Life insurance guide

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Not everyone needs life insurance. In general, life insurance is a good idea if you have family or others who rely on you financially. To decide the amount that’s right for you, consider your debts, the amount of income your family must replace, and whether they’ll have bills or other expenses.

Your life insurance company will make payments after your death to the person you name in your policy. This person is called your beneficiary. You can name more than one beneficiary. Your beneficiaries can use the money to pay bills and living expenses, pay off debts, pay for college, and other things. Some types of life insurance also build savings you can use during your lifetime.

Learn more: Do you need life insurance? | Watch: Life insurance in one minute

How do I get life insurance?

You can buy life insurance from an insurance company, agent, or broker. Brokers sell insurance for multiple companies.

Insurance companies use a process called underwriting to decide whether to sell you a policy. This often includes passing a medical exam and answering questions about your health, job, and habits. A company can refuse to sell you a policy if it considers you a high risk because of your health or other reasons.

Some employers and groups – like churches, unions, and other associations – offer group life insurance to their employees and members. The underwriting criteria for group life insurance isn’t as strict. You usually don’t have to answer questions about your health. As a result, you might be able to get group life insurance even if you aren’t able to buy directly from an insurance company.

How much does life insurance cost?

The cost depends on your age, health, and risk factors. They’re usually lower for younger people. A company can charge you more if you have health conditions, smoke, or have risky hobbies like skydiving or rock climbing.

Your premium will also depend on other things, including the amount of coverage and policy features you choose.

For group policies, risk is based on the whole group, not on one person. The cost is usually cheaper than for a policy you buy directly from an insurance company.

Learn more:  Retirement ahead? Think about your insurance.

Types of life insurance

There are two main types of life insurance: term life and permanent life insurance.

What is term life insurance?

Term life insurance offers protection for a set period of time. This period is called a term. The term can be for one year, or anywhere from five to 30 years or longer. You choose the length of the term. Term life policies pay a lump sum, called a death benefit, to your beneficiaries if you die during the policy’s term. The policy ends at the end of the term, unless you pay to extend it.

Term policies aren’t meant to provide coverage for your entire life. Most people who buy term life policies want coverage for only a period of time, such as while they’re raising a family or have children in college.

Premiums will stay the same for the entire term. They’ll go up if you renew at the end of the term. This is because your new premium will be based on your age when you renew, not when you originally bought the policy. To help avoid higher premiums later, consider buying a policy with a longer term.

Most companies offer term life insurance only up to a certain age, usually 70 or 80.

The two most common features of term life policies are convertibility and renewability. They make it easier to get a different type of policy or keep the one you have.

Convertibility lets you exchange your term policy for a permanent life policy without having to take a medical exam or answer questions about your health. This can be helpful if your health gets worse after you buy a term policy. Converting a policy will raise your premiums. Companies usually allow you to convert term life policies only for a time, typically until you turn 65.

Renewability lets you extend your policy for additional terms, regardless of your health and without having to take a medical exam.

What is permanent life insurance?

Some permanent life insurance policies let you build savings over time. You can withdraw from, invest, or borrow against these savings. You can also use it to pay premiums.

A portion of each of your premiums is put into an account, known as the cash value. The cash value grows at either a fixed or variable interest rate. (Fixed means the interest rate never changes and variable means it can.) Some policies tie the growth to indexes, such as the S&P 500, or to sub-accounts you choose. The sub-accounts are invested in stocks, bonds, or both. Your cash value could go up or down, depending on the performance of your sub-accounts.

It takes a policy years to build a cash value. You might have to pay a surrender fee if you withdraw the money early. And if you withdraw more money than you paid in premiums, you’ll probably have to pay taxes on it. If you withdraw the entire cash value, the company might cancel your policy. If that happens, the coverage will end, and it could affect your taxes.

Premiums for permanent life insurance are higher than for term life. That’s because of the savings feature and because you're buying coverage for a longer period.

You might want to talk to a financial adviser before buying permanent life insurance.

The two most common types of permanent life insurance are whole-life insurance and universal life insurance.

Whole-life insurance stays in effect for your entire life unless you cash the policy in or stop paying premiums.

Some whole-life policies might pay out each year (called a dividend). You can get the dividend in cash, add it to your policy's cash value, or use it to pay premiums. Dividends aren't guaranteed. Your dividend could be lower than the company’s projection. Before you buy a policy, ask the company for a history of its projected dividends versus paid dividends.

Universal life insurance stays in effect until the maturity date, which is usually age 95 or 100, as long as you have $1 or more in cash value. At the maturity date, coverage ends and you get the cash value.

Universal life insurance is more flexible than whole life. You can change the amount of your premiums and death benefit. But any changes you make could affect how long your coverage lasts. If your premiums are lower than the cost of insurance, the difference is taken from the cash value. If the cash value reaches zero, your policy could lapse.

The company will send you a report each year showing your cash value and how long the policy might last. The estimate is based on the cash value amount, the cost of insurance, and other factors. Review it carefully. You might need to pay more in premiums to keep the policy in effect until the maturity date.

Most universal life policies earn a guaranteed minimum interest rate on the cash value. Variable universal life policies depend on the performance of the sub-accounts you choose. Agents who sell variable life insurance in Texas must have a federal securities license and a state insurance license.

Some universal life policies have a no-lapse guarantee. If your premium payments aren’t enough to cover the cost of insurance, the no-lapse guarantee keeps the policy in effect. You must pay your premiums on time for the guarantee to apply.

