Life Insurance 101

Alden Wicker

How Life Insurance Works

To get life insurance, you take out a policy on yourself (or someone else, with their permission), either through your work or privately, choosing the amount and/or type of coverage your family would need if you were to pass away. You pay a monthly premium (a payment to the insurance company) to keep the policy active and keep yourself covered. The more valuable the policy–meaning the more paid out if you were to pass away–the higher the monthly premium you pay. The cost is also dependent on your health, age and other factors, such as family medical history and smoking. The younger and healthier you are, the less you pay. For “term” policies (the most common type of life insurance), you also need to select the length of time for which you want the policy premiums to stay the same; usually this ranges from 15 to 30 years.

In the event of your death, your beneficiary (the person you designated to receive the benefit) makes a claim, and the insurance company writes him or her a check for the amount of the policy (called a “benefit”), either in a lump sum or in regular payments. The cash benefit is almost never subject to federal income taxes.

Who Needs Life Insurance

    • Couples in which one is working and the other isn’t. If one spouse isn’t working, it will take some time for her to get back into the workforce if she suddenly needs income to live on, and it may be at a lower salary. Life insurance can replace the income of the earner, and at the least ease the transition back into working life. This is especially important if the non-working spouse is disabled and can’t work.
    • Families in which one parent stays at home. This is the traditional reason for life insurance: If one spouse is taking care of the children and the earner passes away, the transition back into working life will be difficult, and complicated by the fact that she might have to pay for child care, an enormous expense. And policies should actually be taken out for both parents. If the non-working spouse dies, the earner will also need additional money for child care and outsourcing tasks, from house cleaning to ordering takeout instead of cooking.
    • Families and couples where both parents work. While this may seem counterintuitive, even if one spouse is still earning an income, there are immediate and long-term extra expenses that come with the death of a spouse. First, there is the funeral. The surviving spouse might also have mortgage payments, school or college tuition, car payments and remaining credit card debt that were only feasible on a dual income. Life insurance is a way of ensuring that your lifestyle won’t suffer should you suffer the premature death of a spouse.
  • Larry

    A comprehensive article… however I would ask you to reconsider your comment: “The only people who don’t need life insurance? Singles who have no one depending on them for income and no major liabilities outstanding.”

    I spent 17 years as an insurance specialist and shared this story many times with financial advisors:  my younger brother at 25 had no debts, wasn’t married, had no children… and in your perspective didn’t need life insurance.  A few short years later he was married, had a mortgage, and a baby boy.  But in the interim survived lymphoma.  With significant financial responsibilites he wasn’t able to buy life insurance until about 9 years later, when he was rated and paid 4x the cost a healthy person would have paid.

    He just enjoyed his 54th birthday, his son is in university, and his mortgage is paid off.  It could have been a lot different story.

    I recommend even younger people with no immediate liabilities purchasing a block of Term 10 insurance in anticipation of becoming parents, home owners, and possibly business owners.


  • Gars

    Two books I recommend are Insurance for Dummies and The Invisible Bankers by Andrew Tobias if you want an education in basic insurance.

  • Momentum Risk Transfer

    Life Insurance is the foundation of personal financial planning for many individuals, especially those with dependents. There is lots of misinformation on the web, this site has some great insights on life insurance. Thank you for sharing. I am reading a must read for any consumer interested in knowing more about life insurance..”Life Insurance second edition a consumer’s handbook” by Professor Joseph M. Belth……I know it is not something many of us consider, however it is very important.