe you have a relative who can’t live independently and you will sleep better at night knowing their care will be taken care of if you weren’t here.
We’ll review the options and specifics in more detail so you have all the info you need to pick the right policy for you. Ready? Here we go!
💡 Quick Tip: The group life insurance offered by employers is a nice perk, but it may not be enough to cover your financial obligations. A supplemental life insurance policy can bridge the gap.
How Life Insurance Works
Let’s define some of the life insurance terms you are likely to hear used when you’re shopping for a policy. Here’s what they mean and how they function to give you the coverage you’re hoping for:
• Death Benefit: It’s a scary term, we hear you! But it’s the crux of life insurance policies. This is the lump sum payment that will be paid out at the time of your death to your beneficiaries if you die while covered by a life insurance policy. It can go a long way towards keeping them in good financial shape. Btw, a death benefit is usually not subject to the usual income tax.
• Beneficiaries: These are the people who receive the death benefit from your life insurance policy. You can name one or more people who you want to be covered. (You can also name trusts and charities.) Beneficiaries usually have plenty of flexibility in how to use the funds. Depending upon the specifics of the financial situation and of policy payout, someone might choose to pay off a mortgage loan, for example, or make monthly payments to stay current.
• Premium: This is the monthly or yearly payment you make to the life insurance company to pay for your coverage and keep your policy in effect.
• Cash Value: Permanent life insurance policies have a cash value savings component that grows over time and can be used or borrowed against.
Types of Life Insurance
Now, let’s take a look at some of the main types of life insurance you might be interested in: term life versus whole life.
Term Life
As the name suggests, this insurance covers you for a specific term or length of time (think 10, 20, or 30 years, though other lengths are often available). This works well for people who want to know that, say, if anything were to happen to them, their non-working spouse would be able to pay the mortgage for the remaining term. Or if you have children and you want to be sure their educational costs are taken care of if you were to die. Typically, term life insurance is more affordable than permanent life insurance. Worth noting:
• Regular payments must be made to keep the policy active.
• Payments on term life insurance policies are typically fixed.
• If the term ends and you are still alive, that’s great! But you probably don’t get any refund of premium payments.
Permanent Life
This kind of life insurance covers you for your entire life. Whenever you die, your beneficiaries will receive their lump-sum death benefit. What’s more, these policies have a cash value; that is, some of your payments go into a savings vehicle on a tax-deferred basis that you can then tap or borrow against. Because of this extended coverage and the savings function, permanent life insurance is the costlier option, with the price often ranging from five to 15 times that of term life insurance. Permanent life insurance comes in an array of options. Let’s spell out a couple of common ones:
• Whole Life: These life insurance policies provide a death benefit as well as the cash-value account. The latter may have a guaranteed rate of return, and as it grows, there may be dividends paid that can be put towards your premium payments or reinvested in the cash-value account.
• Universal Life: This kind of policy gives you more options than whole life. For instance, you can possibly alter your premium payments, and the cash value will accrue in different ways. Its growth might be tied to an indexed fund like the S&P 500; you’ll hear these life insurance policies referred to as an indexed universal life policy. Or you might prefer what is known as a variable universal life policy. These usually have varied investment accounts that you can manage as you like.
Guaranteed Acceptance or Simplified Issue Life Insurance
These are policies that allow the applicant to avoid the medical examination that is usually required for life insurance. (These are brief exams that often involve a blood draw and urine sample, to chart factors like cholesterol that might influence the cost of your policy.) These forms of insurance can be good for people who don’t like doctor’s appointments, who fear learning what these tests might reveal, and also who want to considerably shorten the time it can take for approval of a policy with what’s known as medical underwriting, which can equal a couple of months.
In Guaranteed Acceptance life insurance, as the name implies, you can’t be turned down; your medical status isn’t an issue. However, you will probably be offered a small death benefit (say, $25,000) and rates will be higher than with some other forms of life insurance.