Watch: Universal life: Your policy may be evaporating

Comparing the major types of life insurance

Other types of life insurance

These types of life insurance provide only specific coverages:

Customizing your policy

You can usually add features or other coverages to your policy so it better suits your needs. You do this by buying policy riders. Some of the most common riders are:

Group life insurance

Some employers and other groups offer life insurance as a perk. Those that do must make it available to all their employees and members regardless of age or health.

Most group life insurance is term life, but some groups offer permanent life policies as well. The amount of coverage is often limited. A basic group policy through your job usually has a death benefit equal to one or two times your annual salary. Other group policies cap the death benefit at a set amount, such as $100,000 for a term life policy and $50,000 for permanent life.

You usually don’t have to answer health questions or take a medical exam unless you want more coverage than the basic group policy provides.

If you get life insurance through your employer, coverage typically ends when you leave your job.

How life insurance pays the death benefit

Companies usually pay the death benefit as a single lump sum, but there are other options. Either you or your beneficiary chooses how the death benefit will be paid. Common options include:

Companies must pay death benefits promptly

Companies must pay the death benefit within two months after getting proof of death and verifying your beneficiary. For an individual life policy, the company must also pay interest on the death benefit from the time it got proof of death to the time it agreed to pay the death benefit. Companies might take longer to pay the death benefit if you die during the policy’s contestable period.

What is the contestable period?

Life insurance policies have a two-year contestable period. If you die within this period, the company may review the information you gave on your insurance application. If the company learns you gave wrong information or didn’t disclose something, it can deny payment. This can happen even if the wrong information was unrelated to the cause of death or was given by mistake. If a company denies payment, it must return the premiums to your beneficiary.

The company may also investigate the cause of death. During the first two years of a policy, companies usually won't pay the death benefit if the cause of death is suicide. If the company doesn't pay the benefit, it must return the premiums to your beneficiary.

Once your policy has been in effect for more than two years, the company must pay the death benefit regardless of the cause of death. Your policy will have a new contestable period if it lapses and you later reinstate it.

Policy lapses

What if I miss a premium payment?

Most policies have a 31-day grace period after your premium's due date. You may pay the premium during the grace period with no interest charged and still have coverage. If you die during this period, your beneficiary gets the death benefit minus the premium owed.

What if my policy lapses?

If you don’t pay the premium within the grace period, your policy will lapse. This means you no longer have coverage and your beneficiaries won’t get the death benefit when you die. You can usually reinstate a lapsed policy. To do this, you’ll have to pay the overdue premium with interest. Most companies will reinstate a policy within a five-year period. To reinstate a policy, you might have to answer health questions or take a medical exam.

Shopping for life insurance

Watch: How to shop for life insurance

What if I want to replace my policy with a new one?

You should review your life insurance policy every few years to make sure it still meets your needs. But replacing a policy with a new one isn’t always a good idea. Before you replace a policy, consider these things:

It’s illegal for an agent to replace a policy just so the agent can get a new commission. If you think an agent has improperly replaced your policy or persuaded you to replace it, you can file a complaint with TDI.

Financial implications

Having life insurance can affect your taxes and financial situation. Talk to an attorney or financial adviser to understand how it affects you. Here are some things you should know:

Medicaid

A policy’s cash value is considered an asset when determining whether you can get Medicaid. The earnings from a loan using the policy as collateral might also be an asset.

Taxes

The cash value of a life insurance policy is tax-deferred. This means you don't pay taxes on it until later, if ever. Withdrawals from the cash value are usually nontaxable until the cash value exceeds the total premiums paid into the policy.

The law considers a death benefit to be reimbursement for a beneficiary's loss, and not income. Beneficiaries rarely pay income or inheritance taxes on a life insurance death benefit.

If you don’t name a beneficiary, or your beneficiary is dead, the company will pay the death benefit to your estate. Your heirs might have to pay taxes on money they get from your estate.

Bankruptcy

A policy’s cash value and death benefit are usually exempt from:

Selling your policy

Sometimes you might need to sell your life insurance policy to get cash. A life insurance policy is personal property. You can sell it just as you would your other property, but there are special rules.

If you have a terminal illness, you can sell your life insurance policy to a life settlement provider. To do this, a doctor must certify that you have two years or less to live. You don’t have to pay taxes on earnings from a life settlement.

You also might want to sell your policy if you outlive your retirement savings and need to pay living expenses. You’ll probably have to pay taxes on the money you earn from the sale.

Learn more: Can I sell my life insurance policy?

How much can I sell a policy for?

Life settlement providers pay a percentage of the policy's death benefit. For example, a settlement provider might pay $75,000 for a life insurance policy that will pay $150,000 when the policyholder dies. Sale amounts typically range from 10 percent to 75 percent of a policy's death benefit.

Prices vary, so talk to several settlement providers. Settlement providers usually look at these things to decide how much to pay for a policy:

The income from a life settlement could affect your eligibility for Medicaid or other government programs. The income might not be exempt from bankruptcy or creditor proceedings. Before taking a life settlement, talk to an attorney or financial adviser.

Life settlement providers and brokers must register with TDI. For a list of registered life settlement providers and brokers, call our Consumer Help Line at 800-252-3439.

What other ways can I get cash from my policy?

Questions? Call us at 800-252-3439.