What is Life Insurance, and Do I Need It?

What is life insurance exactly? In this article, we explore what life insurance is, how it works and the types of life insurance available on the market. After reading this article, you should have a thorough understanding of who life insurance is suited to, as well as the financial pros and cons, assisting you to determine if life insurance is right for you.


Have you ever heard the phrase, “life happens?” Sometimes, despite our best efforts and intentions, bad things happen in our lives. We may get into a car accident, lose a loved one, or suffer a severe injury. Depending on the severity of these unfavourable events, we may not be fully covered by certain forms of insurance, for example, private health insurance or car insurance.

That’s where life insurance comes in. In this article, we look at what life insurance is, who may need it (and why) and what different types of life insurance are available. We will also examine the financial side of life insurance to help you make an informed decision as to whether or not life insurance is right for you.

I recently published an interview with Katherine Hayes about Insurance, and we spoke in depth about life insurance (as well as other forms of insurance), and previously have spoken in great depth with Vince Scully about this in our superannuation interview where we discussed obtaining insurance through your super.

CaptainFI is not a financial advisor and this article is not financial advice. This website is reader-supported, which means we may be paid when you visit links to partner or featured sites, or by advertising on the site. For more information please read my Privacy PolicyTerms of Use, and Financial Disclaimer.

What is Life Insurance?

Life insurance covers policyholders in the form of a lump sum or ongoing payments (depending on your circumstances) in the event of severe injuries causing disability, diagnosis of a major illness, or if you pass away and leave behind a family that will need financial support.

Like any other form of insurance, life insurance helps to alleviate the financial stress that comes with some of the inherent risks of life- including death itself. It gives families, particularly those with a sole breadwinner, peace of mind that they will be looked after should the unthinkable happen.

what is life insurance
Life Insurance can alleviate financial stress for your loved ones in the event of your death, or TPD.

How does Life Insurance work?

Different types of life insurance policies work in different ways, however, the general gist is that in certain unexpected circumstances like the ones mentioned above, the policyholder and any dependents will receive some form of financial compensation that assists in easing the financial burden of such traumatic events. The Australian Government’s MoneySmart website provides more detail about life insurance policies in Australia.

“Life insurance provides financial support to preserve your way of life, or that of your family, in the event of an accident, serious illness or even death. Many people think of life insurance as covering you only when you die; however there are several types of life insurance that provide you with support if you suffer an injury or illness that leaves you unable to work permanently, or for a period of time.”


What is the purpose of having life insurance?

In case you’re still a little confused as to whether or not you need life insurance, let’s look at what Australia’s largest financial comparison website, Canstar, has to say about it. Their website states that the purpose of having life insurance is to “provide you and your family… with financial security if you were to pass away, become terminally ill, or… become unable to work.”

what is life insurance
The older you get, the more expensive life insurance will be – it also depends on your health and lifestyle.

What are the five main types of life insurance?

Life insurance in Australia can be categorised into five different types. ANZ, one of Australia’s big four banks, provides a handy guide to the five different types on its website.

Life (or term life) Insurance

Perhaps the most simple form of life insurance, policyholders are provided with a lump sum when they pass away, or in some instances, may receive an early payment if they become terminally ill.

Critical Illness (Trauma) Insurance

Trauma insurance generally provides cover for serious illnesses and injuries, like heart attacks, cancer and strokes. This style of life insurance allows the policyholder and their loved ones to focus on recovering, without stressing over money. Often, insurers will offer this insurance as either an individual policy or an optional extra on a term life policy.

Income Protection Insurance

Also known as salary continuance, income protection insurance will continue to pay the policyholder’s salary if a severe injury or illness prevents them from working for some time. These policies often have waiting times before being able to make a claim, which can range from 30 to 90 days.

The conditions of these policies vary widely with individual circumstances, for instance, they don’t always pay the same amount of an individual’s salary and typically only cover up to 70%. Benefit periods (the length of time a benefit will be paid for) also vary from policy to policy.