With Simplified Issue life insurance, the applicant may only have to answer a few questions about their health, no exam required. With these kinds of policies, however, the full death benefit may not be paid unless the policy has been held for two years; if the policyholder dies before then, a refund of premiums may be paid out.
| Type of insurance | Period of Coverage | Benefits | Downsides |
|---|---|---|---|
| Term Life Insurance | For a finite period of time (say, 5-40 years) |
• Affordable • Term is tailored to your needs |
• You might outlive the policy’s term • When the policy is over, your premium payments aren’t refunded |
| Permanent Life Insurance | For your entire life; your beneficiaries will definitely receive a payment |
• Peace of mind that loved ones are covered • Cash value savings account |
• Expensive |
| Guaranteed- or Simplified-Issue Life Insurance | A permanent policy that ensures a small benefit when you die |
• No medical exam needed • Easy to apply for • Quicker approval |
• Lower coverage amount • Expensive • Death benefit may not be paid if policyholder dies within a few years of getting the insurance |
What Does Life Insurance Cover?
Life insurance covers a variety of expenses. Here are some common examples:
• Unpaid debt
• Medical expenses
• End-of-life expenses
• Monthly expenses, such as utilities, food, and rent or mortgage payments
• Replacement of lost income, if the policy owner was still working at the time of their death
• Child care or dependent care
• Cost of education
• Charitable contributions
It’s important to note that there are certain circumstances when life insurance may not pay out. Examples typically include:
• Suicide, if the policy owner ends their life within two years of purchasing a policy
• Death as a result of acts of war or terrorism
• If the policyholder’s beneficiaries murder them or play a role in the murder
• Death as a result of risky behavior or a profession that involves dangerous activities, like professional car racing or flying a private plane
Which Type of Life Insurance Is Right for Me?
So, now, how do you know what type of policy is best for you? Here’s some food for thought. People often choose term life insurance for one or more of these reasons:
• Finite timing: They expect to have saved up enough money or paid off debts by the time this policy expires and would therefore not need to have their income replaced. Or perhaps they believe their beneficiaries will be financially independent by the time the policy expires.
• Affordability: The policy is more affordable and, therefore, easier to fit within their budget.
Whole life policies typically have premiums that are up to 15 times the cost of term life, and some people may prefer to purchase term life — and then personally invest the difference between a term life premium and a whole life one.
That said, there are plenty of people who decide permanent life insurance is right for them. Here are some typical reasons:
• Long-lasting: This type of insurance is designed to be in force throughout the policy holder’s life, which provides a complete sense of security.
• Cash component: This insurance type has a cash value component, as well, which serves as a savings vehicle. The policy holder can borrow against the value at a predetermined interest rate.
• Possibility of “cashing out”: Some people may like having the ability to surrender their whole life policy during their lifetime and receive the cash value of it. Doing so, however, can have tax implications that can be discussed with a tax professional.
How Much Life Insurance Coverage Do You Need?
Everyone’s situation is unique when it comes to getting life insurance. You may have more kids than, say, your brother. He may have a bigger mortgage. One of you may be more concerned about eldercare costs for your parents down the road. There is no one number that says how much coverage is right for either one of you.
But there are helpful formulas that can help you figure out a sensible amount of coverage. One popular option is the DIME formula. The acronym stands for Debts, Income, Mortgage, and Education. Here’s how to use this formula.
Debts
Gather your debt information, from car loans to personal loans, and from student loans to credit card balances. Forecast out for the number of years you want coverage for. In other words, add up everything that’s owed outside of mortgages.
Income
Take the household’s annual income and multiply it by ten (if you are contemplating a 10-year term, that is). This will provide a ballpark estimate of what it would take to replace lost income during that period of time.
If the life insurance policy would be needed to provide financial support for more than ten years (perhaps because there are young children in the household), use a higher multiplier.
Mortgage
Home loans are usually the largest debt of a household, and often have the longest term. As part of calculating the amount of life insurance to take out, include the payoff on mortgages.
Doing so can help to prevent loved ones from taking on the burden of the house payment expenses and/or from potentially being foreclosed upon.
