How Life Insurance Works
You pay premiums to an insurance company. If you die while the policy is in force, the company pays the death benefit to the beneficiaries you named. A few more terms you will see:
- Underwriting: how the insurer reviews your age, health and habits to decide whether to offer coverage and at what price. It may include health questions, records or a medical exam.
- Cash value: a savings-like component inside permanent policies that can grow over time. You can generally borrow against it or withdraw from it, but loans and withdrawals reduce the death benefit if not repaid.
- Riders: optional add-ons, such as one that lets you convert term coverage to permanent coverage, or one that waives premiums if you become disabled.
The NAIC’s Life Insurance Buyer’s Guide, written by state insurance regulators, is a good companion to this page. And on taxes: the IRS says life insurance proceeds paid because of the insured person’s death are generally not taxable income to the beneficiary.
Term Life Insurance
Term life covers you for a fixed period, commonly 10, 20 or 30 years. If you die during the term, it pays. If you outlive it, coverage ends, and there is usually no cash value.
Because it is pure protection for a limited time, term gives the largest death benefit per premium dollar when you buy it. Premiums are usually level for the term and much higher if you renew after it ends. Many term policies include a conversion option that lets you switch to permanent coverage without new health questions, within limits written in the policy.
Term suits needs with an end date: income replacement while children are at home, a mortgage, or business loans. Some people ladder policies, buying several terms of different lengths so coverage steps down as needs shrink. More on our term life insurance page.
Whole Life Insurance
Whole life is permanent insurance designed to last your entire life as long as premiums are paid. Typical features are level premiums, a guaranteed death benefit, and a guaranteed cash value that grows on a schedule set out in the policy. Some whole life policies from mutual companies may also pay dividends, which are not guaranteed.
Whole life costs considerably more than term for the same death benefit at the start, because it is built to pay out eventually and to build cash value. It suits needs that do not end: final expenses, leaving money to heirs, providing for a dependent with lifelong needs, or estate planning. Read the guaranteed column of any illustration first; projected dividends are not promises. See our whole life insurance page, and for small policies aimed at funeral costs, our final expense guide.
Indexed Universal Life (IUL)
Universal life is permanent insurance with flexible premiums and an adjustable death benefit, within limits. Indexed universal life credits interest to the cash value based partly on the performance of a market index, without investing your money directly in the market. Three terms define the crediting:
- Cap: the maximum rate credited in a period, even if the index does better.
- Floor: the minimum rate credited, often 0%, so a down year in the index does not reduce cash value through crediting. Policy charges are still deducted.
- Participation rate: the share of the index gain used to calculate your credit.
Insurers can change caps and participation rates over time within the policy’s guaranteed minimums, and the cost of insurance inside the policy rises with age. If credited interest is lower than illustrated, you may need to pay more to keep the policy in force. That is why IUL illustrations, the projections you see when buying, deserve close reading: the non-guaranteed columns are assumptions, not promises. IUL can fit people who want permanent coverage with flexible premiums and can fund it consistently. Our IUL page goes deeper.
The Three Side by Side
| Feature | Term | Whole life | IUL |
|---|---|---|---|
| How long it lasts | Set number of years | Lifetime, if premiums paid | Lifetime, if adequately funded |
| Starting premium for the same benefit | Lowest | Highest | In between, flexible |
| Premiums | Level for the term | Level, fixed | Flexible within limits |
| Cash value | Usually none | Guaranteed growth schedule | Index-linked, with cap and floor |
| Main risk to watch | Outliving the term | Cost; dropping it early | Underfunding; changing caps and charges |
How Much Coverage?
Start with what would need paying if you died tomorrow, and for how long:
- Income your family would need to replace, and for how many years.
- The mortgage and other debts you would want paid off.
- Future goals, such as children’s education.
- Final expenses.
- Minus savings, existing policies and coverage through work.
The life insurance needs calculator does this math with your own numbers. Then match the type to the timeline: needs that end suit term; needs that last suit permanent coverage. Many families use both.
Before You Buy
- Answer health questions fully and honestly. Misstatements on an application can give the insurer grounds to contest a claim.
- Name beneficiaries, including contingent ones, and review them after marriages, divorces and births.
- Check the insurer’s financial strength, since the guarantees depend on the company’s ability to pay.
- Do not cancel an existing policy until the new one is in force, and compare the costs of replacing it.
- Use the free-look period printed in your policy to review it after delivery.
Want to compare life insurance options?
We will start with how long your family would need the money and how much, then compare term, whole life and IUL quotes from carriers we represent.
Request a free comparison Call 208-350-9933Frequently Asked Questions
What is the difference between term and whole life insurance?
Term life covers you for a set period, such as 10, 20 or 30 years, and pays only if you die during that term. Whole life is permanent coverage for your lifetime, usually with level premiums and a guaranteed cash value that builds over time. Term costs much less for the same death benefit at the start; whole life costs more because it lasts for life and builds cash value.
How much life insurance do I need?
There is no single right number. A common approach is to add up what your family would need if you died: income to replace for a number of years, the mortgage and other debts, future costs such as college, and final expenses, then subtract savings and coverage you already have. Our life insurance needs calculator walks through that math.
Is a life insurance payout taxable?
Generally, no. According to the IRS, life insurance proceeds paid to a beneficiary because of the insured person’s death are generally not included in gross income. Interest paid on the proceeds is taxable, and special rules can apply in other situations, so check with a tax professional for your case.
What is indexed universal life insurance?
Indexed universal life (IUL) is permanent life insurance whose cash value can earn interest linked to the performance of a market index, subject to a cap and a floor set by the insurer. Your money is not invested in the market directly. Caps, participation rates and charges can change, and policy illustrations are not guarantees, so read the guaranteed values carefully.
Can I cancel a life insurance policy after I buy it?
Most states give you a free-look period after a policy is delivered, during which you can return it for a refund. The length varies by state and policy, and it is printed in the policy itself. Read the policy as soon as it arrives so you can use that window if something is not what you expected.
Related Guides
Coverage pages for this topic: Term Life · Whole Life · Indexed Universal Life. Other topics in the Learning Center: Medicare, Health Insurance (ACA), Final Expense, Annuities, Long-Term Care, Disability Insurance, Supplemental Health, Short-Term Medical, Travel Insurance.
Sources
This guide does not quote premiums or returns: they depend on age, health, coverage amount and the insurer. No figure here is a guarantee of future performance. This guide is general education, not individual advice.