Term insurance is temporary life insurance that can help provide financial protection for a set period of time or when you’d like life insurance coverage but cannot yet afford permanent life insurance. For example, if you’re entering the workforce, getting married, or having children, you might have life insurance on your radar because it can help provide financial relief in the event that you pass away. This helps policyholders to avoid leaving their loved ones with debt or a loss of income.
- What is Term Life Insurance?
- Term vs. Whole Life Insurance
- How Does Term Life Insurance Work?
- Types of Term Life Insurance
- Potential Benefits of Term Life Insurance
- Who Should Consider Term Life Insurance?
- What Happens at the End of a Term Life Insurance Policy?
- How To Buy Term Life Insurance
- What To Look For in a Term Life Insurance Policy
What is Term Life Insurance?
Term life insurance only lasts for a set number of years and the death benefit will only be paid out if you die within the policy term. This is unlike permanent life insurance, which is designed to last for the entirety of your life with a guaranteed death benefit payout for your policy beneficiaries when you die.
Term vs. Whole Life Insurance
One of the primary differences between term life insurance and whole life insurance is how long the coverage lasts. While term may be temporary, whole life insurance is considered permanent insurance. This means that it stays active as long as you pay for the coverage. Term insurance may last for only a set amount of years, or it may increase greatly in price after the term ends.
Because of the temporary nature of term insurance, it’s often much more affordable than whole life insurance. As it is not guaranteed that you will ever need to utilize your death benefits — in other words, you may outlive the number of years your term life insurance policy is active — term life insurers do not charge as much for these types of policies.
Meanwhile, whole life insurance tends to have higher premiums because of its lifelong nature, meaning policyholders will eventually utilize their death benefits.
How Does Term Life Insurance Work?
You can buy term life insurance to have coverage for a specific period of your life, and periods of 10, 20, and 30 years are the most common.
No matter how long it will remain active, every term life insurance policy contains a premium, death benefit, and designated beneficiary. The premium is the recurring payment you must make to keep your policy active. Most policies feature a guaranteed rate that will keep your premium the same for the length of your term. However, after the term comes to an end, the policy may increase greatly in price or cancel completely.
The death benefit is the amount of money that will be paid out to the designated beneficiary of your policy. This is set at the time of policy purchase. The amount for the death benefit could be based on providing your beneficiary, such as your child or spouse, with the equivalent of several years’ worth of your income. For example, if your income is $50,000 per year, you may want your death benefit to be the equivalent of 3 years worth of income, or $150,000. Another common option for death benefit amount would be to factor it on how much debt would be left so that the payout could cover it in the event of your passing.
Beyond those basics, term life insurance policies can vary based on type.
Types of Term Life Insurance
Level Term Policies
Unlike term policies where premiums could increase or decrease based on the policyholder’s age, health, or payments, level term insurance policies offer the same premium amount for the entire duration of your insurance coverage term. The death benefit would also remain the same for the years the policy is in effect. This offers a predictable recurring cost that can allow for greater financial planning.
Convertible Term Policies
Convertible term policies act as standard term policies, but with the option to be converted into a permanent life insurance policy after the term is up or during the policy term. Oftentimes, when renewing term policies after the last policy period has ended, a new health assessment is performed. The same is true for applying for a whole life policy after your term life coverage has ended.
A convertible term insurance policy, however, does not usually require a new assessment. The premium of the new policy will be based on the rates of the insured at the time they convert the policy. The trade-off is that convertible policies have a slightly higher cost than regular term insurance due to this feature.
Decreasing Term Policies
Decreasing term policies have level premium payments, meaning the premiums paid would remain the same throughout the duration of the policy. However, unlike a standard level term policy, decreasing term policies feature a death benefit that shrinks each year. The premiums for these types of policies tend to be lower because of this feature. Those who buy decreasing term policies typically use it asset coverage, such as mortgage protection. As you pay down your house, your benefit decreases too, with the goal being leaving enough of a death benefit behind to pay off whatever remains of the mortgage.
The downside of this type of term insurance is that it offers your beneficiaries little flexibility or liquidity. Additionally, you would be paying the same premium for a decreasing benefit.
Return of Premium Policies
In many cases, if you have term insurance and you outlive your policy, you will not get any of your money back. The insurance company keeps the premiums you paid for your insurance coverage.
Return of premium policies, however, feature a way for policyholders to recover some of the premiums paid to the insurer when their coverage period ends. The exact criteria and eligibility for how much is returned varies by insurer.
However, these types of policies tend to charge higher premiums for the feature. Be sure you understand the exact conditions of the policy if you are looking into a return of premium term option.
Yearly Renewable Term (YRT) Policies
Generally every time a period of coverage for a term life insurance plan is up, renewing means submitting to a new health assessment that will factor in any new issues that may have come up along with age. This could result in significantly higher premiums for the new policy. Yearly renewable term policies, however, allow policyholders to renew annually without submitting to a new health assessment; premiums will increase with age, but at a predictable amount that only factors in age and no other health issues.
These types of policies tend to offer lower premiums and can be helpful for someone who needs shorter temporary coverage instead of committing to an entire decade of coverage, as YRT policies only last a year. However, this type of term life insurance is not ideal if you’re looking for a long-term, cost-effective option, as this type of insurance gets more expensive each year.
