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- Life insurance may be used to cover monthly expenses, debts, college education and child or dependent care.
- Long-term needs life insurance can cover end-of-life expenses, estate planning, legacy funds and long-term care.
- Suicide is generally not covered by life insurance within the first two to three years of the policy, and the insurance company can contest the claim if they suspect fraud.
If you’re considering purchasing life insurance, it may feel overwhelming at first. But many people experience relief in knowing that their loved ones will be financially protected after their passing. Generally speaking, life insurance provides a payout to your chosen beneficiary (or beneficiaries) upon your death. However, there are many different policy types, so it may be hard to figure out which is best for you. Bankrate’s insurance editorial team took a detailed look at life insurance to help you navigate what can feel like a complicated market.
What does life insurance cover?
Life insurance is a type of policy designed to provide a death benefit — a sum of money — to your selected beneficiaries after your death. The primary function of life insurance is to provide financial support to your loved ones after your passing. The payout from a life insurance policy can be used in a number of ways, including:
- Paying for end-of-life expenses
- Paying off debts
- Replacing lost income
- Paying for college tuition
- Leaving a financial gift
There may even be other options you or your loved ones decide to use the payout toward.
Monthly bills and expenses
One of the main uses for life insurance is to replace your income for those who depend on it. This is why it can be helpful to work with a licensed agent or financial advisor, or use a life insurance calculator to determine how much coverage you need.
Upon receiving the death benefit, your beneficiary can use the money to pay for bills, including grocery, utility and childcare bills, as well as other costs that may pop up. There aren’t restrictions on what kinds of expenses you can use a death benefit to pay for.
Many types of debt — mortgages and car loans included — are not forgiven upon your death. Debt repayment can be tough on anyone’s budget, but paying down debts on which you co-signed after losing a loved one’s financial support can be even tougher. Your beneficiaries can use the death benefit you provide to help ease the burden.
College tuition and education
If you’re financially responsible for your child’s college expenses, you may want to consider those costs when you purchase a life insurance policy. Adding the cost of college into your life insurance calculations could dramatically increase the death benefit amount that you need. Because life insurance beneficiaries can spend a payout however they see fit, incorporating college prices into your death benefit amount could provide significant support after you’re gone.
Below is the annual cost of tuition and fees for the 2022–2023 school year for various institutions. Keep in mind that these figures are annual and don’t include living costs, books, supplies or other expenses. Rates can also vary widely by state and institution.
- Public two-year in-district college: $3,860 per year
- Public four-year in-state college: $10,940 per year
- Public four-year out-of-state college: $28,240 per year
- Private nonprofit four-year college: $39,400 per year
Another primary function of life insurance is to pay for your end-of-life expenses. These could include your funeral costs, the price of a casket and the expense of a reception. Most life insurance policy death benefits can be used to pay for funeral costs. If that’s the only coverage you need, though, you may want to consider final expense insurance. This type of permanent life insurance provides a small death benefit — usually no more than $25,000 — and generally doesn’t require a medical exam for approval. However, compared to other policy types, final expense coverage may be more expensive for the amount of coverage you’re likely to get.
Child care or dependent care
From daycare and after-school programs to nannies and other expenses, life insurance policies can help cover the cost of childcare. If your beneficiary is also taking care of an aging parent or other dependent, a life insurance death benefit could help with those costs, too, if you pass away.
Medical expenses and long-term care
While life insurance is primarily used to provide financial support for your loved ones, life insurance with living benefits can provide options for you to use your life insurance coverage while you are still alive. There are different types of living benefits you can choose from, based on your needs. For example, many companies offer an accelerated death benefit rider, which provides you with access to a portion of your death benefit prior to your passing if you’ve been diagnosed with a terminal illness. This may help you pay for medical expenses while you’re still alive, reducing the financial burden on your loved ones after your passing.
While this can often be a great benefit, using a portion of your death benefit early will effectively reduce the total amount paid to your beneficiaries after your death. Additionally, living benefits aren’t the same as long-term care insurance, which can help shield your finances from the effects of extended medical costs.
