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How does life insurance work?

What do you know about life insurance?

Whether you’re a “young millennial” or past retirement age, there’s one thing we can all agree on: the topic of life insurance can get very confusing, very quickly. That’s why we created an entire post to address it! 

Here, you'll learn the answer to questions like: 

  • How does life insurance work? 
  • How much does it cost?
  • When do you need to get it? 
  • Do you even need it at all? 

And our favorite, which always catches people by surprise: how do you know if you already have it? (yup. you read that right!)

Put on your cozy joggers and sit tight, you’re in for a ride!

👀: 12min read

how does life insurance work

📸: Bowery Palms Pump

How does life insurance work?

You’re likely familiar with the concept of insurance, in general. 

You make a payment to an insurance company (aka a “premium”) for the promise that they’ll be there for you if something goes wrong. Travel, health, cars, etc. 

Life insurance is the same – except it covers matters that may come up post mortem. 

(Let’s face it: calling it “death insurance” is too morbid, especially for marketing.)

In the simplest, most direct terms: 

You pay an insurance premium — yearly, monthly, etc. 

When you pass on — your beneficiaries get to “cash in”. 

(For the record: yes, you’ll need to tell the life insurance company who your beneficiaries are — aka, the recipients of your insurance payout — and update this info if/when things change!)

Do you really need life insurance? 

Probably, yes. 

Despite the sad trigger, life insurance does make things easier for your loved ones. 

Insurance payouts can be in the hundreds-of-thousands category. So, in addition to making necessary arrangements for you, your beneficiaries can use this money to pay off debt, cover outstanding mortgages, and more. 

Plus, women in the US have an average life expectancy of 81 years

So, yeah. There’s a high chance you’ll need it. 

And it's a good idea to learn more about how life insurance works early. (it’ll be cheaper, too!)

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Which life insurance policy should you get? 

There are maaany types of life insurance. 

We’d need an entire afternoon together to cover them all!

For this blog, we’ll stick to the 3 most common:

  • whole life insurance (aka the “OG”: permanent, traditional life insurance)
  • term life insurance (aka “pure” life insurance)
  • universal life insurance (aka permanent life insurance + investing/retirement)

Once you understand how these 3 work, other variations become much easier to navigate. 

After that, we’ll provide more clarity on WHEN you need to get it, and which questions can help you make an empowered decision for your specific financial situation.

What is “whole” life insurance? 

Traditionally speaking, this is the “original” life insurance. (Funny enough, it’s also called “traditional life insurance” in some areas). 

It’s a type of permanent coverage, which means you have lifetime coverage: it doesn’t matter how many decades it takes for you to kick the bucket. Whenever it happens, you’re covered. 

Whole life insurance also has a “savings” component (aka “cash value”). 

It’s similar to when you invest in the stock market. The more stocks you buy, and the longer it can accrue interest, the more money you get in return. Of course, your premiums are payments to the insurance company. Once you make a payment, that money is the company’s (not yours). 

But the “cash back” idea is similar: 

If you “invest” in your life insurance, the company returns a small percentage, like the accrued interest and dividends you get from investing (or an actual savings account). 

What’s the payout? 

If something happens to you, your beneficiary gets: 

  • the base value of the policy (aka, a "death benefit" of either $100,000, $250,000, $500,000, and upwards; depends on your contract and what you selected) 

PLUS

  • accrued cash that builds up over time at a fixed interest rate (and is usually tax-free or deferred!). 

Basically, the longer you hold a whole life insurance, the more your family or beneficiary gets whenthey cash out. If you’re considering a whole life policy, it’s a good idea to get it early, so your money has more time to grow. 

How much does it cost?

It depends! 

Insurance companies consider your health, age, and other data they find relevant before determining what to charge you for your monthly fee.

That being said, most healthy 20 to 30 year olds can expect to pay over $200-300 per month for whole life insurance. 

Premiums for traditional policies are much more expensive than what you’d pay for term life insurance, which we cover next. 

PS. Not sure if you can afford whole life insurance? Let Penny’s smart calcs do the math for you! Take our free money quiz

What is “term” or “pure” life insurance? 

With term life insurance – aka “pure life insurance” – instead of lifetime or permanent coverage, you’re bound to a specific time frame (aka, term). 

These terms depend on your situation, including your financial health and goals. 

They’re usually for long blocks of time, like 10, 15, or 20 years. At the end of your term, you can choose to renew or cancel your contract. 

How does life insurance work, when confined by a time limit?

