Life insurance is a contract where you pay premiums and the insurer pays a tax-free death benefit to your beneficiaries when you die. The death benefit covers funeral expenses, outstanding debts, mortgage payments and income replacement. Your beneficiaries can use it for any financial need.
What Is Life Insurance: How It Works & What It Covers
Life insurance is a contract where you pay premiums and the insurer pays a tax-free death benefit to your beneficiaries when you die. The death benefit covers funeral expenses, outstanding debts, mortgage payments and income replacement. Your beneficiaries can use it for any financial need.
Learn about how life insurance works and what it covers.
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Updated: October 29, 2025
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Key Takeaways
Life insurance is a contract where you pay premiums and the insurer pays a tax-free death benefit to your beneficiaries when you die.
The death benefit covers funeral costs, outstanding debts, mortgage payments and income replacement. Your beneficiaries can use it for any financial need.
Life insurance covers death from illness, accidents and natural causes. Common exclusions include suicide within two years, undisclosed health conditions and deaths during criminal activity.
Your life insurance cost depends on age, health, coverage amount and policy type. Younger, healthier applicants pay less, and rates lock in when you buy.
What Is Life Insurance?
How Does Life Insurance Work?
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 medical exam and health questionnaire. Younger, healthier people pay less. Your rate locks in once approved and stays the same as long as you pay on time.
- 1How Does Term Life Insurance Work?
Term life insurance covers you for 10, 20 or 30 years. Your beneficiaries get the death benefit if you die during the term. If you outlive the policy, coverage ends with no payout. Term policies cost less because they cover a shorter timeframe.
- 2How Does Permanent Life Insurance Work?
Permanent life insurance, like whole life, covers you for life and guarantees a death benefit payout when you die. It costs more than term insurance because of the lifetime guarantee. Permanent policies build cash value over time that grows tax-deferred. You can borrow against it or withdraw funds while alive.
What Life Insurance Covers
Life insurance covers death from illness, accidents and natural causes. Your beneficiaries get 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 5 to 10+ years
The death benefit is paid regardless of how you die, as long as the death isn't specifically excluded (see exclusions below).
What Life Insurance Does Not Cover
Life insurance policies exclude specific circumstances. Common exclusions include:
- Suicide within two years: Policies include a suicide clause that prevents payout if death occurs by suicide within the first two years. After two years, suicide is covered.
- Misrepresentation on your application: If you die from a condition you didn't disclose, the insurer denies the claim, especially within the first two years. False information leads to claim denial.
- War and terrorism: Policies exclude deaths from acts of war or terrorism.
- Criminal activity: If you die while committing a felony, the insurer may deny the claim.
- Risky activities: Some policies exclude deaths from high-risk activities like skydiving or BASE jumping unless you buy additional coverage.
- Beneficiary involvement: If a life insurance beneficiary causes the policyholder's death, that beneficiary can't collect the death benefit. Proceeds go to contingent beneficiaries.
EXPERT TIP: THE CONTESTABILITY PERIOD
The first two years of any life insurance policy is called the contestability period, where insurers can investigate claims more thoroughly and deny death benefits if they find misrepresentations on your application. Answer all health and lifestyle questions honestly.
What Are The Types of Life Insurance?
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. Here are the most popular policy types:
Term Life | $30 to $75 | 10, 20 or 30 years | No | Families needing affordable protection during high risk years (mortgage, raising kids). What 95% of buyers need. |
Whole Life | $400 to $600 | Lifetime (if premiums paid) | Yes (guaranteed growth 2% to 4%) | High earners who maxed out retirement accounts and need estate planning tools. |
Final Expense | $50 to $150 | Lifetime | No | Seniors (typically 50 to 85) covering funeral costs ($7,000 to $15,000 coverage). No medical exam required. |
Other permanent options include Universal Life, Indexed Universal Life and Guaranteed Universal Life. These offer different cash value growth rates and premium flexibility but work similarly to whole life insurance.
Common Questions About How Life Insurance Works
- 1Who needs life insurance?
Life insurance is worth it if your family depends on your income or would struggle financially after your death. Buy early to lock in lower rates. Singles without dependents benefit from coverage that pays off debts and funeral costs without burdening family. Use our life insurance calculator to estimate how much coverage you need.
- 2How long does it take to get approved for life insurance?
Approval typically takes two to six weeks with a medical exam. No-exam policies can approve you within 24 to 48 hours but may cost more. The insurer reviews your application, medical exam results and medical records before making a decision.
- 3Do I need a medical exam to get life insurance?
Most policies require a medical exam. A paramedical examiner measures your vital signs and collects blood and urine samples at your home or workplace. The exam takes 30 to 45 minutes. Many companies skip the exam for younger applicants, but you'll pay more since the insurer knows less about your health.
- 4How do beneficiaries receive the death benefit in the claims process?
Beneficiaries submit a death certificate and claim form to the insurer. Insurers pay claims within 14 to 60 days. You can get the payout as a lump sum or structured payments.
- 5Are life insurance death benefits taxable?
Death benefits are tax-free. Exceptions include interest on delayed payments and estates exceeding $14 million. If you borrow against or withdraw from a permanent policy's cash value, you'll pay taxes on amounts exceeding your total premiums paid.
- 6What happens if I miss a premium payment?
Most policies give you 30 to 31 days after your payment due date to pay. If you don't pay within the grace period, your policy lapses and coverage ends. Permanent policies may tap accumulated cash value to cover missed payments temporarily.
- 7Can I access my life insurance while alive?
Permanent life insurance policies build cash value you can borrow against or withdraw while alive. Policies also offer accelerated death benefits if you're diagnosed with a terminal illness, letting you tap a portion of the death benefit early.
- 8Do you get money back for life insurance paid?
Not with standard term or permanent policies. Return-of-premium term policies refund your premiums if you outlive the term, but they cost more upfront.
Compare Life Insurance Rates
Ensure you’re getting the best rate for your life insurance. Compare quotes from top providers to find the most affordable life insurance coverage for your needs.
How Does Life Insurance Work: Expert Advice
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About Mark Fitzpatrick
Mark Fitzpatrick, a Licensed Property and Casualty Insurance Producer, is MoneyGeek's resident Personal Finance Expert. With over five years of experience analyzing the insurance market, he conducts original research and creates tailored content for all types of buyers. His insights have been featured in publications like CNBC, NBC News and Mashable.
Fitzpatrick holds a master’s degree in economics and international relations from Johns Hopkins University and a bachelor’s degree from Boston College. He's also a five-time Jeopardy champion!
He writes about economics and insurance, breaking down complex topics so people know what they're buying.
sources
- Internal Revenue Service. "Estate Tax." Accessed September 24, 2025.
- Internal Revenue Service. "Life Insurance & Disability Insurance Proceeds - FAQs." Accessed September 24, 2025.