Wouldn’t it be nice to buy insurance that replaced your actual life if you lost it? You’d never have to worry about dying because life insurance would give you another life and you could just keep going! While that sounds like an awesome sci-fi movie called Term Life: Clone Wars, life insurance doesn’t involve cloning, reincarnation or resurrection.

So, how does life insurance work? Simply put, life insurance helps the people you love replace your income if you die way sooner than expected. (At least, that’s what it’s supposed to do. Some people try to make it do more, and it doesn’t work very well.)

Let’s take a closer look.

 

 

Basics of Life Insurance

Life insurance is a funny thing. It’s the only thing you pay for hoping you’ll never use. Because that would mean you’re, you know . . . deceased. But let’s not get morbid—life insurance is a wise and wonderful way to give you peace of mind and take care of your family!

As long as you live, there’s always the risk you could die, and your spouse and children will suddenly have to make it without your income. So to offset that risk, you should buy a life insurance policy for a set amount (I recommend 10–12 times your annual income) and pay a premium every month. If you die during the coverage term, the insurance company will pay out the set amount to your family.

 

Here’s an example of life insurance in action: Jase is married with two kids and makes $70,000 a year. His wife, Lydia, is a stay-at-home mom. Jase owns a life insurance policy worth $700,000 and pays $50 a month for it. One day on his way to work, Jase gets in a car wreck and dies. Lydia files a claim with the insurance company, and they pay her $700,000.

Now, there are a few different kinds of life insurance you can buy, including:

• Term life
• Whole life
• Universal life
• Indexed universal life

I’ll get into these more in a sec, but each kind offers different protection and even some extra stuff. (Spoiler: You don’t need the extra stuff.)

Life Insurance Calculator 

You can get an idea of how much you need (and save some brain calories while you’re at it) by using this quick life insurance calculator. 

Coverage and Premiums

Now that we’ve nailed down some basics, let’s get clear on what life insurance actually covers. Life insurance pays out after accidental deaths—so in Jase’s case, his wife would have received a cash payout after his car crash. She would also receive the same payout if Jase had died of natural causes or a serious health issue like a heart attack or cancer.

Compare Term Life Insurance Quotes 

Insurance companies love a good gray area, though. That’s where riders come in (industry lingo for policy add-ons). But we’ll talk about those in just a bit.

When you buy a life insurance policy from a company, the main thing you’re purchasing is the death benefit—the total money paid to your beneficiaries when you die. You purchase a policy for a set death benefit amount (Jase’s was $700,000).

How long your coverage lasts depends on what kind of insurance you buy. With term life, your coverage lasts as long as the term is set for—usually 15, 20, 25 or 30 years. With permanent life insurance (like whole life, universal life or indexed universal life), your death benefit coverage lasts until you die—even if that’s when you’re 100. (I know that might sound like a better deal, but usually it’s not. At a certain point, your kids should be grown and, if you were smart with your retirement, you should be self-insured—meaning you have enough saved that your spouse will be fine.)

To get that insurance coverage, you pay premiums—usually monthly. With term life, your premiums are set for the entire term and never change. With any variation of permanent life insurance, your premiums go up as you age.

Here are some factors that impact how much your premiums cost:

• Age: They get more expensive as you get older.
• Health condition: The healthier, the better.
• Lifestyle habits: Think smoking, DUIs or skydiving.
• Policy value: A million-dollar policy will cost more than one worth half a million.
• Type of policy: Term life premiums are cheaper than permanent life premiums.

So, what happens if you don’t die during the term of your policy? Well, nothing—and that’s the point. Term life insurance is pure protection. If you outlive your term, your policy simply ends, and you stop paying premiums. That’s how life insurance works if you don’t die—you got peace of mind while you needed it, and now you’re free to invest that money elsewhere.

Policy Features and Options

When it comes to life insurance, don’t skip the fine print. Let me break down the different kinds of life insurance and riders so you can get a better idea of how each one works and which ones you want to avoid.

Policies

Term life insurance: Provides coverage for a specific term (usually between 10 and 30 years, in increments of five)

Whole life insurance: Offers coverage for your entire life and comes with a cash value account that acts a lot like a low-interest savings account

Universal life insurance: Also offers coverage until you die and a cash value account, but the value grows at an interest rate set by the insurer and your premiums are adjustable

Indexed universal life insurance: Like the two before, provides coverage until you die and a cash value account, but the investment growth in the account is tied to the performance of an index fund

The last three kinds are all types of permanent life insurance, and they’re marketed as a hybrid of life insurance and retirement investing.

Now, pardon me while I get on my soapbox for just a second.