Total and Permanent Disability (TPD) Insurance

Most often purchased as an extra on a life insurance policy, TPD insurance provides cover in case a policyholder suffers a serious illness or injury that prevents them from ever working again, either in their current job or any job they may be suited to based on their qualifications and experience (this will depend on the policy selected).

Funeral Insurance

With funerals in Australia typically costing up to $15,000, this style of insurance can ease the burden on the family members of the deceased by providing a lump sum to cover funeral expenses. This sum is typically paid quite quickly following a successful claim being made.

One benefit to funeral insurance is the option for a policy with capped premiums. This means that, when premium payments reach the cover amount, premium payments will stop and the policy will be free for the rest of the holder’s life. This prevents more money from being paid in premiums than the cover that will be received.

How long do you pay life insurance?

Life insurance is paid from whenever you take out the policy, to the time that you either choose to cease the policy or such time when a claim must be made. In Australia, life insurance policies can usually be purchased up until the age of 65, and cover will usually continue until the age of 99.

It is important to note, however, that life insurance policies continue to increase in price with age, due to the likelihood of a claim increasing. It can therefore be worthwhile to consider taking out a policy as soon as you are financially able, as this could save you lots of money in the long term.

Who is life insurance best suited for?

The simple answer to this question is that life insurance is an important consideration for anyone who has other people that depend on their income. This could be anyone from children, to business partners and spouses.

what is life insurance
If you don’t have any dependents or anyone else who is dependent on your income, you may not need life insurance. Every situation will be different.

At what age should you get life insurance?

Due to the rising premiums as one gets older, the younger you are when you get life insurance, the better off financially you will be. Therefore, the ideal age to get life insurance is as soon as you have someone in your life that is dependent on your income. For example, as soon as you get married (especially if your spouse earns substantially less than you) or as soon as you find out your first child is on the way.

“Generally, you need life insurance if other people depend on your income or if you have debt that will carry on after your death. However, the older you get the more expensive life insurance costs.”

thom tracy – investopedia.com

Who would not need life insurance?

Those people who are financially independent, have no dependents, and who don’t run their own business generally do not need life insurance. This often includes young adults, say 18-25, who don’t yet have any of these things. If you can’t immediately think of someone that wouldn’t be able to get by without your income then you likely don’t need life insurance… maybe?

How much does life insurance cost?

Life insurance providers, just like all insurance providers, are essentially taking on your risk for you, and charge you differently from someone else depending on how “risky” they deem you to be. It is therefore important to note that life insurance premiums vary widely with age as we have already discussed, but also with factors relating to your health and lifestyle. The most critical of these factors is whether or not you are a smoker.

The average life insurance premium for a 28-year-old female non-smoker is only $28 a month, compared to nearly $500 a month for a male smoker in their late 50s, according to Canstar.

what is life insurance
Generally, the higher your income, and the more dependants you have, the higher the life insurance payout, but this will depend on your policy.

How much life insurance gets paid out?

In Australia, a life insurance payout (for standard life insurance) is typically anywhere between $100k to $2.5m. It is impossible to give a standardised figure as there are too many factors that play into this, like income and number of dependents. Usually, the higher each of these numbers is, the higher your payout will be.

Can you cash out a life insurance policy before death?

There are many instances where life insurance may be paid out before death, depending on the policy. Trauma insurance, income protection insurance and TPD insurance are all designed to cover policyholders for events other than death itself and are therefore paid out with the policyholder still living, according to the details in their policy.

Standard life insurance may also be paid out before death should the policyholder become terminally ill. This usually involves a doctor verifying the severity of the terminal illness and stating that the policyholder has less than 12 months or 24 months to live, depending on the insurance company. This early payout is known as a terminal illness benefit and is included in most policies.

What happens if someone dies shortly after getting life insurance?

