What are the benefits of life insurance?

Life insurance offers a tax-free financial safety net for your heirs

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Life insurance is a way to provide financial security for your loved ones in the event of your death. You purchase a policy and make regular payments, and the insurer will pay a tax-free death benefit to your beneficiaries. That death benefit can be used any way your beneficiaries see fit: to pay off debt, save for the future or spend on daily needs.

“Life insurance provides crucial financial protection,” said Daniel Ray, a licensed insurance agent based in Jacksonville, Florida, and founder of PinnacleQuote. “It covers living expenses, debts and future costs like college tuition, ensuring that those left behind are not burdened financially during a difficult time.”

Key insights

Life insurance can provide a financial safety net for your heirs in the event of your death.

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Beneficiaries typically don’t have to pay income tax on any death benefit payouts they receive.

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Permanent life insurance policies can accumulate cash value over time, which can be accessed by the policyholder during their lifetime.

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What are the benefits of life insurance?

More than half of American adults own some form of life insurance, according to LIMRA, an insurance trade organization. Among the reasons why people buy life insurance:

Provides a financial safety net

A life insurance death benefit can replace the income lost if you die unexpectedly. This may be particularly important if you have children or other dependents who rely on your care and financial support.

It can also be beneficial for couples where one partner does not work or earns only a fraction of their joint income.

Can cover final expenses

Many insurers sell a particular type of permanent life insurance called final expense insurance or burial insurance.

It carries a relatively low death benefit of as little as $5,000 and is intended to be used for end-of-life expenses, such as medical or legal bills and the cost of a funeral, burial and/or cremation.

But as with other death benefits, your beneficiaries can spend this money any way they choose.

Payouts are tax-free

According to the IRS, beneficiaries typically do not need to pay income tax on any death benefit payouts they may receive. Any interest earned from that payout is subject to taxation, however.

Speak with a tax expert for more information about how current financial regulations may affect you and your heirs.

Provides coverage for chronic and terminal illnesses

Your insurer may offer at little or no extra cost an optional policy add-on known as a terminal illness and accelerated death benefit rider.

This allows you to access your policy’s death benefit in the event that you are diagnosed with a terminal illness so that you have additional financial assets at your disposal for medical bills, end-of-life planning and other expenses. Accessing these funds may be subject to taxation, however.

Many companies also offer what’s known as a waiver of premium rider. This policy add-on — typically offered for free or at low additional cost to the standard policy — covers your life insurance premiums in the event that you become severely disabled and are no longer able to work.

Can fund your kids' college education

Both term and whole life insurance policies come with a fixed premium and a guaranteed death benefit, making it easy for your loved ones to plan for future financial needs like college education.

» MORE: Types of life insurance

What to consider when buying life insurance

Everyone’s life insurance needs are different. Before you start shopping around for the best life insurance policy, you’ll need to do some homework.

Determine how much coverage you need, if any

If you don’t have dependents or are financially secure, life insurance may not be your best option. But if you’re the primary breadwinner in your household or have large debts like a mortgage, a life insurance policy could provide financial peace of mind.

Decide between term and permanent life insurance

There are two basic kinds of life insurance: term and permanent.

Term life insurance is temporary; it lasts only for a specific amount of time. The typical term life policy has level premiums and a guaranteed death benefit, but it contains no savings component to build cash value.

By contrast, permanent life insurance, such as whole or universal life, lasts for a lifetime. It does accumulate cash value, which can be borrowed against or withdrawn. Generally speaking, whole life insurance policies have a fixed premium and guaranteed death benefit, while universal life insurance coverage has an adjustable premium and a death benefit that isn’t guaranteed.

If you only need coverage until the kids are grown or the house is paid off, a term life insurance policy may be better. But if you want lifelong protection and have investment income, a permanent life policy might be worth investigating.

» MORE: Term vs. whole life insurance

Compare life insurance quotes and companies

Ideally, get three to five quotes from different insurers to find the best price and amount of coverage.

The cost of life insurance depends on a number of factors, including your age, gender, overall health and more. But in general, term life insurance is cheaper than permanent, and premiums will be cheaper the younger you are.

