If you have a family or someone who depends on you financially, term life insurance can be a simple way to provide for expenses or replace your income if the unexpected happens and it’s probably less expensive than you think.
About 3 million people die each year in the U.S. and many of those deaths are unexpected.
Accidents or unintentional injuries are the number 3 cause of death, and none of us are immune from disease or illness.
Here’s what you’ll need to know before choosing an term life insurance policy to protect your loved ones.
What is term life insurance?
The key to understanding term life insurance is in the name itself.
Term life is life insurance, of course, so it can provide for others financially after you’re gone — but the policy is designed to provide coverage for a set amount of time, called a term.
A term life insurance policy can be a powerful solution if you need coverage for a limited amount of time.
For example, if you have a loan, like a mortgage, a term life insurance policy can provide replacement income for your family so that they can stay in your home if you pass unexpectedly.
Term life insurance is often called pure life insurance because it doesn’t have many of the complex features that other types of life insurance have. A term life insurance policy doesn’t build cash value and there’s no investment element.
In that regard, term life is like the life insurance equivalent of collision coverage for your car.
It’s a simple coverage designed to do one thing: protect your family against a financial loss if you die while the policy is in force.
Unlike the collision coverage on your car, the insured amount doesn’t decrease with a standard term life policy, which means you’re buying a fixed amount of coverage.
Most people buy term life insurance when taking on a new financial responsibility, like a mortgage or starting a family. In these examples, there’s a limited amount of time during which you’ll have the financial responsibility.
Most mortgages are 30-year loans. It takes 18 to 20 years to raise a child, although you may have kids in the house for a bit longer before they are financially independent.
A term life insurance policy can address these financial commitments by matching the coverage amount and the term length to your specific needs.
Types of term life insurance
While all term life insurance is similar in the aspect of providing financial protection for a fixed amount of time, there are actually several types of term life insurance, some of which are best suited for families while others meet the needs of business owners or other special situations.
1. Group term life
A group term life insurance policy is typically provided through an employer, but may also be available through professional organizations, guilds, or labor unions.
Typically, these policies are owned by the employer and the insured doesn’t have control of the policy, which also means that you can’t choose the amount of coverage you need.
A common structure is for a group life insurance policy to provide a death benefit equal to 1 to 2 years of salary.
2. Level term
A level term life policy refers to the way premiums are charged. With a level term life policy, your premium payments are equal throughout the entire term of the policy.
This structure makes budgeting for premiums easier and helps to avoid policy lapses, which can be more common with some other types of life insurance.
3. Annually renewable
With an annually renewable term life insurance policy, the term is one year but you can renew the policy for another year. Expect higher premiums as each year passes because the risk of dying increases as we get older.
Some types of permanent life insurance, like universal life insurance, use an annually renewable term life insurance policy in addition to an investment element.
4. Return of premium
One of the criticisms of term life insurance is that if you don’t die during the term, all the premiums were spent for nothing.
This isn’t entirely accurate because your premiums purchased a contract that protected your family in the event of an early death. Still, it can be frustrating.
Return of premium term life insurance does exactly what its name suggests. If you don’t die during the policy term, your premiums are returned to you. Expect to pay a bit more for this type of policy.
5. Increasing term
Most term life insurance policies provide a fixed amount of coverage. An increasing term life insurance policy provides a death benefit that increases over time.
Premiums also increase over time and can eventually grow at a faster rate than the death benefit.
6. Decreasing term life
A decreasing term life insurance policy provides a death benefit that decreases over time at a fixed rate.
In many cases, particularly if the policy was purchased to cover a debt— like a mortgage, this strategy can be effective because the amount of debt decreases as you pay down the loan.
Premiums are usually level with this type of policy and if you’ve ever been offered mortgage insurance when getting a home loan, it was probably a decreasing term life policy.
7. Modified term life
A modified term life insurance policy is usually used to cover smaller insurance needs, such as funeral expenses.
This type of policy has fixed premiums for a certain amount of time, after which the premiums increase to reflect the increased risk.
Typically, a modified term life insurance policy has premium increases at 5 or 10 year intervals.
8. Key person term life insurance
In some businesses, a particular employee can be an essential part of the business and if that employee passed away unexpectedly, the business could be harmed.
Key person term life insurance addresses this risk by insuring the life of the “key person”, without whom the business would suffer a financial hardship.
9. Buy-sell life insurance
Another term policy aimed at businesses, a buy-sell life insurance policy is a term life insurance policy that can fund a buy-sell agreement if a partner in the business passes away.
Typically, the other partner is the beneficiary of the policy and can use the death benefit to purchase the deceased partner’s share of the company.
10. Term to age
Often, the need for life insurance doesn’t last forever and there are now policies that provide coverage until a certain age.
Term to age 65 is a common option and provides coverage until age 65, after which your mortgage or other financial commitments may be paid off and your savings can provide for your spouse or other family members.
