Individual or group life insurance policies are available. We'll be looking at individual policies, not the group life insurance that most employers provide.

What is life insurance?

A life insurance policy is a legal agreement between you and an insurance company. You pay the life insurance company on a regular basis. In exchange, when you die, the company pays a death benefit to your beneficiaries. Life insurance can cover natural deaths, accidental deaths, and even illnesses or injuries while you are still alive, depending on the type of policy you purchase.

There are two types of life insurance: term life insurance and permanent life insurance. Term life insurance protects you for a set period of time, whereas permanent life insurance protects you until the end of your life.

Term life insurance is typically less expensive to purchase than permanent life insurance. Permanent life policies, such as whole life insurance, build cash value over time and do not expire if you pay your premiums on time. If you outlive your term life insurance policy, it is worthless.

How term life insurance works

Term life insurance is coverage that is purchased for a set period of time. This type of life insurance typically covers ten, twenty, or even thirty years. If you die during the covered period, the policy will pay the specified amount to your beneficiaries. Nobody gets paid if you don't die during that time.

Term life insurance is popular because it provides large payouts at a lower cost than permanent life insurance. It's also a short-term solution. It exists for the same reason that temporary tattoos and hair dyes do: sometimes a short time is all that is required.

Term life insurance may be beneficial for the following reasons:

• You want to ensure that your child has enough money to attend college even if you die.
• You have a mortgage that you don't want your spouse to bear after your death.
• You want coverage but cannot afford the higher premiums of permanent life insurance.

There are some differences between standard term life insurance policies. Convertible policies can be converted to permanent life policies at a higher rate, allowing for longer and more flexible coverage. Decreasing term life insurance policies, such as mortgage protection insurance, have a death benefit that decreases over time, and are frequently associated with large debts that are gradually paid off.

How permanent life insurance works

Permanent life insurance policies protect you until death if you pay your premiums on time. The most well-known flavor of this type of life insurance is whole life, but there are others, such as universal life and variable life.

Permanent life insurance policies accumulate cash value over time. Depending on the type of policy you have, a portion of your premium payments are deposited into a cash account, which can earn interest or be invested.

When you're younger and less expensive to insure, cash value usually rises quickly at the start of a policy's life. Whole life policies have a fixed rate of increase in cash value, whereas universal policies fluctuate with the market. It takes time to accumulate cash value in these accounts, which should be taken into account when purchasing life insurance.

While you are still alive, you can use the cash value of your life insurance policy. You can borrow from it, withdraw from it, or simply use the interest payments to pay the premium later in life. You can even surrender the policy, exchanging your death benefit for the current value of the account, minus some fees.

All of these options can result in complex tax issues, so consult with a fee-based financial advisor before accessing your cash value.

Whole life insurance

Whole life policies, with their guaranteed payouts, potential cash value, and fixed premiums, appear to be excellent products, but they come at a price — money. Whole life insurance premiums are significantly higher than term life insurance premiums.

You can see the difference when you compare average life insurance rates. For example, $500,000 in whole life insurance for a healthy 30-year-old woman costs approximately $3,558 per year on average. A 20-year term life policy with the same level of coverage would cost an average of $193 per year.

Consider whole life insurance as an investment with caution. Many investors will find better alternatives elsewhere.

Universal life insurance

A universal life insurance policy provides permanent coverage as well, but with some flexibility. Universal life insurance policies allow you to make larger or smaller payments based on your financial situation or the performance of your investment account. If everything goes well, you may be able to discontinue payments. If not, you may need to increase your payment to make up the difference.

Other permanent life insurance options

Indexed universal life, or IUL, is a type of universal life insurance in which the insurer invests in index funds that attempt to track the stock market. IUL policies are more complicated than plain universal life policies because they frequently include return caps and complex fee structures.

Variable universal life is more adaptable and complicated than IUL. It enables policyholders to invest in a variety of other channels in order to maximize their returns. However, those investments are much riskier.

Variable life sounds similar to variable universal life, but it is not. It's an alternative to whole life insurance with a set payout. Policyholders, on the other hand, can use stocks and other investments to increase the cash value of the policy. Both variable universal life and variable life carry increased risk, and the federal government treats them as securities (i.e., stocks and bonds).

Life insurance basics: Terminology, coverage needs and cost

Life insurance policies can vary greatly. There is life insurance for families, high-risk buyers, couples, and a variety of other groups. Despite their differences, most policies share some characteristics. Here are some life insurance fundamentals to help you understand how protection works.

Common life insurance terminology

• Premiums are the payments you make to the insurance company. These cover the cost of your insurance as well as administrative costs for term life policies. A permanent policy will also allow you to deposit funds into a cash-value account.
• Beneficiaries are the individuals who receive money when a covered individual dies. Choosing life insurance beneficiaries is a critical step in determining the impact of your life insurance. Beneficiaries are frequently spouses, children, or parents, but anyone can be chosen.
• Death benefit refers to the total amount of money the beneficiaries will be paid when the covered person dies. When you buy a policy, you choose this amount, which is sometimes — but not always — a fixed amount. Permanent life insurance can also pay out more money if your cash account has grown and you choose certain policy options.
• Riders are optional features that can be added to a life insurance policy. You may wish to have your premiums paid if you are no longer able to work, or you may wish to add a child to your policy. You can add these and other features to your policy by purchasing a life insurance rider.

Who needs life insurance?

Life insurance, like all insurance, was created to solve a financial problem. Life insurance is necessary because your income is lost when you die. If you have a spouse, children, or anyone else who is financially dependent on you, they will be left without support.

Even if you have no dependents, there will be costs associated with your death. This may imply that your spouse, child, or relatives will be responsible for paying for burial and other end-of-life expenses. Consider your beneficiaries and what they will require as you consider the amount of life insurance coverage you require.

If no one depends on your income and your funeral expenses will not harm anyone's finances, you may be able to forego life insurance. However, if your death will place a financial burden on your loved ones, either immediately or in the future, you may require a life insurance policy.

How much life insurance do you need?

The amount of life insurance you require is determined by your goals. You won't need as much if you're just covering end-of-life expenses rather than trying to replace lost income.

If you want a permanent policy, talk to a fee-only financial advisor. The advisor can explain how a life insurance policy fits into your overall financial plan.

How life insurance is priced

One of the most important factors in determining your life insurance premiums is your health. Because healthier people are less likely to die young, companies can charge them less for life insurance. Because younger people are less likely to die young, life insurance is less expensive (on average) for them.

Women live longer, nonsmokers live longer, people who do not have complex medical problems live longer, and so on. People in these categories typically receive preferential life insurance pricing.

A life insurance medical exam is required for many applications. In order to determine your overall health, the insurer will examine your weight, blood pressure, cholesterol, and other factors.

Some providers will issue life insurance without a medical exam, but the premiums will be higher. You might also be limited to less coverage than you'd like, with some larger insurers capping no-exam policies at $50,000.

If you only need a small amount of coverage, you should see if your employer provides life insurance as a benefit. Employee life insurance may cover some or all of your annual salary as well as basic end-of-life expenses. Basic coverage is usually not subject to an exam and may even be free.