Let's face it, life is unpredictable. And while no one likes to think about death, it's important to have the right life insurance policy in place to protect your family if the unthinkable should occur. Fortunately, life insurance doesn't necessarily have to mean paying high premiums for lifetime coverage. More and more people are turning to term life insurance because it offers the right amount of coverage for a set amount of time — at affordable rates. Learn how term life insurance works, whether it's the right financial safety net for you and your family and what mistakes to avoid when shopping for a plan.
Do You Need Term Life Insurance?
When it comes to life insurance, most people choose a term policy over whole life because they need to cover financial needs for their loved ones that diminish over time. Ask yourself the following questions to help determine whether you're in need of term life insurance.
Are you interested in purchasing a life insurance policy, but currently have limited financial resources?2
Do you have children or plan to have children?3
Do you have a partner or anyone else who counts on your income to make ends meet?4
Do you have a mortgage on your home?5
Do you have outstanding student or business loan debts that you need to pay off over the next 10-30 years?
You may not have a need for term life insurance, but you can still learn more about your options in case your circumstances change later on down the line.
What Is Term Life Insurance?
|Policy Feature||Term Life Insurance||Whole Life Insurance|
|Ability to choose length of policy|
|Low annual premium|
|Medical examination required to qualify|
|Provides cash value accumulation|
|Expires at a set date and must be renewed, if you want to continue coverage|
Note: Some insurance companies may require a medical exam for term life insurance. This requirement can also be dependent on the amount of coverage - lower amounts may be issued without an exam, but insurers may mandate one for higher amounts that involve greater risk.
Term life insurance provides protection for a specified time period, or term, at lower premiums than permanent policies. It's more affordable because it's temporary - coverage is typically one to 30 years and can help cover a variety of needs — such as income replacement, short- and long-term debts and retirement support for your partner — after you're gone. You simply choose the benefit amount to be paid to your beneficiaries and decide the length of your policy. In the event of your untimely death, the death benefit is issued tax-free to your beneficiaries if you died during the policy's term.
Term life doesn't offer a cash return if the policy expires and, unlike permanent life insurance, term life doesn't have an investment component, which is another reason why it's more affordable. To compare, the annual cost of permanent life insurance can be up to 10 times higher than term policies because of the cash savings benefit that accumulates throughout the duration of the policy.
Premiums for term life insurance will vary according to your age, health and the size of your death benefit. The younger and healthier you are, the more affordable the plan because insurers bank on the likelihood of you outliving your policy. For example, a healthy 35-year-old might pay $40 a month for a 20-year level term policy with a $500,000 death benefit, while a healthy 50-year-old might pay two to three times more a month for the same type of policy.
Policy Holder Profiles: Who Needs Term Life Insurance?
Term life insurance can be the right option for anyone who needs a short-term safety net. It appeals to a variety of families and individuals in need of affordable, temporary coverage and can be a particularly good investment for young adults with dependents, such as a spouse and/or children, who rely on their income. It can also help cover any outstanding debts that you'd rather not pass on to your loved ones if you died.
Below is a breakdown of some of the ideal candidates and situations for term life:
Denise started her own acupuncture and wellness clinic five years after completing her master's degree. Opening a clinic was no easy feat, and she had to take out a $350,000 loan to cover the cost of buying a clinic, medical equipment, supplies and other business-related expenses. To protect her loved ones, Denise purchased a 20-year term policy with a $400,000 benefit. Should she die before the policy expires, her beneficiaries can use the death benefit to pay off any business-related debts and taxes.
Beverly is a successful account executive at an advertising agency. She and her husband, Jon, have two kids - David who is 16 and Lyn who is 14. Jon is a stay-at-home parent, making Beverly the sole financial provider. For protection, Beverly purchased two policies - a 10-year term at $320,000 and a 20-year term at $450,000. The former ensures her children will be able to afford college and the latter policy would cover Jon if she died unexpectedly.
Jack and Anne are in their early thirties and newly married. They recently bought a new home with a 30-year mortgage, are in good health and plan to have at least two children within the next five years. Jack and Anne realize that if one of them should die unexpectedly, the surviving spouse- – and potential child-en – would have to live on a fraction of their annual income. The couple decided to purchase two 30-year term policies to ensure that if one of them died in the next 30 years, the other would have the financial support necessary for mortgage payments, income replacement, college tuitions for their future children, retirement and everyday expenses.
Simone is a recent law school graduate and has successfully passed the bar exam. To cover her college tuition, Simone took out $100,000 in private student loans — with the help of her parents who agreed to serve as cosigners. The new attorney is nervous about having so much debt hanging over her head, especially since private loans are not forgiven by the lender in the event of the borrower's death. As a healthy 25-year-old, Simone purchased a 10-year term policy for the amount of her debt plus some, and named her parents the beneficiaries. Should she pass away unexpectedly before she turns 35, her death benefit would to go her parents so they wouldn't take on the financial burden for re-paying her law school loans and would also have some additional financial support as they grow old.