Education
If there are outstanding student loans, they can be incorporated into the life insurance amount. Also consider children who might have future tuition expenses at college, along with their housing costs, textbooks, and so forth.
When adding up debts, income, mortgage, and education (DIME), what is the total dollar amount? This can be a benchmark for the coverage amount of a life insurance policy. If you have any assets, such as a savings account, you can subtract that from the total dollar amount to get a more accurate picture of the possible financial need.
💡 Quick Tip: Term life insurance coverage can range from $100K to $8 million. As your life changes, you can increase or decrease your coverage.
How Much Does Life Insurance Cost?
Life insurance costs will vary tremendously since each person has their own special needs. You might want $300,000 in term life insurance for 20 years and pay one premium. Or maybe you’d prefer $3 million in permanent insurance. Of course, there will be a big difference in those premium payments!
Let’s look at a few scenarios so you have a ballpark idea of costs, but the best way to get prices that reflect your situation is by working with an agent or using a simple online calculator:
• For a 20-year term policy: For $250,000 of coverage, a 30-year old female would pay $142 a year; a male would pay $159, according to an analysis conducted by Forbes. For $500,000 of coverage, the same woman would pay $204, while a man would pay $246. If we scoot the benefit up to $1 million, the annual cost would be $320 for a woman and $399 for a man.
• For a 30-year term life policy: For $250,000 of coverage, a 30-year-old female would pay $198 a year; a male would pay $235. For $500,000 of coverage, the numbers would be $317 and $381; for $1 million, the annual premium would be $525 for a woman and $669 for a man.
• For permanent life insurance, the costs tend to be higher. One recent quote from Forbes saw that $500,000 of coverage in a 30-year term policy would cost approximately $357 a year for a 30-year-old man. A $500,000 whole life policy would cost $4,323 per year, or almost 6 times more.
Of course, there are huge variations in the price of policies. As you see from the above numbers, if you get term life insurance for a longer period, you’ll pay more than for a shorter period. Also, the more coverage you buy, the higher the premium.
Now, let’s look at a few of the factors that influence the cost:
• Age and gender: The older you are, the more expensive a life insurance policy will be, as health issues tend to crop up. Also, since women have a longer life expectancy than men, their rates are usually lower.
• Your health: Those in excellent health will pay less than those who, say, have high cholesterol or blood pressure and a family history of cancer.
• Lifestyle: This includes everything from whether or not you smoke, have a history of substance abuse, and have a clean driving record, to factors like whether your job or hobbies are deemed high-risk (for example, flying airplanes, scuba diving).
What Is the Process of Buying Life Insurance?
Here’s what to expect from the life insurance buying process:
• Once you decide what kind of policy you want and have an idea of the coverage amount, it’s a good idea to explore your options and get some free quotes. You can talk to a life insurance agent or do your own research online; there are many tools that put the information you want just a click or two away.
• Expect to be asked questions about your health, your family history, your hobbies, and your lifestyle as you shop and apply. This is an important step in figuring out your risk factors and life expectancy, which is used to set your rates.
• Once you’ve found a policy and insurer that you like, fill out that carrier’s application as completely as possible. The application will be reviewed as part of what’s called the underwriting process. The carrier will look at the application through the lens of potential risk. In other words, they will review the application to determine how risky it would be to issue a life insurance policy to that particular applicant — and then price it accordingly.
• For many policies, a medical exam is part of the process. Applicants are asked and should honestly answer about family health history, personal health and lifestyle, prescriptions being taken, surgeries performed, and so forth. A physical exam is often done. This can include a height and weight check, the taking of blood pressure, as well as urine and blood samples.
• After that, you have completed your application. For policies that involve a medical exam, it can take 6 to 8 weeks to be informed of your approval.
Choosing a Beneficiary
Once your application is approved, an important step will be choosing your beneficiary or beneficiaries. This is the person or people who would receive the death benefit if you pass away while covered by a life insurance policy. A few points to consider:
• You can name more than one person and determine the percentage of the death benefit each would receive.