The same way your car insurance does: as long as the contract is valid, and you pay your premiums on time, you’re covered. But if you miss your payments or cancel it, you’re not. Simple, right? 

What’s the payout? 

If something happens to you while the term is in effect, your beneficiary gets: 

  • the base value of the policy (that "death benefit" we talked about before, of $100k, $250k, $500k etc) 

But, remember: if you had a 10-year term, and you forgot to renew it, they get nothing. 

So if you sign a term life insurance contract, keep track of those dates!

How much does it cost?

Again, it depends! 

They’re definitely cheaper than their traditional counterpart, whole life insurance.

The monthly fee for a relatively young (think late 20s or early 30s) and healthy person for a 20-year policy can be expected to be around $20-$30 a month.

Unfortunately, most people only get life insurance when they’re much older. 

And there’s a cost to waiting. 

If you wait until you're 40, for example, the exact same 20-year policy could cost $486/year –  or $40ish per month. Yikes!

Which one’s better: whole life insurance vs. term life insurance? 

Whole life insurance has the added “cash value” benefit — which you don’t get with term life insurance. 

Also, lifetime coverage vs. 10 years? Lifetime, duh! 

But all that comes at a price: whole life insurance is much more expensive than term life insurance. You could pay $300/mo for one, and $30/mo for the other. 

Also, you might not love the idea of a lifetime contract. The opportunity to renew or cancel your coverage every 10 or 20 years isn’t a bad bet. 

Of course, it all depends on your circumstances. 

We have more to say on this (and which one may be the best policy for you). 

But first, let’s talk about Brun–oops, universal life insurance. 

What is universal life insurance?

So far, we covered the 2 most common types of life insurance: 

  • whole life insurance (aka traditional, lifetime coverage, plus savings/cash value)
  • term life insurance (aka pure, limited time, no cash bonus)

Now, it’s time for #3: universal life insurance. 

Universal life insurance (UL) is a type of permanent life insurance.

Like “whole” or traditional policies: 

  1. you’re covered for life
  2. you also get a “savings” bonus or accrued cash

However: 

  1. your “price tag” is more affordable, 
  2. you get more flexibility to negotiate benefits and premiums, and 
  3. you may be allowed to invest your “savings” in the stock market — tax-free.

From the “universal” types, one that comes up often in FAQs is Indexed universal life insurance (IUL).

IULs allow you to invest in stock market indexes like the S&P 500 (which is why it’s called “indexed” insurance). Thanks to that, many people are drawn to IULs because you get higher returns on your cash.

Because of this, it’s also a great way to save for retirement. 

An IUL helps you build wealth over time, just like a Roth IRA (a type of retirement account). 

But… 

It’s totally different in that you have to pay an insurance premium every year (as well as higher fees). Also, it may not be the best fit for your financial situation — soon, you’ll learn why. 

What’s the payout? 

With an IUL, your beneficiary gets: 

  • the base value of the policy (aka, the "death benefit" of either $100k, $250k, $500k etc) 

PLUS

  • accrued cash that builds up over time at a variable rate (and that you’re allowed to invest, tax-free!). 

Since the world of universal life insurance is so flexible, you might discover additional benefits as you dip your toes into these waters. (don’t forget your to-go kit!)

How much does it cost?

Prices fall in between their traditional bro, whole life insurance – and the extra-affordable term life insurance – approximately $150 ish per month

Keep in mind, this “average” can vary significantly. 

The final number also changes based on how much you can pay for the policy in advance. Similar to a down-payment on a house, if you can afford to fork up more money upfront, your monthly fees could be lower. 

Or, if you’ve negotiated a higher death benefit for your loved ones, the cost may increase.

When do you need life insurance?

As women, we live a long time. So we’ll likely want life insurance at some point. 

The bigger question is: when? 

Ultimately, the exact age you need life insurance will depend on:

  • your life & financial goals,
  • your family/beneficiaries, and 
  • your ability to pay for the premiums.

Here’s a great rule of thumb to follow: 

Do you have someone dependent on you, and/or you live in a house with a mortgage?

If yes – Time to think about life insurance! 

But… 

If you answered “not yet, but I’m thinking about it” — then why do you need it

If you’re single or not in a committed relationship, and you don’t own a home yet, who’s the money gonna go to, and what will it fund??

Of course you can get life insurance without dependents or a mortgage. But it’s important to get clear on why you’re doing it. When you determine the answer to that, the intention behind your actions will help you make better – and more empowered – decisions about your money. 

We know everyone’s situation is unique. So, we outlined a few questions and scenarios below to help you determine when to get life insurance (and which one). 

