Life Insurance Guide

Our life insurance guide explains the basics of how life insurance works and how it can play an important role in a financial plan.

Family who needs the life insurance guide

You may already know that life insurance protects the people you love by paying out a death benefit after you pass away. But that’s just the start of how life insurance works. In our life insurance guide, we explain how you can use life insurance throughout your life, and how it can work with other parts of your financial plan to help you reach your financial goals faster.

Section 01 What is life insurance?

At its most basic, life insurance is a contract between you and an insurance company. Under the terms of the contract, you make regular premium payments to the company in exchange for a certain dollar amount of coverage. If you pass away while your coverage is in place, the life insurance company will pay out a death benefit to the beneficiaries you designate.

While the death benefit is the primary reason people tend to get life insurance, certain types of policies accumulate cash value, which is money that grows in a tax-advantaged way and is available for you to access throughout your life.

While there are many different types of life insurance, they all fall into two main categories:

Term Life Insurance

Term life insurance offers a death benefit for only a set period of time, which is the term. If you die within that time frame, your beneficiaries will receive the death benefit. After your coverage expires, there would be no payout to your beneficiaries.

Permanent Life Insurance

Permanent life insurance covers you for life. Your beneficiaries will receive the death benefit no matter when you die. Permanent life insurance also accumulates cash value that you can access as a living benefit at any time for any need.1

Life insurance can help protect the life you’ve built.

Our financial advisors can make personalized life insurance recommendations based on your needs and situation.

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Section 02 Different types of life insurance

While all life insurance policies fall into the two broad categories of temporary insurance (term life insurance) or life insurance that lasts your entire life (permanent life insurance), there are a number of different types of life insurance within these broad categories. Here’s a rundown.

Term Life Insurance

  • Annually renewable term life insurance

    Annually renewable term life insurance typically lasts until you cancel your policy or reach a certain age, like 80. With an annually renewable policy, your premiums are based on your age and your health when you first purchase the policy and increase over time. Annually renewable term is typically the least expensive life insurance you can buy when you are young, but it gets more expensive as you age.

  • Level term life insurance

    Level term life insurance gives you more certainty over the cost of your premiums, as they remain level for the length of your insurance. Typically, level term insurance policies are sold in 10- or 20-year terms. Once the term is over, you stop paying and no longer have coverage.

Permanent Life Insurance

  • Whole life insurance

    Whole life insurance is the most straightforward form of permanent insurance. You pay a fixed monthly (or annual) premium for a guaranteed death benefit, and coverage lasts for your entire life — even after you are done paying premiums. Your cash value is guaranteed to grow, and with annual dividends, if paid, it can grow even faster.

  • Universal life insurance

    Universal life insurance allows you to build cash value, but it provides you with more flexibility when it comes to the amount you pay in premiums and your death benefit. Your cash value is not guaranteed to grow in a universal life policy (as it is in a whole life policy), but you do have the ability to accumulate more cash value because of the premium flexibility.

  • Variable Universal Life Insurance

    Variable universal life insurance gives you more control over your cash value by allowing you to allocate it toward a wide variety of market-driven subaccounts. Like universal life (above), the ability to accumulate more cash value exists because of the premium flexibility as well as the investment performance of the subaccounts. However, like any market-based investment, your cash value could also decline.

Converting life insurance

Couple outside a home thinking about converting their life insurance.

When you’re young, a term life insurance policy might be an attractive and affordable option. But as you grow older and your financial priorities change, you may want to add permanent life insurance for its additional benefits. This is where you can use something known as term conversion.

Most term policies include a stipulation that lets you convert some or all of your coverage into a permanent policy within a specified time frame. While you could get a new permanent policy, a term conversion can be easier. That’s because most companies allow you to convert without undergoing another health examination.

The premium for your converted permanent life insurance policy will take your age into account, but not your health status — even if that has changed since you first signed up for term life insurance. This is a key reason to get life insurance when you’re still young.

Some insurance companies offer conversion credits, which will help offset the cost of increased premiums. These credits may help lower your premiums for the first year.

Section 03 How much life insurance do I need?

A common rule of thumb for life insurance is to get at least 10 times your salary in death benefit. But this is just a starting point, as there’s no one-size-fits-all figure for how much death benefit you need. Let’s face it: Everyone’s situation is different.

Life Insurance Calculator

Our Life Insurance Calculator can help you get a sense of how much life insurance you may need.

So how much life insurance do you need? Well, that can depend on several factors, including these:

  1. Your income
  2. How many beneficiaries you have
  3. How long your beneficiaries might need support
  4. Whether you have a mortgage or other debts
  5. Any future costs you’re trying to cover (e.g., a child’s future college or wedding costs)
  6. Any investments or assets you may have

It’s a good idea to get at least some life insurance protection as soon as you can because the cost of life insurance is based primarily on your age and health. The younger and healthier you are, the less expensive your premium will be. And many insurers allow you to add a benefit at younger ages that gives you the right to buy more insurance without having to take an additional health exam later. Locking in your health status is a key reason to buy life insurance when you’re young.

Then, as your needs change over time, you can update your life insurance along with your financial plan to reflect your new reality

Section 04 What is life insurance cash value?

A key benefit of permanent life insurance is the policy’s cash value. The cash value of life insurance grows in a tax-advantaged way and becomes an asset that you can access for anything you wish. Some common ways that policyholders can use cash value include:

  • Paying premiums

  • Paying a child’s college tuition

  • Paying for an emergency expense

  • Funding a down payment or providing collateral on a mortgage or personal loan

  • Purchasing or expanding a business

  • Supplementing retirement income

When it comes to accessing your cash value, you have three options.

  • Loan

    You borrow money from the life insurance company using your policy’s cash value as collateral.

