What are the answers to my life insurance questions?
A slim majority (54%) of Americans have some sort of life insurance coverage, according to LIMRA’s 2020 Insurance Barometer Study. They can sleep easy knowing that their death won’t cause a financial burden for their loved ones.
On the other hand, 46% of Americans aren’t covered by life insurance.
Maybe you’re one of them. Maybe you buy into the persistent life insurance myth that only certain types of people need coverage. Maybe you’re put off by medical underwriting, which often requires a medical exam. Or maybe you’re just overwhelmed by life insurance jargon — riders, premiums, death benefits, and on and on — and don’t know where to turn for answers.
Whatever you want to know about life insurance, you’ve come to the right place. Read on for a comprehensive list of answers to commonly asked questions about:
- Basic life insurance concepts
- The various types of life insurance
- How to shop for, apply for, and purchase life insurance
- How life insurance policies work
Life Insurance Basics
These questions and answers cover the basic concepts and processes every life insurance applicant should know, like calculating how much life insurance you need and who to make the beneficiary of your policy.
What Is Life Insurance?
Life insurance is a binding contract between a policy owner and a life insurance company. Usually, the policy owner is also the named insured — the person whose life the policy covers.
In exchange for regular payments by the policy owner, called premiums, the insurance company promises to pay out an agreed-upon amount of money when the named insured dies. This payment is known as a death benefit and usually goes to the policy’s beneficiary or beneficiaries.
Some life insurance policies pay out only when the named insured dies or in certain other very specific situations, such as when the named insured is diagnosed with a terminal illness. Others are more flexible and can be tapped for cash while the named insured is still alive.
Who Needs Life Insurance?
If your death would create a financial burden for any of your survivors, you likely need some amount of life insurance. This financial burden might arise through the loss of your income, the loss of household labor, or the assumption of debts that survive you.
More specific reasons why you might need life insurance include but aren’t limited to:
- Your survivors would struggle to fund your final expenses, such as funeral and burial costs.
- You have significant personal debts that can’t be discharged in death, such as private student loans.
- You have significant jointly held debts that will survive you, such as a mortgage on which you and your spouse are co-borrowers.
- You live in a community property state where debts initiated during marriage transfer to the surviving spouse, even if they’re not jointly held.
- Your survivors rely on your income to cover household expenses and maintain a reasonable standard of living.
- Your survivors have significant expected future expenses, like college tuition.
- You provide unpaid labor for your household that is costly to replace, such as child care and cooking.
How Much Does Life Insurance Cost?
Numerous factors affect life insurance premiums. The most important include:
- Type of Policy (Permanent vs. Term). Permanent life insurance costs much more than term life insurance. To get the same death benefit, expect to pay anywhere from three to 10 times as much for permanent life insurance, depending on the specific policy type.
- Age. All else being equal, younger life insurance applicants pay lower premiums than older life insurance applicants.
- Length of Coverage. The longer your policy remains in force, the higher your premium will be. This is because older people are more likely than younger people to die.
- Policy Size (Death Benefit). The greater the value of the policy, the higher the premium.
- Tobacco Use. Tobacco use is a big red flag for insurance companies. If you smoke or use other types of tobacco products, or have in the past, your premiums will be higher than an otherwise identical applicant’s.
- Family Health History. If you have known health issues in your immediate family that resulted in premature death, such as cancer or heart problems, you’ll pay more for life insurance.
- Personal Health History. If you have any known medical conditions that could reduce your life expectancy, your premiums may be higher.
- Driving Record. If your driving record is peppered with moving violations, crashes, or serious infractions like driving under the influence, your risk of dying in a car is higher than the baseline. Accordingly, you’ll pay more for life insurance.
How Much Life Insurance Do You Need?
“Ten times your current income” is a rough rule of thumb that works for many life insurance applicants. Under this rule, someone earning $75,000 per year would need $750,000 in life insurance coverage.
