Term Life Insurance
Term life insurance, also known as pure life insurance, is a type of death benefit that pays the heirs of the policyholder throughout a specified period of time.
Once the term expires, the policyholder can either renew it for another term, convert the policy to permanent coverage, or allow the term life insurance policy to lapse.
How Term Life Insurance Works
When you buy a term life insurance policy, the insurance company determines the premium based on the policy's value (the payout amount) and your age, gender, and health.
In some cases, a medical exam may be required. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, and family history.
If you die during the policy term, the insurer will pay the policy's face value to your beneficiaries. This cash benefit—which is, in most cases, not taxable—may be used by beneficiaries to settle your healthcare and funeral costs, consumer debt, or mortgage debt, among other things.
If the policy expires before your death, there is no payout. You may be able to renew a term policy at its expiration, but the premiums will be recalculated based on your age at the time of renewal.
Term Life Insurance vs. Whole Life Insurance
Term life policies have no value other than the guaranteed death benefit. There is no savings component as is found in a whole life insurance product.
Term life is usually the least costly life insurance available because it offers a benefit for a restricted time and provides only a death benefit. For example, a healthy non-smoking man aged 35 could get a whole life insurance policy with a benefit of $500,000 for an average of $28 per month as of 2021. At age 50, the premium would rise to $71 a month.
Depending on the issuer, purchasing a whole life equivalent would have significantly higher premiums, possibly $200 to $300 per month, or more.
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Most term life insurance policies expire without paying a death benefit. That lowers the overall risk to the insurer compared to a permanent life policy. The reduced risk allows insurers to charge lower premiums.
Interest rates, the financials of the insurance company, and state regulations can also affect premiums. In general, companies often offer better rates at the “breakpoint” coverage levels of $100,000, $250,000, $500,000, and $1,000,000.
Top-Rated Term Life Insurance Companies
Example of Term Life Insurance
Thirty-year-old George wants to protect his family in the unlikely event of his early death. He buys a 10-year, $500,000 term life insurance policy with a premium of $50 per month.
If George dies within the 10-year term, the policy will pay George’s beneficiary $500,000. If he dies after he turns 40, when the policy has expired, his beneficiary will receive no benefit. If he renews the policy, the premiums will be higher than his initial policy because they will be based on his current age of 40 rather than 30.
If George is diagnosed with a terminal illness during the first policy term, he probably will not be eligible to renew the policy when it expires. Some policies offer guaranteed re-insurability (without proof of insurability), but such features, when available, come with a higher cost.
Types of Term Life Insurance
There are several types of term life insurance. The best option will depend on your individual circumstances.
The Level Term or Level-Premium Policy
These provide coverage for a period ranging from 10 to 30 years. Both the death benefit and the premium are fixed.
Because actuaries must account for the increasing costs of insurance over the life of the policy's effectiveness, the premium is comparatively higher than yearly renewable term life insurance.
The Yearly Renewable Term (YRT) Policy
Yearly renewable term (YRT) policies have no specified term but can be renewed each year without providing evidence of insurability.
The premiums rise from year to year as the insured person ages. There is no specified term, but the premiums can become prohibitively expensive as the policyholder ages, making the policy.
The Decreasing Term Policy
These policies have a death benefit that declines each year, according to a predetermined schedule. The policyholder pays a fixed, level premium for the duration of the policy.
Decreasing term policies are often used in concert with a mortgage, with the policyholder matching the payout of the insurance with the declining principal of the home loan.
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Benefits of Term Life Insurance
Term life insurance is attractive to young people with children. The parents can obtain substantial coverage for a low cost. If the payout is needed, the family can rely on it to replace lost income.
These policies are also well-suited for people with growing families. They can anticipate that coverage will be needed until, say, their children have reached adulthood and are self-sufficient.
The term life benefit, obviously, may be equally useful to an older surviving spouse. However, other options for providing for a surviving spouse may be preferable given the higher costs of the premiums to older policyholders.
Insurance companies set a maximum age for their term life insurance coverage. This ranges from about 80 to 90 years old.
Do I Need Term Life Insurance or Permanent Life Insurance?
The main differences between a term life insurance policy and a permanent insurance policy, such as universal life insurance, are the duration of the policy, the accumulation of a cash value, and the cost. The right choice for you will depend on your needs. Here are some things to consider.
Cost of Premiums
Term life policies are ideal for people who want substantial coverage at a low cost.
People who own whole life insurance pay more in premiums for less coverage but have the security of knowing they are protected for life.
People who buy term life are paying premiums for an extended period, and getting nothing in return unless they have the misfortune to die before the term expires. And, term life insurance premiums increase with age.
This means that term life premiums may cost more over the years than permanent life insurance premiums would have been.
Availability of Coverage
Unless a term policy has guaranteed renewable policy, the company could refuse to renew coverage at the end of a policy’s term if the policyholder developed a severe illness. Permanent insurance provides coverage for life as long as the premiums are paid.
Some customers prefer permanent life insurance because the policies can have an investment or savings vehicle. A portion of each premium payment is allocated to the cash value, with a growth guarantee. Some plans pay dividends, which can be paid out or kept on deposit within the policy.
Over time, the cash value growth may be sufficient to pay the premiums on the policy. There are also several unique tax benefits, such as tax-deferred cash value growth and tax-free access to the cash portion.
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Financial advisors warn that the growth rate of a policy with cash value is often paltry compared to other financial instruments, such as mutual funds and exchange-traded funds (ETFs). Also, substantial administrative fees often cut into the rate of return. Hence, the common phrase “buy term and invest the difference.” However, the performance is steady and tax-advantaged, a benefit when the stock market is volatile.
Apparently, there is no one-size-fits-all answer to the term versus permanent insurance debate. Other factors to consider include:
- Is the rate of return earned on investments sufficiently attractive?
- Does the permanent policy have a loan provision and other features?
- Does the policyholder have or intend to have a business that requires insurance coverage?
- Will life insurance play a role in tax-sheltering a sizable estate?
Term Life Insurance vs. Convertible Term Life Insurance
Convertible term life insurance is a term life policy that includes a conversion rider. The rider guarantees the right to convert an in-force term policy—or one about to expire—to a permanent plan without going through underwriting or proving insurability. The conversion rider should allow you to convert to any permanent policy the insurance company offers with no restrictions.
The primary features of the rider are maintaining the original health rating of the term policy upon conversion, even if you later have health issues or become uninsurable, and deciding when and how much of the coverage to convert. The basis for the premium of the new permanent policy is your age at conversion.
Of course, overall premiums will increase significantly since whole life insurance is more expensive than term life insurance. The advantage is the guaranteed approval without a medical exam. Medical conditions that develop during the term life period cannot adjust premiums upward. However, the company may require limited or full underwriting if you want to add additional riders to the new policy, such as a long-term care rider.
The Bottom Line
Term life insurance is a good option for people who can't or won't pay the much higher monthly premiums associated with whole life insurance.
It's a bit like car insurance. It's statistically unlikely that you'll need it, and the premiums are money down the drain if you don't. But you have it just in case the worst happens.