11. Term choices
With the most commonly sold term life insurance policies, you choose how long you’d like to have coverage. Typical choices include 5 years, 10 years, 20 years, 30 years, or even 40 years.
What you’ll find however, is that the longer term lengths may not be available as you get older. For example, if you’re 50 years old, you probably won’t find many options for a 30-year term life insurance policy.
12. Simplifying your term life choices
Level term is the most commonly sold type of term life insurance, specifically the 20-year level term, and with good reason: it’s simple to understand and provides a fixed amount of coverage for a fixed amount of time for a fixed premium. Simple is often better.
Many of the other types of term life insurance are only a good fit in special circumstances.
For most households preparing for financial responsibilities, like a mortgage or raising kids, term life can address the need to protect loved ones financially, simply and without premium increases.
How does term life insurance work?
To understand how a term life insurance policy works, it’s useful to understand some of the definitions that you’ll encounter when you’re researching companies or getting quotes.
Common term life insurance definitions
- Term: The term is the length of time that the policy has guaranteed premiums. Most policies can be renewed after the term has expired but the of renewal can be cost prohibitive. Terms can range from 1 year up to 40 years.
- Premium: The premium is the amount you pay annually for your coverage. Most policies use a level premium, which helps make the policy more affordable in later years of coverage. With a level premium, the insurer calculates the cost of insurance over the entire term and divides the amount into even annual premiums, which are often paid monthly.
- Face amount: The face amount, also called a face value, is the amount of insurance you’ve purchased. With permanent life insurance policies, the face amount may differ from the amount your beneficiaries will receive if you pass away while the policy is in force.
- Death benefit: For standard term life insurance policies, the death benefit is the same as the face amount and represents the amount of coverage you’ve purchased.
- Policy owner: The owner of the policy is the person or organization that purchased the policy — but may not be the person whose life the policy is insuring. Only the policy owner can make changes to the policy.
- Insured or proposed insured: The person whose life is being insured by the policy is called the insured, or the proposed insured during the application process.
- Beneficiary: The beneficiary is the person to whom the death benefit will be paid if there is a death claim on the policy. You can choose more than one beneficiary and your beneficiaries can be people, organizations, or trusts.
- Exclusions: Your life insurance policy doesn’t cover every possible cause of death. You’ll find detailed exclusions in your policy, which are causes of death for which the policy won’t pay a death benefit. While exclusions are less of a concern than in years past, you’re still likely to find exclusions for deaths that occur while committing a felony or for a few other reasons.
- Contestability: Most policies have a 2 year contestability period, during which time the insurer can delay claim payouts while it investigates health concerns or other concerns that may affect the validity of the insurance contract. In cases of fraud, there may be no time limit to the contestability period.
Understanding your term life coverage
By now, you understand the basic mechanics of a term life insurance policy.
With the most common type of term policy, the 20-year level term, you purchase a fixed amount of coverage and your premiums are guaranteed throughout the term of the policy.
Let’s investigate a bit more closely and learn how the policy works in further detail.
The concept of insurable interest is essential in insurance and refers to the idea that if you have no risk of financial loss, you can’t buy insurance for a risk.
The concept goes a step further in expressing that you can’t insure a risk for more than your potential loss.
If you’re insuring a car, for example, your insurable interest is limited to the value of the car — and it has to be your car. You can’t insure your neighbor’s car.
As it relates to life insurance, your neighbor can’t buy life insurance on you, which is a good thing. You can purchase a policy for yourself or someone with an insurable interest can purchase a life insurance policy for you, but they’ll need your consent.
Generally, it’s easier to prove insurable interest for yourself, your spouse, your children or grandchildren, your parents, or in creditor-debtor relationships.
Choosing a coverage amount
The face amount of the policy is the coverage amount, but how do you choose an amount of life insurance to buy.
It’s important to know that you can usually have more than one life insurance policy.
If you have coverage from another policy, you may not need to purchase as much coverage for the new policy.
Many agents or financial advisors still use an old rule of thumb that suggests you should buy an amount of insurance equal to 8 to 12 times your income. There are several variations of this rule.
However, term life insurance is usually purchased in conjunction with major life changes, like getting married, starting a business, buying a house, or having children.
In other cases, the policy is purchased to cover a short term loan. Why you’re purchasing the policy should play a large role in choosing a coverage amount.
If you’re buying life insurance because you just bought a house, for example, you’ll probably need enough coverage to cover the mortgage — but you’ll probably also want to buy coverage to replace your income as well, especially if you’re younger and don’t have much in savings yet.
Insurers are looking at your age and the number of working years you have remaining to determine the maximum amount of coverage you can buy.
If you’re 40 years old and have 25 working years remaining, multiplying your income by 25 will give you a good idea of the maximum you amount of life insurance you can buy.
Rather than choosing an arbitrary number, consider the income needs of your family and how long they will need your income replaced.
