Is Life Insurance Taxable? The Answer Depends…
As recently as 2018, about 60% of Americans were covered by life insurance — which means about 40% of Americans had no life insurance coverage at all. And of those people with coverage, many might not have fully understood what benefits they were receiving.
Although the best life insurance does offer valuable protection, it may not be essential in every situation. In this guide, we’ll help clarify how life insurance works and whom it’s right for.
In this article
- How life insurance works
- Is life insurance a good investment?
- FAQs about life insurance
- The final word on life insurance
How life insurance works
Most people have some kind of insurance, such as home or auto, but not everyone has life insurance. In its most basic form, life insurance will pay out money to your beneficiaries when you die. A beneficiary is someone you name in your policy that receives the benefits of the policy upon your death. There can be multiple beneficiaries listed in one policy.
Depending on your life insurance policy, its benefits can be used for a variety of purposes. If your family relied on your income, life insurance can replace that income. It can also pay for funeral and burial costs, create an inheritance for dependents, or serve as a source of savings for beneficiaries.
There are two main types of life insurance, as shown here:
- Term life insurance: Term life insurance covers an individual during the course of the term, which normally lasts from one to 30 years. If you’re on a level term policy, the death benefit remains the same over the course of the term. If you’re on a decreasing term policy, the death benefit decreases over the course of the term.
- Whole life insurance: With whole life insurance, the death benefit is paid out whenever the policyholder dies. Traditional whole life insurance policies aim to keep the death benefit and monthly premium the same over the course of the policy.
Generally, term life insurance is a better option. Because you’re paying for a set term, your premiums will be lower than if you were paying for whole life insurance. Yes, there is still a benefit to having whole life insurance. Mainly, you’re covered for life and don’t have to worry about it. However, with term life insurance, you can set the term for long periods of time, even more than 30 years if you want. So it can last a long time and still be less expensive.
Is life insurance a good investment?
In most cases, life insurance is worth it — especially if you opt for term life insurance. Some people may disagree with that conclusion, but there are many benefits to having term life coverage.
With term life insurance, you get to choose the length of the term and pay a much lower premium than with whole life insurance. You can also receive a lump-sum payout as the death benefit (and it’s usually tax-free). The primary benefit, though, is the financial protection your family receives. If you have dependents and you die, they will benefit from the financial resources your policy gives them.
Here are a few examples to show why life insurance is a good investment:
1. You’re a parent of young children
If you have young children, it’s essential to ensure they’ll be financially taken care of if you die. Young children are almost entirely dependent on their parents for everything they need, so the death of either one could have huge consequences. Financially, there could be a large strain on resources with lost income and paying for childcare services.
With life insurance, any lost income can be replaced, and you can also have the required finances to properly care for your children.
2. You’re the primary breadwinner in a relationship
If you’re the primary or sole breadwinner in a relationship, your partner might have serious financial problems in the event of your death. A sudden loss of income could impact your partner’s ability to cover the bills and other essential expenses.
With a lump-sum payout from term life insurance coverage, your partner could have the finances they need to cover their expenses, including any funeral and burial costs.
Term vs. Whole Life Insurance: Why Term is Almost Always Better
3. You have private student loans with a co-signer
Often, young students need a cosigner to qualify for student loans to pay for school expenses. The cosigner shares equal responsibility with the student for repayment of the loan. If the student dies, their co-signer may need to pay off the loans — or vice versa. Some lenders include an option in student loan contracts to demand the full balance if someone on the loan were to die.
Most of the time, it won’t be possible to pay off student loans all at once, considering the average student loan debt is around $30,000. Although some federal student loans may be discharged completely if the student or cosigner dies, the terms vary with private student loans.
With some private student loans, the cosigner won’t be held responsible for any payments if the student dies, and the debt is forgiven. If there is no specific clause in the contract saying otherwise, the cosigner may be legally obligated to repay the debt, and the repayment plan should continue as normal. The loan will usually not be forgiven if a cosigner dies.
If the student borrower had a life insurance policy that named the cosigner as a beneficiary, the loans could be paid off using the death benefit payout.
FAQs about life insurance
Which type of life insurance is best?
It depends on the situation, but term life insurance is often a better investment. Premiums are less expensive and you can receive a tax-free lump sum payout.
Does life insurance really pay out?
Yes, it does. With term life insurance, beneficiaries can receive a lump-sum payout if the policyholder dies within the term. With whole life insurance, the benefits may come as a similar payout upon death, plus a possible cash value that has been built up over the years.
What’s better: whole or term life insurance?
In most cases, term life insurance is better. With term life insurance, your premiums are lower than with whole life insurance. Also, you can choose the length of the term — even going longer than 30 years if you want.
Do life insurance companies check medical records?
Completing medical exams and answering questions about your health are common steps in applying for life insurance; however, they’re not always necessary. Some online insurers, like Bestow, do not require that you complete a medical exam to apply for a policy. If you have the option for group life insurance, this may not require a medical exam or questions about your health.
The final word on life insurance
Although investing in a life insurance policy may not be for everyone, these policies can be beneficial in certain situations. If you understand how life insurance works, it’s easier to know whether it would be a good investment for you.
No-Hassle Term Life Insurance
- Leave your family up to $1,500,000 in life insurance
- Apply for a policy in under 5 minutes
- No medical exam required
- Policies start at just $10/month
Accidental Death and Dismemberment (AD&D) vs. Life Insurance: Here’s How They’re Different