• You can name contingent beneficiaries in case a beneficiary dies before the policyholder does.
• You don’t have to name a person as a beneficiary. You can also work with a lawyer to set up a trust and have the death benefit used as you determine.
• It’s wise to review and update your beneficiaries regularly once you have a life insurance policy. A new baby, a divorce, and other events can trigger you to alter your selections (changes can be made at any point).
Can a Beneficiary Make a Claim?
No one wants to think about death, but it’s a fact of life. It’s also the event that a life insurance policy is inextricably linked to; the death benefit is there to support loved ones after the policyholder passes away. So let’s spell out what would actually happen in this situation:
• Notification of death: The insurer will probably pay claims quickly, usually within a month or in as little as a week, but paperwork must be filed and the beneficiary may have to inform them of the death. The issuer of the policy may not know otherwise.
• Death certificate: The beneficiary must submit a certified copy of the death certificate, which the insurance company will keep.
• Make sure you have satisfied all claim requirements: When actually submitting your claim, have all the supporting documentation attached. This can include a claim form and death certificate.
That’s it! Also, here’s a good thing to know: You don’t need a copy of the insurance policy to file a claim, just the name of the insurance company and the fact that you are a beneficiary.
Making Policy Changes
Life insurance often is a part of your life for a very long time, decades and decades. Sometimes, people will want to change some aspects, such as the amount of the death benefit or the company that is providing the policy. Let’s look at how that works:
• Coverage amount: Let’s say you started with a $500,000 policy, but now, five years into it, want to double the coverage. Can you? The answer to this can vary by the insurance company. Some carriers provide flexibility in their policies that allow a policy holder to change the coverage amount. If considering a particular insurance company and this flexibility is important, ask that question before taking out the policy.
• Switching providers: Consider changing the policy first. You may be able to save time and money by amending or adding to your current policy instead of replacing it. Also, there can be surrender charges that you need to pay if you give up a permanent policy so you can sign on for a new one elsewhere.
What’s more, if you are switching policies after a number of years with one insurer, you are older now, and the rates will be higher. Swapping policies may not actually save you money. It’s often best to go through underwriting and get approved for the new policy first, see how the features and prices compare, and then decide whether or not to cancel the original policy and sign up for a new one.
• New policy waiting periods: If you are thinking of forging ahead with a change, note the waiting period. Most new policies have a waiting period before certain kinds of death benefits become effective. Consider this before replacing your old policy.
Life Insurance Riders
One way to make a change to your life insurance policy involves riders; think of these as add-ons that can help tailor your coverage to your evolving needs. Riders deliver additional benefits; yes, you’ll pay extra, but the amount is usually low because not much underwriting is required.
For instance, if you are the sole provider for your family, you might want to add an Accidental Death Rider, which would increase the amount of the death benefit if a fatal accident occurred. Or maybe you want to explore a Long-Term Care Rider, which would help pay expenses were you in need of nursing home or in-home care. Talk with an agent or explore options online to learn more.
Life Insurance Benefits
There are many benefits of life insurance, but perhaps one of the biggest is that it can offer loved ones a financial cushion in the event you die. That money can be used to cover a wide range of expenses, and it’s generally not taxed by the federal government. (Note that any interest you receive from the policy does need to be reported.)
If you purchase a whole life policy, it has a cash value that grows over time tax-deferred. You can cash it out at any time to help pay for a major expense or to borrow against it.
Reasons to Buy Life Insurance
Here are some common reasons why you may want to consider a life insurance policy.
• Life insurance helps replace your income if you die, which can be especially useful for any beneficiaries who depend on you financially.
• The death benefit your beneficiaries receive can be used to pay for your end-of-life expenses, debts, medical expenses, or estate-related expenses.
• Life insurance can be used to pay federal and state “death” taxes so your loved ones don’t have to shoulder the costs themselves.
• Life insurance can allow you to create an inheritance for your heirs, and the money is usually tax-free.
