Term life insurance is a type of life insurance policy that provides coverage for a certain period of time, or a specified "term" of years. If the insured dies during the time period specified and the policy is active, or "in force," a death benefit will be paid.
Term insurance is initially much less expensive when compared to permanent life insurance, such as whole life and universal life. This because it's not designed to last through old age, which is when life insurance premiums are the most expensive. And unlike most types of permanent insurance, term insurance has no cash value.
- Term insurance is a type of life insurance policy that provides coverage for a certain period of time, such as 30 years.
- If the insured dies during the time period specified in a term policy and the policy is active, a death benefit will be paid.
- Most term policies offer level premiums for the duration of the policy.
- Many term policies offer the option to convert from term to permanent insurance.
How Term Life Insurance Works
There are various types of term insurance policies available. Many policies offer level premiums for the duration of the policy, such as 10, 20, or 30 years. These are often referred to as "level term" policies. A premium is a specific cost, which is typically monthly, that insurance companies charge policyholders to provide the benefits that come with the insurance policy.
The insurance company calculates premiums based on health, age, and life expectancy. A medical exam that reviews the insured person's health and family medical history might be required, depending on the type of policy chosen.
Premiums are typically fixed and paid for the length of the term. If the person insured dies prior to the expiration of the policy, the insurance company will pay the death benefit to their beneficiaries. If the term expires and the individual dies afterward, there would be no coverage or payout. However, the policyholder can often extend or renew the insurance, but the new monthly premium will be based on the person's age at the time of the renewal. As a result, premiums are higher upon renewal.
Many term policies are also "convertible," which means they can be converted into a permanent life insurance policy, such as universal or whole life, within a certain number of years after the policy was taken out. If you convert term life insurance to permanent life insurance, the premium will increase.
Example of Term Life Insurance
Premiums can range depending on the age and the amount of payout. For example, the premium for a 30-year policy with a $250,000 payout can range from $15 per month for a person in their twenties to $60 per month for someone in their fifties. Of course, each insurance company has different rates depending on policy features, such as living benefits and convertibility, as well as the policyholder's health, history of smoking, and other factors.
The average 30-year-old man can get a 20-year term policy with a $500,000 death benefit for $27.42 a month. Because of her typically longer lifespan, the average 30-year-old woman can purchase the same policy for just $21.74.
Types of Term Insurance
There are various types of term insurance besides the level term policies we've outlined so far. Each policy has its pros and cons, depending on the needs of the policyholder and their beneficiaries.
Convertible term life insurance allows a term insurance policy, which has a limited number of years before expiring, to be converted into whole life or universal life insurance. The major benefits of convertible insurance is that the policyholder gets lifelong coverage and doesn't have to submit to a medical exam, nor are any health conditions considered when the term policy converts to permanent insurance.
Some policies allow you to increase the death benefit as time goes on. The premium increases as well, but it allows policyholders to pay lower premiums early on. The increasing term prevents having to qualify for another policy at an older age to get the added death benefit as would be the case with traditional term insurance.
Mortgage Term or Decreasing Term
A mortgage term or decreasing term policy is the opposite of the increasing term because the death benefit amount decreases over time. The goal is typically to match the decline of the term benefit to the reduction of the policyholder's outstanding mortgage. The idea behind this strategy is that you don't need as much life insurance if you have less mortgage debt. However, although the premiums are smaller than level-benefit term insurance, the premium payments remain constant even as the benefit declines.
As each year passes, annually renewable term (ART) insurance is renewed but for a higher premium since the policyholder is a year older. The benefit to annually renewable term insurance is that the coverage is guaranteed to be approved each year. However, it may not be the most cost-effective for everyone due to the increased costs over time.
Term Life Insurance vs. Whole Life Insurance
Term life insurance is perhaps the easiest form of life insurance to understand because it offers a defined death benefit for your beneficiary should you pass away while it’s in force. As the name suggests, this stripped-down form of insurance is only good for a certain period of time, whether it’s five years, 20 years, or 30 years. After that, the policy expires.
This can be contrasted with whole life insurance: a form of permanent life insurance that lasts your whole life (as long as you pay the policy's premiums). Whole life insurance also accumulates cash value that you can withdraw or borrow against while you are alive.
These two types of insurance offer different benefits. Generally, term insurance has a much lower cost than other types of life insurance, sometimes by a significant margin, and it is simpler to understand than “permanent” policies. On the other hand, protection is only available for the term of the policy, and it cannot be used as a wealth-building or tax-planning strategy.
Whole life insurance is more expensive, but you can lock in your premiums for life. With this type of insurance, you also generally have the ability to borrow against the policy for future financial needs. Loans taken from your insurance, like death benefits, are generally tax-free. There are some drawbacks, however. If you let the policy lapse, you could face surrender charges, and any outstanding loans will reduce your death benefit and could become taxable.
Steve Kobrin, LUTCF
The firm of Steven H. Kobrin, LUTCF, Fair Lawn, NJ
Term life insurance has two features that make it attractive:
- A guarantee on the premium and survivor benefit for a defined amount of years, depending on the company, age of the insured, and other factors.
- No capability of accumulating cash inside the policy. You can't pay an extra premium to get extra benefit. You can’t transfer money from other accounts into the policy. The carrier will not pay dividends or apply interest to your account.
Term life insurance is ideal for covering yourself for a single need, for a specific amount of time. An example is indemnifying a mortgage or business loan.
The kicker is that if you outlive this time and still need coverage, the price of term insurance typically increases astronomically after the guarantee period.
What Is Term Life Insurance?
A term life insurance policy is the simplest, purest form of life insurance: You pay a premium for a period of time—typically between 10 and 30 years—and if you die during that time, a cash benefit is paid to your family (or anyone else you name as your beneficiary).
Do You Get Your Money Back at the End of a Term Life Insurance Policy?
If you're alive when the term expires, you get nothing back from your term life insurance policy. It is a death benefit, payable to your heirs only if you die. That is the reason why term life insurance is relatively inexpensive. Return of premium (ROP) term life insurance policies are available, however, which return some or all of the premiums you paid. Most people outlive their term life insurance policies.
Which Is Better: Term Life Insurance or Whole Life Insurance?
It depends on your family's needs. Term life insurance is a relatively inexpensive way to provide a lump sum to your dependents if something happens to you. If you are young and healthy, and you support a family, it can be a good option. Whole life insurance is permanent coverage but comes with substantially higher monthly premiums. However, it has a cash value which accumulates over time and the policyholder can make withdrawals or tax-free loans for any purpose. So it can serve as an investment product as well as an insurance policy.
The Bottom Line
Term insurance is a type of life insurance policy that provides coverage for a certain period of time or a specified "term" of years. If the insured dies during the time period specified in a term policy and the policy is active, a death benefit will be paid.
Many term policies offer level premiums for the duration of the policy. Other term policies offer decreasing or increasing benefits over time as well as the option to convert from term to permanent insurance.