  • Partial Surrender

    You give up a portion of your policy in order to take a portion of your cash value. This would reduce your death benefit.

  • Total Surrender

    You give up your life insurance policy completely. This ends your death benefit but allows you to take your entire cash value.

There are pros and cons to each option. When surrendering a portion or all of your policy, you are essentially giving up some or all of your death benefit. That’s why it’s important to use this option only if your heirs no longer need the death benefit.

In addition, when you surrender your policy, you can take out as much as you paid into your policy on a tax-free basis. But when you take out any gains, you will owe ordinary income tax on that amount. When you take a loan against your policy, you won’t owe any tax as long as you repay the loan. But interest will accrue on your borrowed funds — and if the loan grows too large, the company will surrender your policy, which can result in you owing income tax on any growth.

CLIENT SPOTLIGHT
As the coronavirus began spreading in 2020, Rubber Products Distributors (RPD) in Indiana got a call from a personal protective equipment (PPE) supplier in China that had masks ready to ship to the U.S. Demand for PPE was red-hot, but RPD needed more cash to be able to distribute it. They had trouble raising cash quickly through their bank, so the solution came courtesy of their financial representative, who helped them access money through the cash value feature on their life insurance policies.

Using life insurance cash value in retirement

When you get to retirement, it’s common to keep a portion of your savings invested. Over the long-term market-based investments tend to outperform other forms of savings. But as we all know, the price of stocks falls from time to time. In retirement, you’ll sell stocks to generate income. During a market downturn, if you have to sell more stocks to generate the same amount of income, you may end up eating away at your retirement nest egg.

That’s where the cash value of life insurance comes in. Because life insurance cash value isn’t tied to the stock market, during a market downturn you can generate income with the cash value of permanent life insurance in retirement. This allows you to wait until the price of your stocks recover before you sell them.

Life insurance can help protect the life you’ve built.

Our financial advisors can make personalized life insurance recommendations based on your needs and situation.

Connect with an advisor

Section 05 How life insurance dividends work

When a company makes a profit, it can pay all or a portion of that profit to its owners. Public companies typically do this by paying dividends to their shareholders, who own the company. If you own stocks or mutual funds, you may be familiar with receiving dividends.

Dividends with a mutual life insurance company are similar. The difference is that with a mutual company (of which Northwestern Mutual is one), there are no shareholders. The company is operated on behalf of its policyowners. When the life insurance company performs better than it expected in a given year, it can choose to pay its policyowners through life insurance dividends.

Here’s how it works: Each year, a life insurance company forecasts how many claims it expects to pay, how much money it will bring in from premiums and investments, and how much it will cost to run the company. If the company performs better than expected, it may issue a dividend. Dividends aren’t guaranteed, but Northwestern Mutual has paid them every year since 1872.

Here’s how you can use your dividend

  • Take your dividend as cash.

  • Use it to increase your permanent insurance coverage.

  • Reduce or pay your premium with it.

Section 06 When to revisit your life insurance coverage

Mom working on a laptop with her baby deciding when to revisit her life insurance coverage.

It’s a good idea to review your financial plan and your life insurance coverage at least once a year. But there are some instances when it makes sense to review your coverage right away. Here are six times when buying more insurance coverage may make sense.

  • Getting married

    Combining your lives is such an exciting time. It also means that you depend on each other, which is a key reason to get life insurance.

  • Starting or growing a family

    When you have a family that depends on you, life insurance can protect them should something happen to you.

  • Buying a house

    A home — more specifically, the mortgage — is a big financial obligation that you may need more coverage for.

  • Starting a business

    It’s not uncommon for business partners to have life insurance on each other in case they need to purchase a share of the business from surviving family.

  • Supporting aging parents

    If your parents depend on you, it’s a good idea to get life insurance to help cover their costs.

  • Taking out a student loan

    If someone co-signs a private student loan for you, they could be on the hook for the entire balance if you die. If you have a co-signer, it's a good idea to get coverage on yourself that names the co-signer as a beneficiary.

Section 07 Where to get life insurance

Group life insurance through work

If you get a benefits package through work, there’s a chance that your employer offers some form of life insurance through a group plan. Often, these basic plans offer a fixed death benefit at little or no cost to you. While this is a great benefit, the life insurance you get through work may not be enough. Life insurance through work typically comes in two forms:

  • Basic life insurance

    If offered, basic life insurance is generally provided at no cost. You may be given this free coverage by default. Basic life insurance coverage is usually fixed, meaning everyone receives the same benefit; or coverage may be a multiple of your annual salary (typically one to two times what you earn). While any coverage is certainly helpful, it’s typically not enough to provide extended financial security for your loved ones.

  • Supplemental life insurance

    This is sometimes offered in addition to the basic life policy. You’ll pay out of pocket for this extra level of coverage, but you’ll continue to enjoy group-based rates. The added benefit allows you to purchase anywhere from a few thousand dollars to several times your annual salary.

While life insurance through work can be a great benefit, there are some drawbacks. First, it typically isn’t portable, meaning that if you leave your job, you could suddenly find yourself without coverage. In addition, the cost of group insurance could change over time.

Individual life insurance

Because group coverage through work may not be enough, many people opt to purchase individual life insurance on their own through a financial advisor. Working with someone can be useful because they can help you talk through what costs you would need to cover in the event something happens to you, what level of coverage you may need, and what type of policy makes the most sense for your financial situation.

Section 08 Conversation starters with an advisor

  • I already have other assets I can leave to family. Why do I need life insurance?

  • What types of costs can life insurance cover?

  • Does it make sense for me to go with term or permanent insurance?

  • What options do I have for changing my coverage in the future?

  • What can I use cash value for in the future?

  • How many beneficiaries can I designate on a policy?