Still wearing those comfy joggers? ;) 

Do you have enough leftover cash each month, after covering your regular expenses AND putting some cash away into a retirement account?

Great! You might want to start with a whole life insurance policy. (yup, the “lifetime” kind.) The monthly payments are lower when you're young. Plus, the longer you hold a whole life insurance policy, the more money your beneficiary will receive once the policy is redeemed.

If you're young, NOT planning to have a family, and in good physical and financial health?

It's a bit more flexible! With a whole life insurance policy, your benefactor will get even more cash if you start early. But if nobody needs it? You might want to consider keeping the extra cash for something else (investing in your 401k, for example).

If you're young, plan to have a family someday, and have the extra cash?

Get started with a whole life policy if you can. Again, it’s the most “bang-for-your-buck” option for 20 and 30 year olds. Yes, it’s more expensive than a 20 or 50-year term policy. But the whole policy’s accrued cash bonus is too good to pass up – especially when it’ll have the chance to snowball for a good 40, 50 years. 

If you have a family (or plan to have one) – and DON'T have much extra cash?

You can take out a term life insurance policy when your child is born, and have it last for an 18 or 20-year term. That way, you're covered throughout the period they'll be most dependent on you. (Win-win!) Also, you may have the opportunity to convert your term life insurance into a permanent contract (aka, “convertible” term life insurance). This gives you more time to set the stage for you to comfortably afford permanent or whole life insurance later on. 

In fact, that’s exactly why Penny started: to help women like you pay off debt and increase your financial net worth – so you’re ready for whatever comes next. Start with our free money quiz. 

If you’re older, already have a family (or plan to have one), and have a SIGNIFICANT amount of money to invest?

Then, universal life insurance (or IUL, indexed life insurance) might be the better fit for you. 

An IUL makes sense if you are:

  • slightly older, 
  • have a family/kids, 
  • have a significant amount of money to invest (and want to reduce risk). 

When we say “significant” we mean literal thousands. So, if you don’t have that much cash to put aside straightaway, then whole life insurance might still be the better fit for you. 

If you’re older, already have a family (or plan to have one), and have a SIGNIFICANT amount of money to invest – and you’re stuck: IUL vs. Roth IRA?

Again, an IUL is a type of universal life insurance that allows you to invest your “extra money” in the stock market. An IRA is a type of retirement account that also includes investing perks.

Here’s how you can tell if the IUL (vs. an IRA) is the right choice for you: 

  1. Are you contributing over $6k a year to an IRA? 

IULs are best for people who are making LARGE upfront investments. Roth IRA caps your contributions to $6k a year. How much are you planning to invest?

  1. How old are you? 

If you’re younger than 40… IUL's might not be great, as they limit the market returns you get from investing (usually 25% of how the stock market performed).

If the stock market has a great year — like 2021’s 28% returns — the IUL may cap your stock market return at 7%. You’ll miss out on tons of growth, and end up with much less at retirement. 

  1. Do you have kids/family and need life insurance anyway? 

Then, you might want to consider it. The IUL is said to be better than whole life insurance, since it’s a dual-insurance plan and retirement investment plan, all in one. 

But if you don’t care for that extra component, or you don’t have large investments to make, stick to the traditional, whole policy route. 

Still confused? Penny has 2 money modules that can teach you all you need to know about both investing and retirement accounts. In less than 1 day. With words you can actually understand. (yup, none of that heavy financial lingo). Curious? Learn more here

How do you know if you have life insurance? 

If you work for a big corp, you might already have it. 

Many Fortune 500 companies offer standard life insurance and disability insurance as part of your benefits package — and you don't even know it

CHECK! 

If you DO have life insurance in your benefits package, take a few minutes to familiarize yourself with your plan. 

Whole life insurance, term life insurance, and universal life insurance are only the tip of the iceberg. 

Other policies may offer you:

  • the ability to adjust your premiums (change your payments at no cost, or pay more/less depending on your current financial situation) 
  • options for variable interest rates (they can change over time; fixed rates stay the same)
  • add-on benefits for both you and your beneficiaries (including an investing component)

So, it’s always good to know what you’re signed up for, even if you don’t intend to “use” it anytime soon! 

If you don’t have life insurance yet, keep this knowledge in your back pocket. Who knows? It might come in handy at your next job, promotion, or salary negotiation. 

In the meantime, we’ll be here cheering you on! 

Ready to make smart money moves? Start with the money maker quiz

Want more money #inspo? Follow us on Insta @startwithapenny

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