What Is Term Life Insurance?
Term life insurance, sometimes known as pure life insurance, is a type of life insurance that ensures the payment of a given death benefit if the insured person dies within a certain time period. When the term life insurance policy’s term expires, the policyholder has the option of renewing it for another term, converting the policy to permanent coverage, or allowing the policy to lapse.
TAKEAWAYS IMPORTANT
- If the insured individual dies during a set term, term life insurance assures payment of a stated death benefit to the insured’s beneficiaries.
- These policies have no value other than the guaranteed death payment and do not include any savings features like full life insurance.
- Premiums for term life insurance are determined by a person’s age, health, and life expectancy.
- It may be possible to convert term life insurance to whole life insurance, depending on the insurance company.
- Term life insurance contracts that last 10, 15, or 20 years are commonly available.
What is Term Life Insurance and How Does It Work?
The premiums for term life insurance are calculated by the insurance company based on the policy’s value (the payment amount) as well as your age, gender, and health. A medical examination may be required in specific instances. Your driving record, current medications, smoking status, career, hobbies, and family history may all be questioned by the insurance provider.
If you die within the policy’s term, the insurer will pay your beneficiaries the face value of the policy. Beneficiaries may utilize this cash benefit, which is usually not taxable, to pay for medical and funeral expenses, consumer debt, or mortgage debt, among other things. 2 There is no reimbursement if the policy expires before your death. You may be able to renew a term policy after it expires, but your rates will be recalculated based on your age.
Aside from the guaranteed death reward, term life insurance has little value. There are no savings features like there are with a whole life insurance policy.
Because it only pays out for a limited period of time and only provides a death benefit, term life insurance is usually the most affordable option. For example, a healthy 35-year-old nonsmoker may often get a $250,000 face value 20-year level-premium coverage for $20 to $30 per month.
Purchasing a whole life equivalent would have substantially higher premiums, maybe $200 to $300 per month or more, depending on the provider. The overall risk to the insurer is smaller than that of a permanent life policy because most term life insurance policies expire before paying a death benefit. As a result of the lower risk, insurers can pass on cost savings to clients in the form of cheaper premiums.
Premiums are also affected by interest rates, the financial health of the insurance firm, and state legislation. Companies typically provide better rates at “breakpoint” coverage levels of $100,000, $250,000, $500,000, and $1,000,000.
Term Life Insurance as an Example
Thirty-year-old George wishes to safeguard his family in the improbable event that he dies young. He purchases a $500,000 10-year term life insurance policy at a monthly cost of $50. If George dies within the first ten years of the policy, the beneficiary will receive $500,000. His beneficiary will not receive any benefit if he dies after he turns 40 and the policy has expired.
If he renews the policy, the premiums will be higher than before since they will be calculated using his age of 40 rather than his age of 30.
If George is diagnosed with a terminal illness within the first policy term, he will most likely be unable to renew the insurance once it has expired. Some policies provide assured re-insurability (without requiring proof of insurability), however, these characteristics tend to increase the policy’s cost.
Term life insurance comes in a variety of forms.
There are numerous forms of term life insurance, and the best one for you will be determined by your unique circumstances.
Level Term policies, also known as Level-Premium Policies, are policies that last for a set period of time.
These provide coverage for a set period of time, usually between 10 and 30 years. The death benefit, as well as the premium, are both fixed. The premium is considerably greater than yearly renewable term life insurance because actuaries must account for increasing insurance costs over the policy’s effective life.
Policies with a yearly renewable term (YRT)
Yearly renewable term (YRT) policies have no set term and can be renewed year after year without the need to provide proof of insurability. Rates vary from year to year, and premiums rise as the covered person grows older. Despite the fact that there is no set term, premiums can become prohibitively expensive as people get older, making the coverage undesirable to many.
Reduced Term Policies
The death benefit on these policies decreases each year, following a predetermined schedule. For the length of the insurance, the policyholder pays a constant, level premium. Decreasing term policies are frequently used in conjunction with a mortgage to match coverage to the house loan’s lowering principle.
Once you’ve decided on the policy that’s perfect for you, do your homework on the companies you’re considering to ensure you obtain the finest term life insurance possible.
Term Life Insurance’s Advantages
Young people with children find term life insurance appealing. For a relatively low cost, parents may get a lot of coverage. When a parent passes away, the substantial benefit might help to replace lost income.
These policies are also ideal for persons who only require a little quantity of life insurance for a short period of time.
For instance, the policyholder may determine that by the time the policy expires, their survivors will no longer require additional financial protection or will have amassed sufficient liquid assets to self-insure.
Term life insurance vs. permanent life insurance: what’s the difference?
The period of the policy, the building of a cash value, and the cost are the primary distinctions between a term life insurance policy and a permanent insurance policy, such as universal life insurance. The best option for you will be determined by your requirements; here are some things to think about.
Premiums Costs
Term life insurance is great for customers who desire a lot of coverage for a reasonable price. Customers who purchase whole life insurance pay more premiums for less coverage, but they have the peace of mind of knowing they are covered for the rest of their lives.
While many purchasers prefer term life because of its affordability, they are paying premiums for a long time, and having no benefit once the term ends is an unappealing feature. Term life insurance rates rise with age and might become prohibitively expensive over time.
Premiums for renewal term life insurance may be higher than premiums for permanent life insurance at the time of the original term life policy’s issue.
Coverage Availability
If the policyholder develops a severe disease, the firm may refuse to renew coverage at the end of the policy’s term unless the policy is guaranteed renewable. As long as premiums are paid, permanent insurance offers coverage for the rest of one’s life.
Permanent life insurance is preferred by certain clients because it can be used as an investment or savings vehicle. With a growth guarantee, a percentage of each premium payment is assigned to the cash value.
Some policies offer dividends, which can be paid out or saved in the policy. The cash value growth may be adequate to pay the policy premiums over time. There are also some specific tax advantages, including tax-deferred cash value growth and tax-free cash access.
Financial counselors caution that when compared to other financial vehicles like mutual funds and exchange-traded funds, the growth rate of a cash value policy is sometimes meager (ETFs). In addition, large administrative expenses frequently reduce the rate of return. As a result, the slogan “purchase term and invest the difference” has become popular. The performance, on the other hand, is consistent and tax-advantaged, which is advantageous when the stock market is erratic.
Other Considerations
There appears to be no one-size-fits-all solution to the term vs. permanent insurance dispute. Other things to think about are:
- Is the rate of return on investment sufficient to entice you to invest?
- Is there a loan provision and other characteristics in the permanent policy?
- Is the policyholder running or planning to start a business that requires insurance?
- Will life insurance help a large estate avoid paying taxes?
- Convertible Term Life Insurance versus. Term Life Insurance
- A term life policy with a conversion rider is known as convertible term life insurance.
The rider ensures that in-force term insurance—or one that is about to expire—can be converted to a permanent policy without going through underwriting or showing insurability. The conversion rider should give you complete freedom to convert to any permanent policy offered by the insurance company.
The rider’s key characteristics are keeping the term policy’s original health rating upon conversion, even if you later develop health problems or become uninsurable, and determining when and how much coverage to convert. The premium for the new permanent policy is determined by your age at the time of conversion.
Of course, because whole life insurance is more expensive than term life insurance, overall premiums will rise dramatically. The benefit is that approval is guaranteed without a medical checkup. Premiums cannot be adjusted upward because of medical issues that arise during the term life period. If you want to add additional riders to the new policy, such as a long-term care rider, the firm may need limited or full underwriting.
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