What is Term Insurance?
Term life insurance offers a death benefit for a set period, ensuring financial support for the policyholder’s beneficiaries. When the term ends, the policyholder can choose to renew it for another term, convert it to permanent coverage, or let the policy lapse.
Key Takeaways
- Term life insurance provides a guaranteed death benefit to the insured’s beneficiaries if the insured person passes away within the specified term.
- These policies provide only the guaranteed death benefit and do not include a savings component, unlike permanent life insurance products.
- A person’s age, health, and life expectancy determine the premiums for term life insurance.
- Insurance companies may allow policyholders to convert term life insurance into whole life insurance.
- Insurance companies may allow policyholders to convert term life insurance into whole life insurance.
Understanding How Term Life Insurance Works
When you buy a term life insurance policy, the insurance company sets the premium based on the policy’s value (pay-out amount) and factors like age, gender, and health. They also consider their business expenses, investment earnings, and age-specific mortality rates to determine the rates.
In certain cases, you may need to undergo a medical exam. The insurance company might also review your driving record, and ask about your current medications, smoking habits, occupation, hobbies, family history, and related details.
If you pass away during the policy term, your insurer pays the policy’s face value to your beneficiaries. This tax-free cash benefit can help them cover healthcare and funeral expenses, consumer debt, mortgage payments, and other financial obligations. However, beneficiaries have no obligation to use the insurance proceeds to pay off the deceased’s debts.
There is no pay-out if the policy expires before your death or you outlive the policy term. You can often renew a term policy when it expires, but the premiums will be adjusted based on age.
What are the Types of Term Life Insurance?
Term life insurance comes in various types, and choosing the best one depends on your specific needs. Most companies provide policies with terms of 10 to 30 years, while some extend their offerings to 35- or 40-year terms.
Level Term or Level-Premium Policy
Level-premium insurance locks in a fixed monthly payment for the duration of the policy. Most term life insurance policies feature a level premium, which has been the primary focus of this article. As previously noted, these policies typically offer coverage for 10 to 30 years, with a fixed death benefit.
Actuaries set level premiums higher than yearly renewable term life insurance to account for the rising insurance costs throughout the policy's duration.
Yearly Renewable Term (YRT) Policy
Yearly renewable term (YRT) policies allow you to renew your coverage each year without needing to prove insurability.
Premiums increase each year as the insured person gets older, which can make them unaffordable over time. However, these policies can be a suitable choice for individuals needing short-term coverage.
Decreasing Term Policy
These policies reduce the death benefit each year based on a set schedule while maintaining a fixed level premium throughout the policy's term.
Policyholders often use decreasing term policies alongside a mortgage, aligning the insurance pay-out with the reducing principal of the home loan.
Advantages of Term Life Insurance
Young parents often find term life insurance appealing because it offers significant coverage at a low cost. If the insured passes away during the policy term, the family can use the death benefit to replace the lost income.
People with growing families often find these policies ideal, as they provide coverage until their children reach adulthood and become financially independent.
An older surviving spouse can also benefit from term life insurance. However, individuals who wait until later in life to apply will face higher premiums compared to those who secured a level-term policy at a younger age.
Insurance companies determine a maximum age for term life insurance coverage, typically ranging between 80 and 90 years.
Term Life Insurance vs. Permanent Life Insurance
Term life insurance and permanent insurance policies, like whole life or universal life, differ mainly in policy duration, cash value accumulation, and cost. Choosing the right option depends on your needs. Consider the following points when making your decision.
Cost of Premiums
People seeking significant coverage at an affordable cost often find term life policies ideal.
Whole life insurance policyholders pay higher premiums for less coverage but gain the assurance of lifelong protection.
Term life insurance buyers pay premiums over a long period but receive nothing unless they pass away before the term ends. Additionally, term life premiums rise as the policyholder ages.
Availability of Coverage
If a term policy is not guaranteed renewable, the insurer may refuse to renew coverage if the policyholder develops a serious illness by the end of the term. In contrast, permanent insurance offers lifetime coverage, as long as premiums are paid, regardless of changes in the insured's health.
Investment Value
Many customers prefer permanent life insurance because these policies often include an investment or savings component. A portion of each premium goes toward the cash value, which grows while the policy is active. Some plans also pay dividends, which policyholders can receive in cash or leave within the policy.
The cash value may increase enough to cover the policy's premiums. Additionally, there are several distinct tax benefits, including tax-deferred growth of the cash value and tax-free access to the cash portion.
Financial advisors caution that the growth rate of a policy with cash value is often much lower than that of other financial instruments, such as mutual funds and exchange-traded funds (ETFs).
Substantial administrative fees often reduce the rate of return, which is why the phrase "buy term and invest the difference" is commonly used. However, permanent insurance tends to offer steady performance and tax advantages, providing extra benefits, especially during volatile stock market periods.
Other Factors
The debate between term and permanent insurance has no one-size-fits-all solution. Additional factors to consider include:
Term Life Insurance vs. Convertible Term Life Insurance
Convertible term life insurance is a term policy with a conversion rider, which guarantees the right to convert an active or soon-to-expire term policy into a permanent plan without undergoing underwriting or proving insurability. This rider typically lets you convert to any permanent policy offered by the insurance company without restrictions.
The rider’s main features include preserving the original health rating of the term policy when converting (even if you develop health issues or become uninsurable) and giving you the flexibility to decide when and how much coverage to convert. The premium for the new permanent policy is based on your age at the time of conversion.
While overall premiums will rise significantly because whole life insurance costs more than term life insurance, the benefit lies in guaranteed approval without a medical exam. Medical conditions that arise during the term life period won’t lead to increased premiums. However, the insurance company may require limited or full underwriting if you wish to add extra riders, like a long-term care rider, to the new policy.
Which is the better option: Term Life Insurance or Whole Life Insurance?
The choice depends on your family’s needs. Term life insurance offers an affordable way to provide a lump sum to your dependents if something happens to you. It can be a great option if you’re young, healthy, and supporting a family.
Whole life insurance has significantly higher monthly premiums but provides coverage for your entire life. As the policy matures, it accumulates value, allowing the policyholder to withdraw funds for any purpose. This makes it both an insurance policy and an investment product.
Will you receive your money back at the end of a term life insurance policy?
If you’re still alive when the term expires, you won’t receive anything from your term life insurance policy. The death benefit is only paid to your beneficiaries if you pass away. This is why term life insurance is generally affordable, as most people outlive their policies.
Can a Senior Citizen Get Term Life Insurance?
It depends on the individual’s age. Insurance companies establish a maximum age limit for term life insurance policies, typically ranging from 80 to 90 years, though it can vary by company. Premiums also increase with age, so a person in their 60s or 70s will pay significantly more than someone much younger.
Conclusion
Term life insurance is a great option for those who cannot afford or choose not to pay the significantly higher monthly premiums of whole life insurance.
Term life insurance is similar to car insurance in that it’s statistically unlikely you’ll need it, and the premiums are wasted if you don’t. However, if the worst occurs, your family will receive the benefits.