This is where I differ with a lot of these so-called wealth strategists out there, like @mrmoneybagz77 on TikTok. I’m going to tell you—you only want life insurance to replace your income if you die. And it shouldn’t do anything else. Those other guys are going to say it’s smarter to also invest for retirement through life insurance.

It’s not smart. In fact, it’s a big waste of money. I won’t bore you by explaining all the reasons why life insurance as an investment is a bad idea because I already wrote an article that dives deep into that. Just know the investment returns are microscopic and eaten up with tons of fees.

Okay, done (steps off soapbox). I’ve got to say, as a shorter guy, the view up there was nice . . .

 

One of the other features permanent life insurance offers is the ability to take out a loan against your policy. Essentially, you’re just borrowing your own money but paying interest on it to the insurance company. And if that isn’t enough to put you off, they’ll also reduce the death benefit for your loved ones if you don’t pay the loan back before you die. You had one job, permanent life! One job.

Okay, I said I was off my soapbox, but it looks like I’m back on it—so just one more awful thing about permanent life insurance. If you die before using your money in the cash value account, the insurance company usually keeps it!

Term life doesn’t come with any of these “features”—it does exactly what it’s supposed to do. As a dad and husband, I sleep better with term coverage because if anything ever happens to me, it would fulfill the only purpose of life insurance: replacing my income for my family.

Riders

Once you understand the basics of how life insurance works and have a policy in place, you can add extra coverage called riders. Before I show you all the riders, I’m going to tell you up front, some are not a ride worth taking. I’ll explain as we go.

Some common life insurance riders are:

Accidental death and dismemberment: This rider will pay out extra money if you die in an accident or get pulled apart limb from limb. The thing is, you’re just as dead this way as another, so your family will need the same amount of money either way. It’s kind of a scam.

Accelerated death benefit: If you’re diagnosed with a terminal illness, this rider lets you get a partial benefit payout before you die to help with illness costs. Insurers have their own definitions of what qualifies as a terminal illness, and it will cost you an administrative fee to enact it. But it could be helpful in some situations.

Waiver of premium: If you become disabled before a certain age, this rider waives your premiums until you’re able to work again. (But you should already have long-term disability insurance, so there’s no need to pay extra for this.)

Child term rider: This is basically a small term life policy on your kid. But unless that kid makes millions from unboxing and reviewing toys and games on YouTube, you'll want to pass on this. The only exception might be if you’re still in debt, don’t have a full emergency fund, and need a way to cover funeral costs. Then you could get a small child rider on your own policy.

Return of premium (term life): You pay a higher monthly premium, but if you’re still alive when your term is over, you get all the money you spent in premiums back. Sounds good, but if you took the extra money you paid in premiums over 30 years and invested it instead, you’d end up with more money.

The big thing to note with all these riders is that they all make your premiums higher (or reduce your death benefit) and don’t really provide enough value for that extra cost.

Claim Process and Settlement

This is the part everyone hopes never comes. But in case it does, you should know how it works. If you’re the beneficiary of an insurance policy and the person insured by the policy dies, you’ll have to file a claim with the insurance company to get the death benefit.

Here’s a list of what you’ll need to do:

1. Find the policy and contact the insurance company. They’ll give you a claim form.
2. Collect the required documents and complete the claim form. Here’s the information about the insured person and the documents you’ll need:
   • Social Security number and insurance policy number
   • Name, date of birth, date and cause of death, state of residence
   • Death certificate
3. Choose how you want to receive your death benefit payment.
4. Submit the claim form and documents to the insurance company.

Life insurance payouts can be a little confusing, so it’s important to understand how life insurance works when you die—so your loved ones aren’t caught off guard when it matters most. Insurance companies usually pay out the death benefit by check or direct deposit within 60 days. You can choose to receive it in one big payment or in a specific income payment. With the second option, the insurance company puts your death benefit into an account and sends you small payments from it regularly. I recommend you take it all in one lump sum. That way you can invest it and start earning interest on it right away.

Death benefits from life insurance aren’t taxable. But if you have any of the permanent life insurance options, interest earned in the cash value account connected with those is taxable. (One more reason to go with term life!)

In rare cases, you might be denied life insurance. Don’t panic! Whether the issue is medical or nonmedical, you have options. Talk to an independent life insurance agent who will know how to work around any red flags in your application and make sure your family is protected.

Who Needs Life Insurance?

You only need life insurance if you have someone depending on your income. That’s it. If you’re single and the closest thing you have to a dependent is your temperamental fiddle-leaf fig tree, you probably don’t need life insurance quite yet. But life insurance is a must for anyone with a spouse, kids or someone else to financially support.

