How Life Insurance Works — A Jargon-Free Explanation

Find out the options available to you and how you can protect your family.

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Updated May 13, 2024
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Most people have insurance policies that protect them in the case of an unexpected event, such as a health issue or a car accident. But fewer Americans (57 percent) have secured life insurance policies that will protect their families in the event of their death. That’s likely because 54 percent of adults aren’t knowledgeable about how life insurance works.

If you’re curious about life insurance plans, we’re here to explain them — without all the jargon. It might be easier (and less expensive) than you think to protect your family’s financial future. Read on to find out whether life insurance is right for you.

In this article

What is life insurance?

A life insurance policy represents an agreement between you and an insurance company. You agree to pay monthly premiums. In exchange, the insurance company agrees to pay out an amount of money to your beneficiaries (family members who you want to benefit from the policy) if you die.

Simply put, it’s a form of financial protection for surviving loved ones and family members if you die. The most common benefit of life insurance is money being paid out to beneficiaries upon the policyholder’s death.

The two most popular options for life insurance are term life insurance and whole life insurance. Here’s how those work.

How does life insurance work?

Term life insurance explained

Term life insurance is one of two common types of life insurance coverage, the other being whole life insurance. Term life insurance covers the policyholder during the course of the term, which can last a varying period of time, typically from one to 30 years. This means the policyholder must die within the course of the term for any benefit to be paid out.

If your term ends and you still want life insurance coverage, you have a few options:

  1. Extend the policy. Most policies don’t typically expire, even once you’ve hit the end of the term. You can keep paying for life insurance, but your premiums will most likely be a lot higher.
  2. Convert from term life to whole life. Your current term life policy may have an option for converting it to whole life. If you go this route, you can expect to pay more on your premiums because whole life insurance is more expensive.
  3. Start a new policy. Often, the least expensive option will be to shop around for a new life insurance policy, whether with the same company or a new one. If you’re still relatively healthy, there are plenty of options to choose from.

In general, term insurance is less expensive and more straightforward than whole life insurance. It’s how most people understand how life insurance works. If the policyholder dies within the term, beneficiaries can receive a tax-free lump sum payout. Choosing a term that covers your peak earning years can ensure that your loved ones aren't stuck with financial obligations (such as a mortgage) without access to your income.

Whole life insurance explained

Unlike term coverage, whole life insurance is a policy type that covers the policyholder for their entire life. This is often called a permanent life insurance policy because there’s no set term, so benefits will come into play whenever the policyholder dies. Because this permanent coverage could last well over 50 or more years, the cost of life insurance with this type of policy is generally higher compared to term life insurance policies.

When you make monthly payments on your whole life insurance policy, a portion of the money is deposited into an interest-bearing, tax-deferred account. The cash value of this type of policy accumulates over time. 

You have the option to borrow against that account or use it to pay monthly premiums when it reaches a certain amount. Just be careful when taking out a loan against the cash value, as this will reduce the payout for your family if you die while the loan is outstanding.

If you purchase a whole life insurance policy, your family will receive a death benefit (equal to the value of your policy) when you die. They won’t receive the cash value amount in addition.

Universal life insurance explained

Universal life policies are a type of whole life insurance that typically has a cash account attached to it. The cash account can act as a form of savings or investment account that can earn interest or investment gains (or possibly incur investment losses).

The policyholder can access the cash account during their lifetime, though any withdrawals or loans from the account may affect the policy’s death benefit. In most cases, the cash account is built up by your premium payments on the policy.

How to decide how much life insurance you need

If you’re married and have young children, what do you think they would need financially if you were no longer around? If you are leaving behind a spouse, how much financial support will they need to live without stress? Your salary will end upon your death, but there will still be expenses your family members will have to take care of, and knowing how much they’ll need isn’t always as simple as replacing your annual income.