Legally, insurance companies are obligated to pay life insurance claims when the policyholder dies, regardless of how long ago they purchased their policy (excluding any waiting periods). However, if a loved one with life insurance passes away soon after purchasing the policy, the payment of the claim may be delayed, as the insurance company will go to great lengths to identify any reasons why they shouldn’t pay the claim, for example, undisclosed medical conditions, or if it appears that the death was a suicide.

what is life insurance
In Australia, life insurance payouts are tax-free, with the one exception being income protection insurance

This is especially true if the death occurs soon enough to fall into the contestability period, which is the period of time where an insurance company is able to investigate the accuracy of a life insurance application.

Do you pay taxes on life insurance?

In Australia, life insurance payouts are tax-free, with the one exception being income protection insurance, as the purpose of this type of insurance is to replace your income, which, of course, is taxable. Therefore, with the other four types of life insurance, beneficiaries will receive the entire amount stated on the policy.

Is it better to have savings rather than life insurance?

At first glance, this may be a fair question. “I have a savings account, which will continue to grow as I age. Why pay for life insurance when that money could be going towards to my savings and investments, which will go to my family anyway when I die?”

To understand why life insurance is essential, even if you are a great saver, let’s crunch some numbers. The average household savings in Australia as of June 2020 (according to a survey conducted by the ABS) was $26,500. According to Debt Busters, the average household debt in Australia is $250,000, nearly 60% of which is mortgages. We’ve already established that funerals can cost up to $15,000. For the average household, this means if their sole income earner passes away, they have a minimum of $265,000, 10x their savings, worth of expenses for which they are now responsible. In addition, if the death was due to a terminal illness then there is likely large medical bills to take into account as well.

Now consider that the purchasing power of money in a savings account is eroded by inflation, which today, is running rampant. Pair this with the effect of inflation on living (and funeral) expenses, and rising interest rates causing variable rate mortgages to skyrocket. It’s clear: relying on your savings to look after your family when you’re gone is simply not a safe option for most families. Better to pay a small fee each week, for a large sum when you die and the peace of mind that comes with it.

Katherine Hayes – Financial Advisor and Insurance Specialist

Recently I got the opportunity to speak to Katherine Hayes about insurance. Katherine is a financial advisor and insurance specialist, and opened our discussion on insurance with;

“What I specialize in is the personal insurances. So that broadly falls into four key areas. You’ve got your life insurance, which pretty straightforward if you die or you’re terminally ill, you get your pay out TPD, which most people have that in conjunction with their superannuation. And that stands for total and permanent disablement. That’s the insurance that is only going to pay if you will never, ever work.

Then the two other insurances are income protection, which most people are familiar with. That’s security of cashflow. And then the last one, which is the insurance that people have the least off, but it’s actually my favorite and that’s trauma insurance, which also gets called critical illness cover. And that’s got nothing to do with your ability to work. It actually pays out if you get diagnosed with an event. So for example, cancer, heart attack stroke. They don’t care if you’re working or not. If you get diagnosed, do you get a lump sum payment to use as UC for it? “

Katherine Hayes

Make sure to check out the podcast for all the information about life insurance from a specialist financial advisor.

Final Words – Is life insurance worth it?

All in all, this article outlines not only why life insurance is worth it, but why it is essential for people with dependents, businesses or people who otherwise rely on their income. If, after reading this article, you feel as though life insurance is something you would benefit from, you can visit sites such as Compare The Market to start getting quotes and determining which provider and policy are right for you. Wouldn’t it be a relief to know that when you’re gone, your loved ones will be looked after? 

Just be aware that many online comparison sites exist as a form of internet marketing. This means you might not be getting the full story, so don’t ever just trust one website, make sure you do a meta analysis of everything you can get your hands on

CaptainFI is not a financial advisor and this article is not financial advice. This website is reader-supported, which means we may be paid when you visit links to partner or featured sites, or by advertising on the site. For more information please read my Privacy PolicyTerms of Use, and Financial Disclaimer.

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