What is life insurance?
Key takeaways
04 · ideas- Life insurance replaces your income if you die and leave dependents
- Term life (10–30 years) is cheapest; whole life is expensive and complex
- A 35-year-old can get $500k of 20-year term for ~$25–40/month
- You need life insurance if others depend on your income
Basic level
The essentials · 1 min
Life insurance is a contract: you pay monthly premiums, and if you die, the insurance company pays a lump sum (the death benefit) to your chosen beneficiaries — your spouse, children, or others.
Who needs life insurance:- ✅ Parents with children who depend on your income
- ✅ Spouses where one or both incomes are needed
- ✅ Anyone whose death would leave others with debt or financial hardship
- ❌ Single person with no dependents (usually don't need it)
- ❌ Children (they don't have income to replace)
The two main types:
Term life insurance:- Covers you for a fixed period (10, 20, or 30 years)
- Pays only if you die during the term
- Much cheaper — $25–$40/month for a healthy 35-year-old to get $500,000
- The right choice for most people
- Covers you for life, as long as you pay premiums
- Has a cash value component that grows slowly
- Very expensive — 5–15× more than term
- Often oversold; rarely the best financial choice
Simple rule: Buy term, invest the difference.
Intermediate level
How it applies · 1 min
How much life insurance do you need?
The most comprehensive formula: DIME method
| Component | What it covers | Example |
|---|---|---|
| **D**ebt | All debts except mortgage | $20,000 |
| **I**ncome | Years until youngest child is independent × annual income | 15 × $80,000 = $1,200,000 |
| **M**ortgage | Outstanding mortgage balance | $280,000 |
| **E**ducation | Future college costs per child | 2 × $100,000 = $200,000 |
| **Total need** | **$1,700,000** |
A simpler rule of thumb: 10× your annual income. On $80,000/year income: $800,000 in coverage.
Term life cost by age and health
Monthly premium for $500,000 of 20-year term (non-smoker):
| Age | Excellent health | Good health | Average health |
|---|---|---|---|
| 25 | $18 | $22 | $32 |
| 30 | $20 | $25 | $36 |
| 35 | $25 | $32 | $48 |
| 40 | $38 | $50 | $75 |
| 45 | $65 | $85 | $130 |
| 50 | $115 | $155 | $240 |
Buy early and stay healthy. The premium you lock in at 30 is guaranteed for 20 years.
Term vs. whole life: the math
For a 35-year-old needing $500,000 of coverage:
| Term (20yr) | Whole life | Difference | |
|---|---|---|---|
| Monthly premium | $28 | $350 | $322/month saved |
| Total 20-year premiums | $6,720 | $84,000 | Save $77,280 |
| If $322/mo invested at 8% for 20 years | — | — | $190,000 |
The "invest the difference" strategy: buy cheap term + invest the $322 saved = $190,000 in 20 years. The whole life's cash value over the same period: typically $80,000–$120,000 — worse on both return and flexibility.
Advanced level
The math, step by step · 1 min
How insurers price life insurance
Actuarial pricing uses mortality tables and expected claims:
- $q_x$ = probability of death at age $x$ (from mortality tables)
- $B$ = death benefit
- $i$ = investment return the insurer earns on premiums
- The discount factor assumes claims pay mid-year on average
Why term is cheaper than whole life: Term has no savings component — the entire premium buys pure mortality protection. Whole life premiums are split: part for insurance, part invested in low-yield general account. The insurer profits from the spread between their investment return (~5%) and what they credit to your cash value (2–4%).
The present value of life insurance coverage
The net present value of term insurance from the policyholder's perspective:
Where q_t is the probability of dying in year t and r is your personal discount rate. For most healthy 30-year-olds, this NPV is negative — you expect to pay more than you collect. But insurance isn't about expected value; it's about protecting against catastrophic loss variance.
The risk-transfer value: $500,000 death benefit for $300/year transfers a 0.06% probability event into certain annual cost. The actuarially fair premium for a 30-year-old is ~$120/year; paying $300 is a 2.5× risk premium for the certainty of coverage.