Deciding which life insurance policy fits your needs can be complicated. Most providers offer terms of varying lengths and premiums with different payment structures. Apart from factoring in what all goes into your policy, it’s also important to consider what your loved ones will get out of it. While some policies are designed to make sure that significant sums of money are left to your beneficiaries, others assign the death benefit to lingering expenses that the policyholder may still have.
Understanding the ins and outs of term life insurance can be frustrating for someone who is just beginning to look into it. Learning more about it will help you know what things you need to prioritize to make sure that you and your loved ones are taken care of.
What is term life insurance?
Term insurance is a form of life insurance that pays out a certain amount of money, also called a guaranteed death benefit, as long as the policyholder passes away during the pre-determined term for which the policy is active.
If the policyholder outlives the initial term of the life insurance that they purchased, they can renew the policy for another term of their choosing, convert the policy to permanent coverage or let the policy expire. So let’s say that you purchase a 10-year term life insurance policy and it expires without you renewing it or converting it to a permanent policy. If you die 11 years after purchasing the policy, your beneficiaries don’t receive a death benefit because you died after the expiration of your policy.
This kind of policy has its advantages and disadvantages. On the plus side, it’s a lot cheaper than permanent life insurance because it is only valid for a set period of time and most policyholders outlive the policies that they purchase. Another benefit for some policyholders is that the premiums on the policy are based on age, health and life expectancy. If you purchase a term life insurance policy when you’re young, it’s not likely to cost you much at all. Finally, many users like term life policies because the premiums are said to be level, meaning they stay the same from one year to the next.
Though life insurance gets more expensive as you age (because your life expectancy decreases), policyholders with level premiums don’t feel this effect as much.
Term life insurance also has its drawbacks. For one, the savings component that you might find in a whole life insurance policy does not exist with a term life policy. This means that the only value of the policy to the policyholder’s beneficiaries is the death benefit. While many policyholders use other life insurance policies to invest and build wealth, that option does not exist in a term life policy.
Another downside to having a term life insurance policy is the fact that it only covers a policyholder’s beneficiaries for a set period of time. Because policyholders can, and often do, outlive their policies, there’s a chance that the coverage will end up as a sunk cost—a lot of money spent on something with nothing to show for it in return.
How does term life insurance work?
The only value attached to term life policies is the guaranteed death benefit. Unlike a whole life insurance policy, there is no savings component. The goal of a term life insurance policy is to provide insurance to the policyholder’s beneficiaries against the loss of life in the form of a cash death benefit. Upon the policyholder’s death, their beneficiaries can use the cash benefit to settle any outstanding costs that the deceased may have, such as consumer debt, mortgage debt, funeral or cremation costs or any outstanding healthcare bills.
A side effect of the non-savings feature of a term life insurance plan is that its policyholders cannot use it to build wealth. Therefore, a term life insurance policy is not used for charitable-giving purposes or estate planning. The premium of a term life insurance plan is used to cover the cost of underwriting insurance. Because of this, term life premiums are typically less expensive than permanent life insurance premiums.
How much does term life insurance cost?
Term life insurance premiums are calculated based on the age, health and life expectancy of their policyholders. Because of this, pricing for a term life insurance policy is highly variable but typically significantly cheaper for a younger user than it would be for someone who is either nearing or already in retirement.
The health factors that a term life insurance provider is likely to take into account will vary from one provider to the next. Consult with a provider to get a better idea of how much your health will or won’t contribute to your premium.
Frequently asked questions
Which is better: term or whole life insurance?
Which kind of life insurance is better for you depends on several factors, including your age, life expectancy and goals for your beneficiaries. Because a term life insurance policy does not include a savings element, many users that are interested in estate planning or leaving some sort of financial endowment to their beneficiaries prefer a whole life insurance policy. However, if your aim is to take care of any outstanding costs that you may have, such as debts, bills or funeral costs, a term life insurance policy may be a better option for you due to its more affordable premiums.
What happens to term life insurance at the end of the term?
At the end of your term life insurance policy’s term, you have the option to either renew the policy for a predetermined term of your choosing, convert the policy to a permanent plan or let the plan expire.
While letting the plan expire in most term policies means that you’ll forego the money that you paid into it in premiums, some providers offer “return of premium” options that require users to pay higher premiums in exchange for the option to have all premium payments returned if they outlive their term.
What are the different types of term life insurance?
The three main types of term insurance are level term, yearly renewable and return of premium policies.
Level term policies keep the amount that you pay in premiums the same for the duration of your policy. The rates are more expensive than they should be at the beginning of your term to counterbalance the fact that your premiums will be cheaper than they should be as you age.
Yearly renewable policies allow users to renew them each year without needing to provide evidence of insurability. These policies have no term limit but get progressively more expensive each time they are renewed because the premiums reflect the age and life expectancy of the policyholder.
Return of premium policies charge users a higher premium rate on a fixed-term policy with the guarantee that, if they outlast the term on their policy, they will be refunded their premiums payments in their entirety. This option is significantly more expensive, but it provides insurance against an expiring policy.