What is life insurance?

Life insurance is an important way to provide protection for your family. However, it's often misunderstood, and misconceptions are plentiful—including that it's expensive and difficult to purchase. But once you have a basic understanding of what life insurance is, how it works, and the two main types of life insurance, you’ll be on your way to providing protection and financial security for your family.

What is life insurance?

Life insurance is a contract between you and an insurance company where you make a monthly or annual payment, called a premium. When you pass away, the insurance company pays a specified amount of money—the death benefit—to your beneficiaries.

If you have people who depend on your income, like underage children, a spouse, or elderly parents, then life insurance is important. You should also consider life insurance if someone would incur additional costs if you pass away (like childcare, for example). The money obtained from a policy can help your family pay their regular monthly bills, your children’s future college tuition, or for your funeral expenses and outstanding medical bills. 

In some cases, people decide to purchase a policy when a major life event takes place—like getting married, buying a home, starting a business, or having a baby. But life insurance can be purchased at any time.

In fact, the sooner you buy life insurance, the lower your monthly or annual payments will likely be. Other factors that determine the cost of life insurance are your health status, medical history, and driving record. Smoking status is also a large determinant of your payments, with people who don’t smoke generally receiving significantly better rates.

While historically, purchasing life insurance required medical exams and blood testing, this is often no longer the case. In fact, for relatively healthy individuals, many insurance companies offer a significant benefit without a medical exam or blood test. For larger policies or for people with extensive medical histories, a medical exam can still be required.

Two basic types of life insurance

The two main types of policies are term life insurance and permanent life insurance.

Term life insurance

This offers a cash payout if you pass away during a specific period of time (for example, 10, 20 or 30 years). You pay a fixed monthly or annual premium during the term of the policy. 

Term insurance is a viable option for covering specific costs such as a mortgage or college education. Often, insurance companies will allow you to convert your term policy into a permanent policy for a specified period of time after purchase.

Permanent life insurance

This offers lifetime protection with a cash payout at the time of death, regardless of when that is. It often includes a cash account value that you may be able to access while you are alive, which has the ability to grow, similar to money in other investments (mutual funds, or bonds). Your monthly payments may be fixed or they may be flexible depending on the type of policy you choose. 

Permanent life insurance is a viable option for people looking to pass money on to their family after they pass away, or for people concerned about paying for funeral costs or medical bills at the time of their passing.

When life insurance is offered at work

Some employers offer life insurance as a benefit to their employees. This is generally temporary, good only while you are employed with the company. It may be wise to take advantage of this benefit, however, as the monthly payments may be offset by your employer. 

If you have family who is dependent upon your income, additional insurance, outside of work is generally required. Life insurance can be purchased online, over the phone, or from a licensed financial professional.