If you have significant debts or expected future expenses, or you earn a disproportionate share of your household income, the “10x rule” might underestimate your life insurance needs. Instead, you can calculate your income replacement needs in four steps:
- Figuring out how long you’ll need life insurance (in number of years) and multiplying your income by that number. For example, if you earn $75,000 per year and expect to need life insurance for 30 years, you’d multiply $75,000 by 30 to get $2.25 million.
- Add in any debts or expected expenses that would increase the financial burden on your survivors, such as an outstanding mortgage balance or tuition bill.
- Subtract your assets, such as savings and investment account balances and home equity.
- Use a future value calculator (Calculator.net has a free one) to adjust for inflation. Set the inflation rate at a realistic but conservative level, such as 2%. In this example, the future value of $2.25 million in 30 years is about $4.08 million. That’s how much life insurance you need right now to replace your expected income — perhaps rounded up to $4.1 million to add a margin of safety.
What’s the Minimum Amount of Coverage for Life Insurance?
Life insurance coverage minimums vary by policy type and insurer.
The typical minimum amount of coverage for an individual term life insurance policy is $50,000 or $100,000, although some insurers may offer coverage in lower amounts.
Term life insurance issued through an employer may come with a lower coverage minimum, such as $25,000. This is more likely if coverage is offered as a free or pre-tax benefit of employment.
Because permanent life insurance is more expensive for policyholders, coverage minimums tend to be lower, in the neighborhood of $10,000 to $25,000.
More specialized types of life insurance, like final expenses life insurance and life insurance for children, may have coverage minimums as low as $1,000.
What Is a Life Insurance Death Benefit and Who Gets It?
A death benefit is a lump-sum payment to a life insurance policy’s beneficiary or beneficiaries. It is equal to the policy’s face amount (or face value) — the amount of coverage you applied for.
Usually, the death benefit is paid within days or weeks after the named insured’s death. If the policy has an accelerated death benefit rider, the insurer may pay a portion of the death benefit before the named insured dies.
Who Should You Name As Your Life Insurance Beneficiary?
When you apply for a life insurance policy, you must name at least one beneficiary. Life insurance beneficiaries are usually individual people but can also be business entities, trusts, charities, and other qualifying organizations.
Most people name their spouses, domestic partners, or children as beneficiaries. In some cases, such as when the death benefit is large or the beneficiary is a child, it may make more sense to name a trust as a beneficiary. This ensures that you (through the trustee) have more control over how and when the policy’s death benefit is distributed.
If you’re legally married, you may need permission from your spouse to name someone other than them as your life insurance beneficiary. This rule varies by state, so ask your insurance agent or consult an insurance attorney for guidance.
Can You Name More Than One Life Insurance Beneficiary?
Yes, you can name more than one beneficiary, and you probably should.
There are two types of life insurance beneficiaries: primary beneficiaries and contingent beneficiaries.
When you name one primary beneficiary, they receive 100% of the death benefit. When you name multiple primary beneficiaries, they each receive a percentage of the death benefit. This can be a custom percentage, such as 50% for your spouse and 25% each for your two adult children, or simply divided evenly among all primary beneficiaries you name.
Contingent beneficiaries don’t receive any portion of the death benefit unless there are no primary beneficiaries remaining when you die. This can happen if the primary beneficiaries die before you do or if they waive their right to the death benefit.
Can Children Buy Life Insurance?
Children can’t buy life insurance by themselves. However, you can buy a life insurance policy in your child’s name before they reach adulthood.
Child life insurance is usually structured as whole life insurance, so it remains in force as long as premiums are paid. Children generally assume ownership of the policy when they reach adulthood and may have the option to buy more coverage as adults.
Can You Take Out a Life Insurance Policy on Another Person?
Yes, you can take out a life insurance policy on another person. This means that you are the policy owner and beneficiary and the other person is the named insured.
You can’t take out a life insurance policy on someone else without them knowing about it, however. You must get the person’s written permission first.
Depending on your relation to the person, you may also have to prove an “insurable interest” in them. In other words, you may have to show that you’d suffer financially if they died.
