How Does Life Insurance Work? What It Is and What It Covers

Life insurance covers a specific financial risk: the income your family would lose if you died and your earnings stopped. It pays out only on death, unlike health insurance, which covers medical costs while you're alive. Some permanent policies also build savings over time, but income replacement is the core purpose.

Life insurance comes in two main types: term and permanent. Both pay death benefits if you die while covered. Premiums stay the same throughout the policy period. Most people just need term life.

Rates are based on average monthly quotes for 40-year-old nonsmokers with average weight and health across insurers, based on MoneyGeek's analysis of composite quotes for a $500,000 policy. Term life figures use a 20-year term length.

Variable life insurance is another type of permanent coverage. It lets you invest your cash value in market-based subaccounts, so your cash value and potential death benefit can grow faster than whole life insurance, or shrink if the investments perform poorly. Indexed universal life insurance works differently: it ties growth to a stock market index with a cap on gains instead of direct market investment. 

Guaranteed universal life guarantees the death benefit to a set age, often 100 or 121, with little or no cash value growth. Final expense insurance is a small, guaranteed permanent policy sold without a medical exam.

You pay premiums to keep your policy active. When you die, your beneficiaries submit a death certificate and the insurer pays the death benefit within 14 to 60 days.

Your age, health, coverage amount and policy type determine your cost. Insurers assess your risk through a process called underwriting: reviewing your medical history, running a health questionnaire and, for most policies, a brief physical exam. Younger, healthier people pay less. Your rate locks in once you're approved and stays the same as long as you pay on time.

Term life insurance covers you for a set number of years: 10, 20 or 30. You choose the term when you buy. If you die during that window, your beneficiaries get the death benefit. If you outlive the policy, coverage ends with no payout and no refund of the premiums you paid. Term costs less than permanent because it covers a finite period and has no savings component.

You can name anyone with an insurable interest in your life as your beneficiary. Insurable interest means your death would create a financial loss for them: a spouse who relies on your income, children you support or a business partner whose share of the business would be affected. Common choices include a spouse, children, a trust or a charitable organization.

Naming a trust as your beneficiary, rather than a person, controls how and when a minor child receives the money, instead of getting a lump sum at 18. You can name more than one beneficiary and set the percentage each receives, and you can change your beneficiary at any time by submitting a new form to your insurer.

Keep beneficiary designations current. 

Your designation overrides your will. An ex-spouse named before a divorce and never updated will receive the payout regardless of what the divorce decree says. Update after marriage, divorce, the birth of a child or the death of a named beneficiary. Name a contingent beneficiary as a backup. Without one, if your primary beneficiary dies before you, the death benefit goes to your estate and must clear probate (the court process for distributing an estate, which can take months) before your family can access it.

Life insurance covers death from illness, accidents and natural causes. In 2024, U.S. insurers paid $89 billion in death benefits to beneficiaries, according to the American Council of Life Insurers. Nearly every claim filed throughout the industry's history has been paid. Insurers pay the death benefit regardless of how the insured died, as long as the cause isn't listed in the policy's exclusions.

Your beneficiaries receive a tax-free lump sum they can use for:

• Immediate expenses: Funeral and burial costs ($7,000 to $15,000)
• Outstanding debts: Mortgage balance, car loans, credit cards
• Ongoing expenses: Monthly bills, groceries, childcare
• Future needs: College tuition, income replacement for five to 10-plus years

Life insurance policies don’t pay out in every situation. These are the usual exclusions:

• Suicide within two years: If death is by suicide during the first two years, the suicide clause stops the payout. Once those two years pass, it’s covered like any other cause.
• Misrepresentation: Die from a condition you left off your application, and the insurer can deny the claim, especially in the first two years.
• War and terrorism: Acts of war and terrorism are typically excluded.
• Criminal activity: Dying while committing a felony can lead to a denial.
• Risky activities: Skydiving, BASE jumping and similar pursuits may be excluded unless you pay for added coverage.
• Beneficiary involvement: A beneficiary who causes the policyholder’s death forfeits the benefit, and contingent beneficiaries receive it.

Term life is the most affordable policy type across all age groups. A 20-year-old woman pays $30 per month for a $500,000 term policy; a 20-year-old man pays $36. Whole life costs the most: $303 per month for a 20-year-old woman and $337 for a man the same age. Age drives costs up sharply regardless of policy type.

The table below shows average monthly costs by policy type, age and gender for a nonsmoker in average health with $500,000 in coverage. Rates vary by provider, so get multiple quotes before buying.

Rates based on MoneyGeek's analysis of composite quotes for a $500,000 policy, nonsmoker in average health. Term life uses a 20-year term.

Life insurance underwriting is the process insurers use to evaluate your risk and determine whether you qualify for coverage and how much you'll pay. The insurer reviews your age, health history, medical exam results, prescription history, tobacco use, occupation and lifestyle.

This review takes two to six weeks for policies requiring a medical exam, while some no-exam policies can approve applicants within 24 to 48 hours.

Filing a life insurance claim takes three steps:

1. Order the death certificate. Ask the funeral home for certified copies. Get at least two, one for the insurer and one for you.
2. Tell the insurer. Phone the claims department or notify it online, with the policy number in hand.
3. Send in the claim form. Fill it out and return it with the death certificate, plus the original policy if you can find it.

Two things can hold a claim up:

• The contestability period. A death in the first two policy years prompts an investigation before payment.
• No named beneficiary. The benefit then goes to the estate, and your family has to wait for probate to clear, which can take months.

In many states, insurers must pay or deny within 30 days of getting a complete claim, though the exact deadline varies. Store the policy documents and the insurer’s contact details somewhere your beneficiaries will find them.

After a claim is approved, beneficiaries choose how to receive the death benefit. The insurer pays the death benefit itself tax-free, regardless of which option a beneficiary chooses. Any interest that accumulates on funds held by the insurer is taxable as ordinary income.

Most beneficiaries choose the lump sum because it provides the most flexibility. The annuity option removes the risk of managing a large sum all at once, which some beneficiaries prefer.

Start by collecting quotes from at least three insurers, since the same $500,000 term policy can cost hundreds of dollars more or less a year from one carrier to the next. Once you’ve picked a policy, name one person as your primary beneficiary and a backup as your contingent beneficiary. Keep your policy documents where your beneficiaries can easily find them.

Revisit your coverage whenever your life changes: a marriage, a divorce, a new child or a big shift in income or debt.

• Life Insurance Calculator: See how much coverage your income, debts and dependents call for.
• Best Term Life Insurance: Compare top term policies for your age and health, ranked on cost, financial strength and customer satisfaction.
• Best Whole Life Insurance: Compare the leading whole life insurers on premiums, cash value growth and financial strength.
• How to Buy Life Insurance: Walk through the buying process and see what you’ll need to apply.