“Earlier is generally better as younger individuals benefit from lower rates due to being at a lower risk for health issues. However, it's still worth considering life insurance at any age, as there are policies designed to cater to the needs of older individuals,” said Ray. “Additionally, maintaining a healthy lifestyle and comparing rates from different providers can help lower insurance costs.”

Apply for coverage

Depending on the company, you may be able to apply online, or you may have to speak with an agent. You may have to answer questions about your general health or submit to an insurance medical exam before your application is approved.

Once you’ve been approved by the insurer, you can purchase your policy. Depending on the company, you may be able to do this online, on the phone with a company rep or in person with an agent or broker. Your coverage will then take effect.

» COMPARE: Best life insurance companies

Where to buy life insurance

Generally speaking, you have three options for buying life insurance:

  • Directly from the insurer, typically via its website or by telephone. Prudential and Haven Life are just two examples of companies that allow you to purchase coverage online. Others allow you to begin the process online before switching to a company representative to complete the transaction.
  • From a company representative or agent. Some insurers, such as State Farm, make you work with a local agent in order to get a quote or purchase coverage. These people, sometimes called “captive” agents, are typically salaried employees of one company.
  • From an independent agent or brokerage. Unlike a company agent, who can only offer policies from one insurer, an independent representative can give you quotes from several insurers, potentially offering more options than a captive agent.

Note that not all companies that sell life insurance offer every type of policy.

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How much life insurance do I need?

Everyone’s needs are different when it comes to life insurance. For those without dependents or shared outstanding debts, life insurance is not a necessity. However, you should consider getting a million-dollar policy if you have dependents relying on you for financial stability. Remember, dependents you leave behind will still need to pay for the mortgage, large debts and future college expenses.

Is life insurance taxable?

Generally speaking, the death benefit of a life insurance policy is not considered gross income by the IRS and therefore does not need to be reported on your taxes, so long as it is paid in a lump sum and does not accrue interest.

If you have a permanent life insurance policy, its cash value will grow on a tax-deferred basis. You’ll only be subject to tax if you withdraw money from the policy or do not repay any funds you’ve borrowed.

What are the five types of life insurance?

The five types of life insurance are term, permanent, variable, final expense and guaranteed issue.

  • Term life insurance lasts for a set period of time. It has level premiums and a guaranteed death benefit, but no cash value.
  • Permanent life insurance, such as whole or universal, lasts for a lifetime and includes a savings component that accrues cash value over time. Whole life insurance has fixed premiums, a guaranteed death benefit and a fixed rate of return on the cash value. Universal life has adjustable premiums but the death benefits are not guaranteed.
  • Variable life insurance is another type of permanent life coverage. It has fixed premiums, a guaranteed death benefit and a savings component that allows you to invest in stocks, bonds and money markets.
  • Final expense insurance, also called burial insurance, has relatively low premiums and an equally low death benefit. It is intended for end-of-life expenses such as doctor bills and funeral costs.
  • Guaranteed issue insurance is a form of permanent life insurance that is marketed to older individuals, regardless of health. But death benefits tend to be much lower, while premiums can be high.
What's better, term life insurance or whole life insurance?

Choose term life insurance if you only want coverage for a temporary period of time, such as five, 10, or 20 years. A standard term life policy has a fixed premium and a guaranteed death benefit, with coverage of up to $1 million or more, depending on the policy and company.

Choose whole life insurance if you want coverage that lasts for a lifetime as well as potential investment income while you’re alive. The typical whole life policy has level premiums and a death benefit that’s guaranteed, as well as a savings component with a fixed rate of return. Depending on the policy and company, coverage of $1 million or more may be available.

Generally speaking, a whole life insurance policy is more expensive than a comparable term life policy.

Bottom line

Buying a life insurance policy can benefit both you and your loved ones. Both term life insurance and permanent life insurance will provide a death benefit for your beneficiaries, allowing them to use the tax-free payment for bills, savings and future expenses.

A term life insurance policy is cheaper on average than a comparable permanent life policy. But only permanent life insurance contains an investment component that you can withdraw or borrow from while you’re alive.

Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
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  17. Progressive, “Final Expense Insurance.” Accessed March 26, 2024.
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  19. Fidelity Life, “What is guaranteed issue life insurance?” Accessed March 26, 2024.
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