Paul and Renee just had their first baby. Paul was a medical assistant, but quit his job after the baby was born to be stay-at-home father. A risk-averse planner, Paul purchased a 10-year, $100,000 term life policy to ensure that if he died unexpectedly while his son was still young, his wife and son would have the money needed to cover child care after he was gone.
Types of Term Life Insurance
Based on your need, you can choose from three types of term life insurance plans:
Picking a Policy Length and Amount
Term life insurance plans usually range from one, five, 10, 20 to 30 years and it's entirely up the consumer to select the length of the policy. When choosing a policy length, consider the following questions:
- What is your annual income before taxes?
- How many dependents do you have?
- Would you like to provide replacement income for your dependents? If so, for how many years?
- How much of your income do your dependents rely on?
- If you are not a parent, are you planning on starting a family in the future?
- Would you like to cover your end-of-life costs (funeral, burial, medical bills)?
- Do you have outstanding debts (mortgage, credit cards debts, student loans)?
- Will you be paying to send your kid(s) to college?
- How healthy are you?
- Do you want to provide your spouse with retirement support?
- Will you require additional coverage after your term expires?
These are some of the factors that will determine the length of your policy and how much insurance you should buy. For example, if you intend to send your kids to college, you'll likely need a 20- to 30-year plan, depending on the age of your youngest child and when he/she is projected to graduate.
Online calculators, such as those offered by Life Happens or Accuterm, can give you a ballpark estimate of how much coverage you'll need and for how long. Before you decide on an insurer, you may want advice from an insurance expert. Grace Prentice, an account executive at the brokerage firm Andreini & Company, recommends starting off with a fee-only insurance consultant. These are "free agents" that you pay by the hour and who aren't financially tied to any one insurer. They can provide a thorough evaluation of your needs and offer objective recommendations on term policies.
Common Mistakes & How to Avoid Them
Shopping for life insurance doesn't have to be complicated. Below are a few examples of common mistakes people make and how you can avoid making them:
|Common Mistake||How to Avoid it|
|Paying a higher premium because you underestimated your death benefit and length of coverage||Insufficient coverage will likely force you to renew your policy when it expires, but at a much higher premium - say, from $380/month to $4,800/month. Make sure that your policy matches the amount and length of your need by utilizing online insurance calculators or speaking with a fee-only insurance consultant.|
|Settling on the cheapest option||Many companies offer additional features, or "riders", that you can add to your policy, such as the ability to convert to a permanent plan, accelerated death benefits, disability waiver or accidental death benefits. You should also make sure to go with a company that has the financial strength to back up your plan. These options might cost you extra, but your goal shouldn't to be to just find the cheapest plan; instead, it should be to find the most affordable plan that gives you the most coverage and flexibility as you age.|
|Not knowing about or understanding potential exclusions||Prentice cautions that some term plans have exclusions that could prevent your beneficiaries from collecting your death benefit. Examples may include if the insured dies as a result of an extreme sporting accident (i.e., skydiving), or commits suicide within the first few years of the plan. She advises to "be sure that you are reading the exclusions and thinking about your lifestyle, and whether or not your loved ones will be left without the benefits you are paying for in the event of your death."|
|Working with non-reputable insurers||Finding the right policy is all about working with the right professionals. Here a few tips for finding a credible life insurance agent:
|Failing to assess your coverage on a regular basis||Your life insurance policy needs to cover your family at every stage within your set term. You should review your policy regularly to expand or reduce coverage to accommodate any new life changes, such as a new baby, a divorce, a second marriage, a new home, etc.|
|Not understanding the age reduction provision||According to Prentice, some term life policies come with an age reduction provision in which your coverage amount will reduce by a certain percentage as you age. "You will want to look for a policy that will cover you at your full amount up to the highest age, with the smallest percentage reduction over time," she advises.|
What to Do Before Your Term Ends
As the end of your term policy approaches, you'll have a few different options to pursue based on your circumstances and needs.
Let your plan go
For some, temporary coverage was good enough and no additional protection is needed.
Renew your policy
Perhaps you still have loan debt that you don't want to pass on or you want to cover your end-of-life expenses. You can choose to renew your existing plan. However, as you grow older your annual premiums will increase significantly and your quality of health may even prevent you from securing a new plan. Renewal costs will vary, but your policy should include details that project maximum premiums for each year. It's also important to keep in mind that in order to renew, you'll likely need to reapply and may need to take a medical exam for proof of insurability.
Convert to a permanent policy
Typically offered as a rider, some plans have a conversion option, meaning you can convert your term life insurance into a permanent policy without having to take a new medical exam. Some policies, however, only allow you to convert during a specified time period, such as the first few years, while others may allow you to convert any time before it expires. Depending on your needs, you can convert for the same death benefit value or for a reduced amount. Whether or not you choose to convert your plan, it's a good idea to at least discuss permanent policy options with the company you're considering so that you know what your options are later on down the line if your circumstances change.