“Insurable interest” is assumed for close relations like spouses or parents. When the relationship isn’t as clear, insurance companies typically require documentation of financial ties between the policy owner and named insured. For example, if you’re taking out a life insurance policy on your business partner, you’ll need to prove that you both own an interest in the business.
Can You Get Life Insurance Through Your Employer?
Yes, many employers, labor unions, and professional associations offer group life insurance plans.
The details of these plans vary, but the plan sponsor (the employer or other organization) often pays part or all of the premiums. The default amount of coverage is usually low, like $25,000 or $50,000, but employees may have the option to purchase additional coverage. Under federal tax law, the IRS considers employer-paid premiums for coverage over $50,000 to be taxable income.
Are Life Insurance Premiums Tax-Deductible?
Premiums paid by an employer on less than $50,000 in group life insurance coverage may not be considered taxable income.
Group life insurance premiums paid by an employee via payroll deduction may be “pretax,” which means they’re not included in the employee’s taxable income.
However, individual life insurance premiums are not tax-deductible when paid by the policyholder.
Are Life Insurance Death Benefits Taxable?
Generally, no — life insurance beneficiaries usually don’t have to pay taxes on benefits.
Limited exceptions to this rule include:
- Estate Tax. When the death benefit goes to the named insured’s estate, the estate’s heirs may be subject to estate tax. This happens only if the estate is big enough not to qualify for the estate tax exemption (about $12 million as of 2021).
- Interest Income. If you ask the life insurance company to delay payment of your death benefit, your beneficiaries may have to pay taxes on interest income generated during the delay.
How Do Life Insurance Companies Make Money?
Life insurance companies make money by collecting more in premiums than they pay out in death benefits. They may also invest premium payments, generating income that offsets the cost of paying out death benefits.
Types of Life Insurance
Once you’ve assessed your life insurance needs, you’ll need to determine which type of life insurance (or types) best fit them. Expect these questions to come up sooner or later.
What Is Term Life Insurance?
A term life insurance policy remains in force for a set length of time, measured in years. This is the policy term.
If the named insured dies during the policy term, the beneficiary receives the full death benefit (with limited exceptions). If the named insured outlives the policy term and doesn’t renew, the policy expires worthless and the beneficiary receives nothing.
What Is a Life Insurance Policy’s Cash Value?
Certain types of permanent life insurance may build cash value over time. They do this by putting a portion of premiums paid toward a cash balance that is separate from (although related to) the death benefit.
Policies that can build cash value include whole life, universal life, variable life, and variable universal life. Look for policies specifically marketed as having a “cash value component.”
Life insurance cash value is similar to the equity in a home. Depending on the type of policy, policyholders can access it in several ways:
- Borrowing against it at an interest rate that’s lower than credit card and personal loan rates)
- Withdrawing it from the policy, although this can reduce the death benefit if it’s not repaid before the policyholder’s death
- Putting it toward policy premiums, reducing premiums’ out-of-pocket costs
- Using it to buy additional coverage, raising the policy’s death benefit
- “Surrendering” the policy and taking the cash value as a lump-sum payment
What Is Whole Life Insurance?
Whole life insurance is a type of permanent life insurance. Rather than having a fixed, finite term, whole life insurance remains in force until the policy is canceled or the policyholder dies.
Whole life premiums remain fixed for the entire length of the policy.
Whole life insurance policies generally have a cash value component. The cash value grows at a relatively low fixed rate that is guaranteed not to decrease. Whole life is therefore more predictable and less risky than types of permanent life insurance that allow the cash value to fluctuate.
What Is Universal Life Insurance?
Universal life insurance is a type of permanent life insurance that allows the policyholder to adjust the premium and death benefit upward or downward while the policy remains in force. Its cash value earns interest at variable rates that can fluctuate upward or downward but cannot go negative.
What Is Variable Life Insurance?
Variable life insurance is a type of permanent life insurance that allows policyholders to invest the cash value in mutual funds and other instruments provided by the insurance company. Because the value of these instruments can increase or decrease, variable life insurance is regarded as both higher-risk and higher-reward than whole or universal life insurance.
Variable life premiums and death benefits remain level for the life of the policy.
