Most of the confusion in life insurance comes from comparing products that were built for different jobs. This guide sets out what each type is for, and the one piece of tax treatment that affects every one of them.
The four types
Term life
Cover for a fixed number of years — commonly 10, 20 or 30. If you die within the term, it pays. If you outlive it, it ends and pays nothing. It builds no cash value, which is why it buys the largest death benefit per dollar of premium. It fits a need with an end date: a mortgage, the years until children are independent, a business loan.
Whole life
Permanent cover with a level premium and a cash value that accumulates. It costs substantially more per dollar of death benefit than term, and in exchange it does not expire and cannot be repriced.
Universal life
Permanent cover with flexibility in premium and death benefit. That flexibility is the attraction and also the risk: a policy underfunded for years can require much larger premiums later to stay in force. Universal life needs reviewing periodically rather than filing away.
Final expense
A small whole life policy, typically bought to cover a funeral and the costs immediately following a death. It has its own guide: final expense insurance.
How much cover
There is no formula that survives contact with a real household, but the question is answerable. Work from what would actually need paying rather than from a multiple of salary.
- Income that would stop, and for how many years it would need replacing.
- Debts that would not die with you — a mortgage, co-signed loans, business obligations.
- Costs the death itself creates, including the funeral.
- Money already available: existing policies, savings, a spouse’s earnings.
Subtract the last from the first three and you have a working figure. Revisit it when the mortgage shrinks or the children leave, because the right amount falls over time for most households.
How the payout is taxed
Life insurance proceeds paid to you because of the death of the insured person are generally not taxable income. That is the general rule and it is why life insurance is an efficient way to leave money.
Two qualifications matter. Interest income received as a result of life insurance proceeds may be taxable — so if the payout is held and paid in instalments, the interest element is treated differently from the benefit itself. And the general rule does not apply if the policy was transferred to you for a price, or acquired in a reportable policy sale.
This is the point at which the tax return and the insurance decision meet, which for a household using one adviser for both is a conversation rather than a referral.
What underwriting looks at
Pricing is based on the risk you present: age, health history, medications, tobacco use, sometimes occupation and travel. Some policies require a medical examination and some do not; the ones that do not generally cost more or cover less for the same premium.
The practical implication is about timing rather than tactics. Cover costs less the younger and healthier you are when you buy it, and a policy already in force is not repriced because your health later changes. Waiting is the expensive option.
Also on this site
Dated coverage of this topic, where the figures move year to year:
Frequently asked questions
Is a life insurance payout taxable?
Generally not. Life insurance proceeds paid because of the death of the insured are not normally taxable income. Interest received as a result of the proceeds may be taxable, and the general rule does not apply where the policy was transferred for a price or acquired in a reportable policy sale.
Is term or whole life better?
Neither in the abstract. Term buys the most death benefit per dollar and ends on a date, which suits a need with an end date such as a mortgage. Whole life costs more, does not expire and builds cash value. The right answer follows from how long the need lasts.
How much life insurance do I need?
Work from what would have to be paid: income that would stop and for how long, debts that survive you, the cost of the funeral — then subtract what is already available in savings, existing policies and a spouse’s earnings. A multiple of salary is a starting point, not an answer.
Do I need a medical exam?
It depends on the policy. Some require one, some do not. Policies that skip the exam generally cost more or cover less for the same premium, because the insurer is pricing with less information.
Sources
- Publication 525, Taxable and Nontaxable Income — Life Insurance Proceeds — Internal Revenue Service · read 2026-10-19
- Topic no. 403, Interest received — Internal Revenue Service · read 2026-10-19
This guide explains published rules and figures, with the source for each one. It is not advice about your own situation.