How much life insurance you need will be determined by a number of factors:

  • Marital status
  • Number of dependents
  • Future college tuition and other education expenses
  • Family income
  • Debts
  • Final expenses (funeral and burial costs)

How to purchase life insurance

These days, life insurance policies are widely available. You can easily contact an insurance company and talk to one of its agents about the life insurance products offered. A life insurance agent will answer any questions you may have and hopefully walk you through the entire application process and what you and your loved one will need to know about the implementation of the policy in the event of your death.

A more modern way of buying life insurance is getting online and using comparison shopping tools to find the best deal from a variety of insurance carriers. This way may be more efficient because you can see all the available policies (and their prices) in one place, which allows for an easy side-by-side comparison of the best life insurance companies.

Many providers will require paperwork, an interview, and a medical exam to assess your risk and determine your monthly premium. But applying for life insurance doesn’t necessarily need to be that involved. With Bestow, you can apply for coverage in minutes by answering a series of simple questions, and you don’t necessarily need a medical exam. Not only is it easy to apply, but the coverage is also inexpensive. Life insurance coverage through Bestow costs as little as $5 per month for some applicants.

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What is an underwriter?

An underwriter is a person who works for or on behalf of a life insurance company. They assess your life insurance application and calculate your life insurance rates by reviewing the provided information. You may be required to take a medical exam, provide medical records, and/or answer questions about your health and medical history, habits, and occupation during the application process.

If the life insurance quotes you receive when you are shopping for life insurance come back with higher premiums than you expected, it may be because of concerns the underwriter has about your health and/or lifestyle. Let’s say you smoke or have a serious health condition. The life insurance company is taking on more risk by insuring you than someone who doesn’t smoke or have a serious pre-existing condition. You would have a higher likelihood of dying while under coverage, and it would have to pay out money.

What is a death benefit?

The tax-free lump sum payout associated with term life insurance is called a death benefit. This is what is paid to any beneficiaries listed on the life insurance policy. The amount paid depends on how much coverage you signed up for. The total amount can be divided among beneficiaries as you see fit.

In most cases, the coverage you signed up for will be what’s paid out as the death benefit. So if you bought a $500,000 life insurance policy, that should be the amount paid out upon your death.

Who should be my beneficiary?

Your life insurance beneficiary is the person you name in your policy who will receive the life insurance benefits upon your death. You can name one or multiple beneficiaries. Most of the time, policyholders name their loved ones as their beneficiaries. 

These are the people who would most need financial assistance if there was a sudden change in income. It might be wise to discuss your life insurance options with a financial advisor to create the best financial plan for your family's situation.

The bottom line on life insurance

No one likes to imagine the worst-case scenario happening to their family, but it’s important to be prepared. If you don’t want to risk leaving your spouse alone with your financial obligations, you should consider applying for life insurance. Your monthly premium depends on several factors, including your health, history of tobacco usage, and the amount of coverage you need. But you might find that achieving peace of mind is more affordable than you expected. It’s worth exploring your options, especially because you can get an estimate without leaving your home.

Once you’ve decided on a life insurance policy, be sure to inform your family. They’ll need to know the name of the company to access the benefit in the event of your death. Hopefully, the policy you choose will offer you the peace of mind you need to live a long, healthy life with your family.

Ethos - Life Insurance Benefits

  • No medical exams
  • Same-day coverage
  • Affordable policies
  • Honest advice. No up-selling.

Author Details

Lindsay Frankel

Lindsay Frankel is a Denver-based freelance writer who specializes in credit cards, travel, budgeting/saving, and shopping. She has been featured in several finance publications, including LendingTree. When she's not writing, you can find her enjoying the great outdoors, playing music, or cuddling with her rescue pup.

Author Details

Ben Walker, CEPF, CFEI®

Ben Walker, CEPF, CFEI®, is credit cards specialist. For over a decade, he's leveraged credit card points and miles to travel the world. His expertise extends to other areas of personal finance — including loans, insurance, investing, and real estate — and you can find his insights on The Washington Post,, Yahoo! Finance, and Fox Business.