What is Term Life Insurance?
Term life insurance is a policy that offers coverage for a specified number of years. If the insured person passes away within the time frame, their beneficiary receives the death benefit.
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How does term life insurance work?
Term life insurance policies can cover nearly any length of time and will stay in effect for the entire period, as long as you continue to pay the premiums, usually on a monthly or annual basis.
Term life insurance doesn't accrue a cash value over time, meaning you can't borrow against it. The advantage is that the cost of a term life policy is low, and it’s still customizable to your situation.
Payouts
Term life pays out the value of the policy upon death in almost all circumstances. This payout is called the death benefit, or face value of the policy, and it can range from $10,000 to more than $1 million. The amount of coverage you need depends on your particular financial situation. Still, you’ll generally want to make sure your family will be able to cover any outstanding financial obligations, such as your:
- Mortgage
- Children's education (including college tuition)
- Funeral costs
- Auto loans
- Student loans
- Survivors' living expenses (for several years)
If you pass away while the term policy is active, then yourbeneficiary would submit a claim to the life insurance company. Usually, the insurer will request a copy of the death certificate and then pay out the death benefit or face value of the policy. Depending on the policy, it may be paid in a lump sum or in annual payments.
Make sure to let your beneficiary know about the life insurance policy, because they will need to file a claim to receive the benefits.
One exception to this process is suicide. Insurance companies all handle this differently, so we recommend that all parties read through the terms. In general, suicide within two years of purchasing the life insurance policy is excluded from being paid out.
Types of term life insurance policies
Term life insurance policies vary and depend on several factors, meaning the best policy for another person may not be optimal for you. It's essential to understand how policies work to find the right product for your family and your finances.
Length of term
When choosing a term policy for yourself or someone else in your family, you’ll have to pick the length of the coverage period, or term. If the insured person dies within that time frame, the listed beneficiaries will receive funds from the life insurance company. While some policies are as short as one year, term policies are generally available in lengths of:
- 5 years
- 10 years
- 20 years
- 30 years
As an alternative, many insurers offer the option of term coverage until you reach a certain age, such as 65. This is essentially the same product, as it provides coverage for a predetermined number of years, so long as you consistently pay the premiums. However, age-based term life insurance often gives you more flexibility, because it's a nonstandard term.
Level or decreasing term life insurance
When deciding between level and decreasing term life insurance, the critical question to ask is whether your dependents would need less coverage if you were to pass closer to the end of the term than they would if you were to pass in the next few years.
Level term life insurance, by definition, offers the beneficiaries the same payout over the entire length of the term. With decreasing term life insurance, you’ll pay a flat premium throughout the policy, but the policy's death benefit will decrease over time. The idea is that a person may need a higher death benefit earlier in life than they do as they get older.
Decreasing term life insurance may be more appropriate if you're in the process of paying back loans. This would give you coverage to ensure your debts are not transferred to your family upon your death. But as you pay off loans and reduce debts over time, your life insurance benefit will also decrease.
Renewable term life insurance
Short term life insurance policies often have the option of being renewable, meaning each year (or number of years, depending on the term), you’ll essentially purchase a new policy with the same insurer, under the same terms. The benefits of this type of policy are that you can get coverage for a short period and have the option to renew without going through a lengthy underwriting process. But the downside is that your premiums will increase each time you renew, as you age and enter a higher risk bracket.
Simplified issue and no medical exam life insurance
Simplified issue term life insurance, also referred to as "no medical exam" life insurance, may sound great. Still, it is a significantly more expensive product that may not be worth the convenience. After all, a medical exam to get a life insurance policy usually takes less than an hour.
A life insurance–related medical exam is relatively short and can often be performed at your home or work.
If you think you won't pass a medical exam, simplified issue insurance might be the best route to go. However, you will still be required to share your medical history with the insurer. If you don't tell the truth, and the insurer finds you've misstated anything, your policy may be canceled.
Convertible term life insurance
Many insurers offer convertible term life insurance policies. This type of insurance allows you to convert the term policy to a permanent life insurance policy without going through a new medical review.
We recommend having a convertible term policy, since it's common for your financial situation to change over time. For example, if your income rises, you may want to switch to a permanent life insurance policy to take advantage of the tax benefits.
As having a convertible policy doesn't change the insurer's risk while maintaining the term policy, it shouldn't increase your premiums. Just make sure to note when you are allowed to convert the policy.
Additional scenarios to understand
Riders
Riders are essentially customizations to an insurance policy. Riders available for a particular policy vary according to the insurer. Evaluate riders carefully, because the actual cost may exceed the financial benefits.
For example, you may have heard of a "return of premium" rider, which pays back a percentage of your premiums if you outlive the term of your policy. Let's say you’re a parent who is only worried about life insurance coverage for your child while they are in school. You may want to make sure your child has financial protection and money for education if you die. But if you don’t die, it sounds like a good deal to get some of the money back. However, this type of rider would increase your premiums. Even though you would get some of that money back, its value would be locked up in the policy.
Voluntary and group term life insurance
Voluntary term life insurance refers to the extra coverage that employees can opt to purchase, hence "voluntary." Group life insurance is usually offered through an employer as part of a compensation and benefits package. Group and voluntary life insurance policies are usually term life as opposed to permanent.
Your employer might offer a certain amount of coverage at no cost to allow employees to take advantage of a discounted group rate for additional coverage. While group term life insurance comes at a discount, the policies tend to be less customizable and often are not transferable, meaning that the coverage ends if you change employers.
Given the median tenure for employees at a particular job is less than five years, you'll likely move to a new company within the coverage term. It's essential to evaluate the options available and terms of the policy before purchasing group coverage.
Direct term life insurance
Direct term life insurance is also known as direct-to-consumer life insurance. It's a policy taken out by an individual from an insurance company, instead of getting it through a third party, such as an agent or employer.
Should I buy term life insurance?
Whether or not you need term life insurance is a personal choice. The decision to purchase it is often related to life events like marriage or the birth of a child.
Term life insurance offers financial protection to partners, spouses and dependents. If you are single and don't have any outstanding debts that could be passed on to your extended family or estate, you may not need a term life insurance policy.
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