What Is Variable Universal Life Insurance?
Variable universal life insurance blends characteristics of variable and universal life insurance. Policyholders can adjust premiums and death benefits while the policy remains in force, and the cash value is subject to grow or shrink based on the performance of the funds where it’s invested.
What Is Key Person Life Insurance?
Key person life insurance is an insurance policy taken out on the life of a person considered critical to a company or business venture. The idea is to offset the financial harm that the person’s death would cause to the enterprise.
In closely held businesses and partnerships, the beneficiary or beneficiaries may use the death benefit to buy out the ownership interest of the key person’s survivor or survivors. This prevents potentially unqualified heirs from getting involved with the business.
The owner of a key person life insurance policy is often the company itself but can be another owner or partner in the business. The policy owner typically pays the premiums as well. The named insured is usually an owner, partner, or top executive.
What Is Accidental Death and Dismemberment Insurance?
Accidental death and dismemberment insurance, or AD&D, is a type of life insurance that pays out when the named insured is killed or maimed in covered accidents.
Unlike most forms of life insurance, AD&D pays out for serious but nonfatal injuries such as losing an arm or being blinded in one eye. Payouts for such “dismemberment” injuries are lower than the full death benefit, however.
AD&D can be purchased separately or added to an existing life insurance policy for an additional premium payment. When added to an existing life insurance policy, AD&D increases the policy’s death benefit for accidental death.
For example, a $1 million life insurance policy with $500,000 in AD&D coverage would pay out $1.5 million if the named insured died in a covered accident and $1 million if the named insured died of natural causes.
What Is Guaranteed Issue Life Insurance?
Guaranteed issue life insurance is a type of whole life insurance that does not require medical underwriting. That means you don’t need to take a medical exam when you apply and your application can’t be turned down for any health-related reason.
Guaranteed issue policies have low death benefits, usually not more than $25,000 or $50,000. Premiums are very expensive in comparison with other types of life insurance, including whole life policies that require medical underwriting.
For these reasons, guaranteed issue coverage is best for people with health problems that may interfere with medical underwriting. It’s useful for covering final expenses and not much else, which is why the terms “guaranteed issue insurance” and “final expenses insurance” are often used interchangeably.
Is Whole Life Insurance a Good Investment?
Purchasing a whole life insurance policy (or any other type of permanent life insurance policy) is not an efficient way to build wealth.
This is because every permanent life policy sets aside a significant fraction of total premiums paid for the death benefit, leaving less for the cash value component. By contrast, when you buy stocks or other market-traded investments, your entire purchase has the potential to grow.
Returns on whole life policies do increase over time, so the investment gets “better” as it ages. Likewise, because insurers don’t accept term life applications from older people (usually age 65 and over) and whole life coverage does not have a fixed term, whole life makes sense if you really do need coverage for your entire life.
Finally, whole life is useful if you have a high net worth and want to further diversify your investments or shield some of your liquid wealth from estate taxes after you die.
Can You Convert a Term Life Insurance Policy to a Permanent Life Insurance Policy?
Often, yes — many term life insurance policies include a conversion rider that allows you to change to a permanent policy during what’s known as a conversion period. The conversion period generally extends from five years after the policy is purchased through the end of the policy term.
When you convert a term policy to a permanent policy, your premium will increase significantly. However, you may have the option to reduce your death benefit and partially offset the increase.
Buying Life Insurance
Shopping for and buying life insurance is just a tad more complicated than navigating Amazon. Expect these questions to come up as you search and apply for life insurance.
Can You Apply for an Individual Life Insurance Policy If You Have Life Insurance Through Your Employer?
Yes, you can have a group life insurance policy with an employer and an individual policy purchased on your own. If your employer policy isn’t big enough to address your life insurance needs, you’ll want an individual policy to make up the difference.
Plus, an individual policy you purchase on your own remains in place even if you change jobs. Employer-sponsored group policies typically only cover you as long as you remain an employee.
When Buying Life Insurance, Should You Use a Life Insurance Agent or a Life Insurance Broker?