Potential Benefits of Term Life Insurance
One of the major advantages of term life insurance is that is considerably more affordable than permanent life insurance. Because the coverage only lasts for a finite number of years, the premiums tend to be lower. This could be a good option for those who want coverage as soon as possible but are on a tighter budget, or for those who only need additional coverage for a specific period, such as right after having a child or buying a home.
Term insurance is also highly customizable. When shopping for a policy, you have a lot of flexibility regarding how much coverage you want, how much you want to pay, and for how long.
Conversion To Whole Available
Term insurance that’s convertible also provides a way to get more affordable coverage as soon as possible, with the ability to convert it into permanent insurance later. This way, you don’t have to reapply and undergo a new medical examination.
Large Death Benefits
Term life policies do not necessarily come with smaller death benefits, despite the fact that they are oftentimes more affordable than whole life policies. You can still provide your beneficiaries with a death benefit large enough to pay off your outstanding debts and offer income replacement in the event of your passing with a term life policy.
Who Should Consider Term Life Insurance?
People With Growing Families
Life insurance can help financially protect your dependents and your spouse in the event of your death. The death benefit from your policy can help your surviving beneficiaries pay off debts and temporarily replace your income, easing the transition to a household without you. If you have young children, having insurance can ensure their needs are met in terms of paying for child care, supplies, and other necessities.
The upfront cost of bringing children into your life can be high; term life insurance offers a more affordable way to get immediate coverage to protect your family.
People Who Need Temporary Coverage
Sometimes, you only need temporary coverage or temporary additional coverage if you already have a whole life insurance policy. For example, if you have a whole life insurance policy, but wish to increase coverage just to get you through a period — such as for 20 years to cover your children while they’re young, or for 10 years to cover your mortgage payments — term life insurance can help supplement that period.
What Happens at the End of a Term Life Insurance Policy?
When a term policy is at its end, you may have the opportunity to renew coverage. Otherwise, your policy and coverage may end and you will stop you stop paying premiums, or the premiums will go up usually significantly.
If You Still Need Life Insurance
If you still need insurance, it’s a good idea to consider your next steps before your existing coverage comes to an end. If you have convertible insurance, you can convert your policy into whole life as long as you do it before your coverage ends.
In other cases, you will have to buy a new policy altogether. Unless you have a YRT, it is likely you will have to reapply and undergo a medical examination to determine your new premium. Note that if you are over 80, you may be unable to get new life insurance with some companies, so it is important to purchase a whole life policy earlier on to cover your later years.
If You No Longer Need Life Insurance
When your term ends, you can expect a notice from your insurance company and you can review your options. Typically, that’s all that happens and no further action is necessary on your part. Other times, you may need to contact the insurance company to confirm a policy end or interest in renewing. For example, if you started your term insurance with a return of premium option, you could receive some of what you paid for back.
If you no longer need your insurance, be advised that there’s no payout on a term insurance policy. When your coverage lapses or ends, that’s it. The death benefit will go away with it. In addition, unlike whole life insurance, term insurance has no equity component, so you don’t receive any sort of cash value.
How To Buy Term Life Insurance
Know The Term Length And Coverage You Need
When buying insurance, consider how long you will want coverage. A longer policy can cover your mortgage, while a shorter policy can cover your children while they’re still dependents. Something in between could help cover your student loans or medical bills.
The DIME formula is a good rule of thumb for assessing the coverage you may need: add up your debt, income, mortgage, and education costs for your children to calculate a suggested minimum amount. On the other end of the spectrum, the maximum amount of coverage may want to purchase is typically your annual income multiplied by the number of years you have left until retirement.
Consider Coverage Features Along With Cost
Before purchasing a term life insurance policy, consider not only the cost but your end goal for coverage. If you plan to renew for fewer than 10 years and then switch to a whole life policy, a term life policy with a YRT feature could suit your needs as it would offer shorter terms at relatively lower prices.
If you plan to immediately jump from a term life plan to a whole life plan after your term period is over, a convertible term life policy feature could be beneficial. Though cost is certainly a factor in choosing a term life insurance policy that would suit your needs, taking each policy’s perks into account can help you customize your coverage.
Once you have determined the type of term life policy you’d like and the amount of coverage you need, looking at multiple companies can help you get the best deals and benefits. Not all term life policies are the same, so shop around to ensure you know what is available before purchasing.
What To Look For in a Term Life Insurance Policy
When you’re shopping for term life insurance, there are a few key features to keep your eye out for that can make a major difference in your experience.
For starters, look for guaranteed renewable products. This is a contractual agreement that so long as you pay premiums, you have coverage in place. This is important because some policies don’t have this provision, and you could lose your coverage if your health changes. This also means you are re-insurable and can buy more coverage later.
Knowing if your policy is convertible is also important. It can make your insurance slightly more expensive, but offers you much more flexibility if you decide you want a permanent policy. This is especially true because you would lock in rates at your current age and health.
Next, be aware of any riders you may be able to add to your coverage. These come at an additional cost but can make your insurance more useful to you. For example, you may be able to add disability coverage or a child rider.
Don’t choose a policy simply because it’s the cheapest. Instead, consider the entire product to ensure that you are receiving the kind of coverage you need for a price that is within your budget.