In addition to funeral costs, life insurance can cover the cost of estate planning following your death. Estate planning is a little different from end-of-life expenses in that it involves securing an attorney to close out any remaining accounts in your name and officially report your death to the county and IRS. Many people fail to realize that descendants may still owe taxes to the IRS, and a life insurance policy can help them cover these costs so they are not incurring an unnecessary financial burden.
Leaving a legacy
It’s easy to see life insurance as a practical purchase. After all, it’s helping your loved ones feel financially secure after your passing. But life insurance can go a step further. You could use your life insurance policy to leave a financial gift to your beneficiary, your children, an organization or a charity. If you choose to do this, you’ll probably want to think through your loved one’s needs and your financial wishes to ensure you buy an appropriate amount of coverage to finance both.
What does life insurance not cover?
As mentioned, there aren’t any limitations on how a beneficiary can use a life insurance death benefit payout. However, in some cases, a death benefit may not be paid out, which means that the beneficiary wouldn’t get the money upon your death. Here are a few examples of when this might occur.
- Expired or lapsed policies: If your life insurance policy is no longer active when you pass away, your beneficiary will not receive the death benefit. Term life insurance, for example, covers you for a specific number of years. Once the term ends, your coverage is no longer active (although most term policies include a guaranteed renewability feature). Permanent life insurance policies, like whole life and universal life, don’t typically expire but may still lapse if your premium isn’t paid.
- Suicide: Many life insurance policies contain a provision that death by suicide is not covered for the first two to three years. If you end your life while the clause is still in place, your beneficiaries may not receive a payout.
- Fraud: Life insurance policies come with a contestability period. This is usually a two-year period following the date your policy starts. If you pass away during this time and your insurer discovers that you intentionally misrepresented something on your application, your beneficiaries may be denied the payout.
- Exclusions: While rare, some insurance carriers include exclusions that identify specific circumstances in which your beneficiary may not be eligible to receive a payout, such as if the policyholder dies as a result of a hazardous activity. Exclusions most commonly apply to deaths caused by risky professions or hobbies; however, there may be other exclusions stipulated in your policy. Be sure to review your policy to understand your specific coverage.
Frequently asked questions
How much life insurance coverage you need depends on the unique financial needs and commitments of you and your family. Some factors to consider when choosing your coverage include your annual income and how many children you have (if any). Many insurance professionals recommend you speak with a licensed agent or financial advisor to review your life insurance options and financial goals before purchasing your policy.
Your life insurance policy generally pays out after your death, although some policies have living benefits you can use while you’re still alive. How long it takes for your beneficiary to receive this payout can vary. For example, the insurance company may launch an investigation if you pass away during the contestability period. This investigation will need to be complete before the death benefit is released. The same situation may occur if it appears that you died by suicide during the first two years of the policy. Additionally, your life insurance company will need time to calculate your payout if you borrowed from your permanent life insurance policy. You may be able to alleviate unnecessary stress for your beneficiaries if you explain to them what your life insurance policy is, how it works and what it covers.
If you’re single, your need for life insurance will depend on your financial goals and overall circumstances. If you take care of any loved ones, such as a parent or sibling, you may want to purchase a life insurance policy to take care of their financial needs after your death. If you have co-signers on a leased or financed vehicle, your co-signer could be left with the debt after you pass away. You may consider taking out a life insurance policy to protect their finances. If you’re not sure if you need coverage, speaking with a life insurance agent or financial advisor can help you determine if coverage makes sense for your situation.
Buying life insurance for your child can feel odd and even morbid. However, life insurance rates increase as you get older, so buying permanent life insurance for a child could help them keep a low rate as they age. Additionally, if your child develops health problems as they age, it may be harder to get life insurance coverage. Buying a policy at a young age can help protect their insurability in the future.
A life insurance payout will depend on your policy type, term and level of coverage. Life insurance payouts are typically not taxable, though you may wish to work with an insurance professional to gauge whether this would be the case for your policy.