Life insurance agents generally work for one insurance company. This limits applicant choice. Self-employed agents may work with multiple companies, but they still may not offer a truly comprehensive selection of life insurance options.
By contrast, life insurance brokers work with many different life insurance companies and strive to provide the best value for potential applicants. Begin your search with a digital broker (like PolicyGenius) that impartially serves up policies that fit your needs.
Can You Buy Multiple Life Insurance Policies at the Same Time?
Yes, you can buy multiple overlapping life insurance policies. This is a common cost-cutting strategy known as life insurance laddering.
The idea behind life insurance laddering is to carry only as much term life insurance coverage as you actually need. As you age, your net worth (hopefully) increases and your debts and expenses (hopefully) decrease, so you’ll need less coverage. A typical ladder for a 30-year-old applicant might include:
- A 30-year, $500,000 term life policy
- A 20-year, $1 million term life policy
- A 10-year, $500,000 policy
During the first 10 years, when their net worth is lowest and debts are highest, the applicant has $2 million in combined coverage. That steps down to $1.5 million in coverage from years 11 to 20 and down again to $500,000 from years 21 to 30. After that, they’ll be close to retirement, their house will be paid off or close to it, and they’ll have an ample nest egg to draw upon.
What Happens If You Lie on Your Life Insurance Application?
If the insurance company discovers a false statement before approving your application, it may ask for clarification or simply deny the application altogether. A denial is more likely if the lie is obvious and seems intentional, like saying you’re 30 years old when you’re actually 40 years old.
Worse, the insurer may report the incident to MIB. MIB is an information broker that insurance company underwriters use to research applicants. If you apply for life insurance again, your new would-be insurer will see that you’ve been dishonest in the past and may choose not to consider your application.
If you’re approved for coverage after intentionally misrepresenting something on your application, the insurer has the right to reconsider your policy if you die within the first two years. If it decides that the lie affected its approval or rate decision, it may choose not to pay out death benefits.
Do All Life Insurance Applications Require a Medical Exam?
No-medical-exam life insurance policies (or “no-exam policies”) do not require a medical exam during the application process. However, some no-exam policies do consider the applicant’s answers to health- and lifestyle-related questions and may review their medical records for evidence of potential health issues.
What Happens During a Life Insurance Medical Exam?
Sometimes called a “paramedical exam,” a life insurance medical exam is a brief but important health check that insurers may require as a condition of approval. The exam helps insurers more accurately assess your health and thus your risk of dying prematurely.
Depending on your insurer, your life insurance medical exam might take place in an exam room at a public medical testing center or in your home. It’s usually conducted by a licensed nurse. They’ll take your weight, height, blood pressure, pulse rate, and possibly other vitals.
Your nurse may also draw a blood sample for lab tests or ask you to provide a urine sample. They’ll send it off to a lab to test for:
- Illicit drugs, which may disqualify you from coverage altogether
- Nicotine, which can raise your rates or disqualify you from coverage
- Sexually transmitted diseases, including HIV/AIDS, which can raise your rates or disqualify you from coverage
- Cholesterol and other signs of possible heart disease
- Proteins associated with diabetes or prediabetes
- Proteins and other indicators associated with kidney disease
During the in-person portion of the medical exam, you may also be asked questions about your health history and behaviors. This is done to confirm your answers to similar questions on the life insurance application and to compare your reported health behaviors with your exam results.
For example, if you say that you don’t use tobacco but your urine sample is positive for nicotine, the insurer may decline your application.
All told, the medical exam should take 30 minutes or less. However, it can take days or even weeks to get test results back from the lab.
How Should You Prepare for a Life Insurance Medical Exam?
You want to be in the best physical shape possible for your life insurance medical exam. For at least 24 hours prior, avoid excessive sugar consumption (such as soda). Avoid alcohol, caffeine, and over-the-counter drugs like ibuprofen as well.
Don’t eat a big meal for at least eight hours before your exam. If you can, schedule the exam in the morning and skip breakfast.