Life Insurance at Different Stages

Life insurance isn’t one-size-fits-all. Depending on your stage in life, your needs might look a little different—or you may not need coverage at all. Let’s break it down:

• Stay-at-home parents: You may not bring home a paycheck, but you’re basically doing multiple full-time jobs—teacher, chef, chauffeur, housekeeper and more. Even though a life insurance policy for a stay-at-home parent won’t replace income, it’ll give your spouse money to cover those essential roles you handled.
• Kids: Ready for it? This is a hard no. Life insurance exists to replace income. Unless your kid is raking in serious money as a child actor or influencer, you can pass on an insurance policy for children.
• Retirees: If you’re in your golden years and still have dependents, are paying off debt, or are working on building up your retirement fund, a senior life insurance policy could still be useful. But if you’re debt-free and self-insured (aka your investments can cover your income), drop the policy and enjoy the extra cash each month.
• People with chronic conditions: If you’ve been diagnosed with something like diabetes, life insurance will cost more than the Average Joe—but it’s worth it if your family depends on you. Catch it early, show it’s well managed, and you’ll have a much better chance at coverage.

Buying and Managing Life Insurance

When you’re ready to buy a life insurance policy, don’t cut corners. Find a licensed life insurance agent who can shop the marketplace and help you land the best deal. They’ll ask you a few questions, and sometimes you’ll have to get a medical exam. Then the insurance company underwrites your application to determine if they will approve a policy. (Underwriting means assessing how risky you are to insure and setting your premiums based on that risk.)

Usually, people buy policies for themselves and name their own dependents (kids, spouse, etc.) as the beneficiaries—like we saw earlier in the example of Jase. But there are exceptions. You can buy a policy for someone else—for example, one that insures your wife or your dad—and name your kids or your special-needs brother as the beneficiary. These can be tricky when it comes to taxes though, and you must have a valid reason for owning a policy on another person.

Here are a couple terms you’ll want to be familiar with:

Policy owner: the person who owns the policy (typically the insured person)

The insured: the person whose life is insured by the policy

Beneficiary: the person who’ll receive the death benefit

Life insurance isn’t something you can just set and forget like a Crock-Pot. Every few years, you need to take a look at your policy and make sure it’s still the best option.

Maybe you’ve gotten a raise and had another kid or two—you should up the death benefit so they’ll still have enough to live on if you die. Maybe you bought a house and now have a mortgage—it could be a good idea to raise your death benefit so there’s enough money to pay off the house if you die. Maybe you got divorced and remarried—definitely update the beneficiary. These are the kinds of things you need to keep in mind when you review your policy.

Is Life Insurance Worth It?

Short answer? Yes—term life insurance is 100% worth it. But let’s break it down one more time with a quick story.

Imagine you’ve been spending about $20 a month on your favorite streaming service. For years, you and your family have laughed, cried and rewatched The Office together more times than you can count. But then, suddenly, you’re gone. The account gets canceled—not just because no one knows the password, but because there’s no income to cover the basics, much less the extras. Groceries? Tuition? The mortgage? All gone with your paycheck.

Now rewind that scene. Instead of streaming The Office, you put that $20 toward a term life insurance policy. Same sad ending—you pass away. But this time, your family has a safety net. They’re not scrambling. They can grieve without panic. And yes, they still rewatch The Office, but this time in your memory. That’s what term life does—it gives your family stability when everything else feels unstable.

So is life insurance worth it? Absolutely. In fact, having life insurance in place is one of the most practical steps toward finding financial peace during the unthinkable.

Considerations and Planning

Hopefully you feel confident about how life insurance works now. Here are a few things to keep in mind when you’re looking at buying a life insurance policy.

You need to figure out how much to get. Your annual income, of course, is the biggest consideration—you want 10–12 times that—but you should also consider buying more if you have:

• Debt
• A mortgage
• A beneficiary who may have a big specific expense in the future, like college

Another consideration is your estate. Dying can be expensive. There are taxes and sometimes lawyer fees to pay, a funeral and a few tubs of potato salad for your wake. Consider pushing the policy value up a bit if you think these expenses will be high.

Finally, don’t forget what I said earlier about reviewing your policy! One thing we can always count on in this life is change (and of course, death and taxes). Make sure you go back and review your policy any time you go through life-change, like getting married or having kids.

Bottom line? When you understand how life insurance works, you can make a confident decision that protects your family for the long haul. If you need more life insurance or you’re looking for new coverage, the good people at Zander Insurance can hook you up with a term life policy that offers the right amount of protection for the right price.

They’ve served my family for over a decade now—and I’m not the only one. Tons of folks in our Ramsey Baby Steps Community on Facebook trust them too. Ryan B. has been with Zander for more than 20 years and has saved $19 a month after making the switch.

“Seeing how Zander got me about 30 quotes in 30 seconds and I got to choose the best one, I’ll roll with Zander,” he said.