• You can make a significant gift to a beloved charity after you pass away by naming the organization the beneficiary of your life insurance.
How to Shop for Life Insurance
When you’re ready to look for a policy, you have a couple of places to start your research: online or talking with an agent who’s licensed by your state’s insurance department.
No matter which route you choose, you’ll likely find that the prices of life insurance policies will vary. Though it can take more time, getting multiple quotes can help you find the best deal for your needs and budget.
As you’re weighing your options, consider looking into the financial rating of each insurer. The Insurance Information Institute recommends going with “a company that is likely to be financially sound for many years, by using ratings from independent rating agencies.”
Life Insurance Alternatives
Although life insurance can provide loved ones with a financial safety net after you’re gone, you might be able to get a similar result with another type of vehicle. Here are some common alternatives to life insurance to consider exploring:
• Investments. Investing may be able to potentially grow your wealth, which you can leave behind to loved ones after you’re no longer here. Just remember that there’s a degree of risk involved with investing. Plus, proceeds may be subject to estate taxes and probate.
• Accidental death & dismemberment insurance (AD&D). Like the name suggests, AD&D is a type of supplemental life insurance that provides coverage to your beneficiaries if you’re killed or seriously injured in a type of accident that’s covered in the policy.
• Annuities. An annuity guarantees a certain amount of income each month during retirement. Here’s how it works: You pay into an annuity for a predetermined number of years. After that, the insurance company pays you back the money in monthly installments. Note that some annuities charge fees, and if you pass away prematurely, the value of the annuity might decrease.
The Takeaway
Life insurance can be a challenging topic to dig into. But take heart: Part of what makes it seem complex is that it’s designed to meet the needs of so many very different people. Whatever the specifics of your situation and lifestyle, there is probably a policy that can give you peace of mind.
By acquainting yourself with the basic concepts, terms, and processes, you’re now ready to go out and find a life insurance policy that will let you know your loved ones will be well-provided for if a worst-case scenario occurred (though we sure hope it doesn’t!).
SoFi has partnered with Ladder to offer competitive term life insurance policies that are quick to set up and easy to understand. Apply in just minutes and get an instant decision. As your circumstances change, you can update or cancel your policy with no fees and no hassles.
FAQ
How is life insurance paid out?
Generally speaking, life insurance is paid out in a few different ways. It can be distributed as a lump sum, through a retained asset account, or by way of a life insurance annuity. Contact your insurer to find out which options are available.
Why is life insurance worth it?
Life insurance can provide the policyholder peace of mind that their loved ones are financially protected after they pass away.
How long do you have to pay life insurance before it pays out?
It depends on your plan. Some plans have a waiting period before coverage begins. If you die during that window, your beneficiaries only receive a refund on the premiums you’ve paid.
Can you use life insurance money for anything?
Yes. Once your beneficiaries receive the death benefit, they can generally use the money however they wish.
Coverage and pricing is subject to eligibility and underwriting criteria.
Ladder Insurance Services, LLC (CA license # OK22568; AR license # 3000140372) distributes term life insurance products issued by multiple insurers- for further details see ladderlife.com. All insurance products are governed by the terms set forth in the applicable insurance policy. Each insurer has financial responsibility for its own products.
Ladder, SoFi and SoFi Agency are separate, independent entities and are not responsible for the financial condition, business, or legal obligations of the other, SoFi Technologies, Inc. (SoFi) and SoFi Insurance Agency, LLC (SoFi Agency) do not issue, underwrite insurance or pay claims under LadderlifeTM policies. SoFi is compensated by Ladder for each issued term life policy.
Ladder offers coverage to people who are between the ages of 20 and 60 as of their nearest birthday. Your current age plus the term length cannot exceed 70 years.
All services from Ladder Insurance Services, LLC are their own. Once you reach Ladder, SoFi is not involved and has no control over the products or services involved. The Ladder service is limited to documents and does not provide legal advice. Individual circumstances are unique and using documents provided is not a substitute for obtaining legal advice.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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