An hour or two before the exam, drink a glass of water. This ensures you’ll be able to produce a urine sample if asked. But don’t over-hydrate because too much water could dilute your urine and mess up your test results.
How Long Does It Take to Get Life Insurance?
The life insurance application process can take anywhere from a few minutes to a few weeks.
This depends on how thorough the insurer’s underwriting process is (and whether the insurer does traditional underwriting at all). Approval is much faster for no-exam life insurance than for traditional life insurance.
Life Insurance Policies
You’ve made it through the shopping and application process and you’re now the proud owner of a shiny new life insurance policy. But you still have questions about how your policy works. And you want to be absolutely sure it’ll be there for your loved ones should you die before your time.
These common policy-related questions have you covered.
How Long Does a Life Insurance Policy Last?
A term life insurance policy lasts at least as long as its initial term. Life insurance terms typically range from five to 30 years. Terms of 10, 15, and 20 years are common as well. During this initial term, the premium remains fixed or “level” and doesn’t rise.
At the end of your initial term, you may have the option to renew your policy for one or more shorter terms, usually lasting one year each. Your premium will be much higher if you choose to renew because you’ll be older.
Permanent life insurance policies don’t have fixed terms. As long as you pay premiums, your permanent life policy remains in force until you die or cancel the policy.
How Frequently Do You Pay Life Insurance Premiums?
Life insurance companies generally charge premiums monthly or annually, but some offer quarterly or semiannual (twice per year) options. Some insurers offer small discounts (usually 5% or less) for policyholders who pay semiannual or annual premiums.
What Happens If You Stop Paying Your Life Insurance Premiums?
If you fail to pay your premium, your policy could be at risk of lapsing (being cancelled by the insurance company).
This is a particular risk for term life policyholders. Every term life policy has a grace period that runs for about 30 days after the premium payment is due.
If you don’t pay your premium during the grace period, the insurer has the right to cancel the policy. If this happens, you may have to reapply for coverage, likely at higher rates than your initial policy. However, if it hasn’t been too long since you made a payment, you may be able to apply to reinstate your original policy without full underwriting.
As soon as you know you’ll have difficulty making a payment, you should contact your insurer and ask about your options.
Permanent life policyholders have more options to reduce or even temporarily stop their premium payments. Depending on the policy’s terms, these options may include:
- Using the policy’s cash value to reduce or cover premium payments
- Reducing the policy’s death benefit
- Cashing out the policy
- Converting the policy to a term policy, significantly reducing the premium
Can You Get Your Term Life Insurance Premiums Back If You Outlive the Term?
Yes, it’s possible to get your premiums back if you outlive a term life policy, but only if you add a return of premium (ROP) rider. With a return of premium rider attached to your policy, you’ll receive all premiums paid toward the policy at the end of the policy term. Like the policy’s death benefit, the returned premiums aren’t taxed.
A ROP rider might sound like a good deal, but it comes with some key drawbacks:
- Higher premiums, often two to three times the premium on a policy with no ROP rider
- No interest on premiums, meaning they’ll be worth less at the end of the term due to inflation
- Depending on the insurer, a requirement that you carry the policy for the entire term
If you stop paying premiums at any point before the policy’s term ends and the policy lapses as a result, the insurer likely won’t refund your premiums.
Due to the restrictions and limitations on the ROP rider, it’s not a good deal financially for most policyholders. It makes more sense to invest the additional premium payments where they’ll generate returns, like in the stock market or FDIC-insured certificates of deposit.
Can You Access Your Term Life Policy’s Death Benefit Before You Die?
In some cases, yes, if your policy has an accelerated death benefit rider, you may be able to access a portion of your death benefit before you pass away. The allowed percentage varies but can be a majority of the death benefit (up to 75%) depending on the policy type and insurer.
The accelerated death benefit rider kicks in only when the policyholder is diagnosed with a terminal illness likely to result in death within a defined period of time. This period can vary but is often two years. Like regular death benefits, accelerated death benefits are tax-free.
Are There Any Restrictions on How Death Benefits Can Be Used?
Beneficiaries can use life insurance death benefits however they wish. Life insurance companies don’t place any conditions or restrictions on their use.
Will Your Beneficiaries Still Receive Benefits If You Die by Suicide?
If you die by suicide within two years (sometimes three) of initiating coverage, your insurer may have the right to deny claims made on the policy. This coincides with the policy’s “contestability period,” during which insurers treat claims with more scrutiny. After two or three years, the insurer will likely pay out the full death benefit even if you die by suicide.
Can a Whole Life Insurance Policy Expire?
Whole life coverage generally doesn’t expire if you make your premium payments on time. However, a whole life policy can be canceled by the insurance company under certain circumstances, like if you lied on your application.
Can You Cancel a Life Insurance Policy?
Yes. Every policy has a “free look” period, usually lasting 30 days or fewer. During this window, you can contact the insurer to cancel your policy for a full refund of any premiums paid.
After the “free look” period, you can cancel a term life policy simply by no longer paying the premium. After the grace period ends, the insurer will cancel the policy with no further action required from you.
Canceling a permanent life policy is a bit more complicated and generally requires you to contact the insurer. The process for canceling a permanent life policy is also known as surrendering the policy.
When you surrender your permanent life policy, you receive the policy’s cash value minus any surrender fees. During the first 10 years or so of your policy, surrender fees negate most or all cash value, leaving you with very little to show for your payments. It’s therefore best not to cancel a permanent life policy until much later in life (if ever).
What Happens When a Whole Life Insurance Policy Is Paid-Up?
“Paid-up” refers to two different but related features of whole life insurance.
First, some whole life policies allow policyholders who’ve built up ample cash value to convert to “paid-up status.” Paid-up status allows policyholders to preserve their death benefit without making additional premium payments for a period of time.
Second, some whole life policies allow “paid-up additions.” A paid-up addition is a purchase of additional life insurance coverage using the income (dividends) from the policy’s cash value, rather than another out-of-pocket premium payment. Paid-up additions increase the policy’s death benefit.
How Can You Be Sure Your Life Insurance Company Will Pay Your Policy’s Death Benefit?
The simple answer is: You can’t ever be 100% guaranteed a life insurance company will pay up. However, you can reduce the risk of an unpaid death benefit by choosing an insurer with very high financial strength ratings.
Moody’s, Fitch, and A.M. Best all independently assess insurance companies’ likelihood of making good on claims. Each rating system is a little different, but you should always look for companies near the top of the rank list. For example, A.M. Best’s top insurance financial strength rating is A++ (Superior).
What Happens If Your Life Insurance Company Goes Out of Business?
Life insurance companies don’t go out of business very often. The last major insurance company to face failure in the U.S. was AIG in 2008. In that case, AIG received an $85 billion bailout from the federal government and restructured its business to avoid total collapse.
That said, there’s no insurance equivalent to the FDIC, which reimburses customers for deposits lost when a bank fails. Life insurers are required to keep extra money on hand (known as capital reserves) to pay out death benefits if they become insolvent.
However, this is not a guarantee that policyholders or their beneficiaries will be made whole. It’s yet another reason to choose a financially sound life insurer.
What Happens If Your Policy’s Beneficiary Dies Before You Do?
If your primary beneficiary dies before you, the contingent beneficiary becomes eligible to receive death benefits.
If you didn’t name a contingent beneficiary and you don’t name another primary beneficiary before your own death, the death benefit will go to your estate. It will become part of the estate’s assets to be distributed to your survivors in accordance with your will (or with applicable state law if you died without a will).
If you named multiple primary beneficiaries and one dies before you, the remaining primary beneficiaries receive a proportional share of the deceased beneficiary’s share.
Most working-age Americans need some amount of life insurance coverage. But many never get around to buying it. They’re busy and worry it’ll take too long to apply, or they’re intimidated by medical underwriting, or they just don’t know where to start.
If you’ve put off buying life insurance until now, hopefully this guide puts you at ease and prepares you to take the next step. Our guides to the best life insurance companies overall and the best no-medical-exam life insurance companies stand ready to assist if and when you do.