If your family is grown, you may not need to replace as much income as someone who is just starting a family.
In addition to replacing income, many people buying life insurance like to purchase enough to cover outstanding debt as well, like car loans, credit cards, and other loans.
The amount of life insurance you’ll need depends on your unique situation, but you may also need to weigh the cost of premiums.
If you can only afford half the coverage you’d like to buy, that’s still a better option than not buying coverage at all.
Choosing a term
Choosing the term of your policy is also dependent on why you are purchasing life insurance.
You’ll have more options when you’re younger and by the time you approach age 50, you find fewer term lengths available.
The most common choice is a 20-year term policy, but if you just signed a 30-year mortgage, a 20-year policy probably doesn’t protect your family well enough.
Shorter commitments, like a personal loan, might make a 5-year or 10-year term policy worth considering.
Your term life insurance premiums are affected by a number of health and longevity-related factors. Here is some of the information your insurer will need to process your application and determine a premium.
- Age: The older you get, the higher the premiums will be for a new policy. Your premium reflects how much longer someone your age is expected to live.
- Gender: Women live longer than men, on average, so gender affects premiums.
- Medical exam: Term life insurance policies usually require a medical exam, during which you can expect your weight and height to be measured. Often, blood tests are taken as well and will report on other health factors like blood pressure, cholesterol, nicotine, controlled substances, and more.
- Medical history: Your insurer will also inquire about your past medical history and may pull medical records from a shared medical database used in the insurance industry.
- Family history: A family history or cancer, diabetes, or other concerns can affect the cost of your coverage or can lead insurance underwriters to investigate further to understand the risk.
- Ratings: Based on all the medical-related information your insurer gathers, you’ll be assigned to a category of risk, called a classification, which then affects the amount you’ll pay for coverage. In some cases, your application may be “rated” which means the insurer found risks that prevent you from qualifying for the main classifications. Expect to pay more for a rated policy.
Behavioral or vocational factors
What you do for a living or what you do in your free time can affect the cost of your coverage as well — or could even affect your eligibility for a policy with some insurers.
For example, a roofer can expect to pay more for coverage than a librarian because the risk of death is higher based on occupation.
Hobbies can play a large role as well. Someone who knits quilts in their free time will pay less than someone who climbs mountains.
Other behaviors can also affect premiums and eligibility. For example, a DUI conviction can increase the cost of your policy, as can drug use — even where legalized in some cases.
Other rating factors
Health and hobbies aside, insurers have found other factors that can indicate risk and affect rates. Some might surprise you.
- Driving record
- Criminal record
You can think of your life insurance application as a comprehensive evaluation of how much risk you have of dying while the policy is in force.
In most cases, the death benefit paid to your beneficiary is tax-free, which means your coverage can go further.
If you paid for your coverage as a business expense or if your coverage is through your employer, however, there may be a tax liability for your beneficiaries.
Exempt from probate
When someone dies, the probate process distributes assets to heirs and settles debt.
The good news is that life insurance proceeds are usually exempt from probate and in most cases are paid directly to your beneficiary without the long delays associated with probate.
Most term life insurance policies provide a conversion option that allows you to change your policy to a permanent policy, like a whole life insurance policy.
One popular option for term policies is an accelerated benefits rider. A rider is just an add-on for your policy and an accelerated benefits rider allows you to access some of the death benefit if you become terminally ill.
This option can help you and your family navigate medical expenses due to illness.
Exclusions and contestability
Your policy won’t cover every risk and activities like auto racing, hang gliding, or rock-climbing may be excluded from coverage. In some cases, you may be able to purchase coverage for excluded activities for an additional cost.
Aviations and acts of war are also commonly excluded. A term life policy may or may not cover suicide, largely dependent on how long you’ve had your policy.
A death ruled to be a suicide, including some drug overdoses, may not be eligible for coverage if it happens within the 2-year contestability period after the policy went into force.
Term life insurance pros and cons
Term life is an affordable option for many families, but it may not be a great fit for every situation. Here are some pros and cons to consider.
- Buy only the coverage you need: Term life can be laser-focused on a coverage need.
- Lower premiums than permanent insurance: Expect to pay considerably lower premiums for term life than with permanent life insurance options.
- Limited coverage duration: If you need coverage after your term is expired, getting another policy may be pricey — or impossible.
- No cash value: Term life doesn’t build cash value, so the policy can’t be sold or borrowed against — unless you convert it to to permanent life insurance.
- Most term policies never have a claim. Many policies are allowed to lapse or don’t pay a claim during the term.
Term life insurance rates by age
Youth has its advantages when purchasing life insurance.
Here are some examples of the cost of term life coverage at different ages.
In this case, we’re pricing out the monthly premium for a term policy with $300,000 in coverage for a non-smoking male of average height and weight.
|Age||10-year term||20-year term||30-year term||40-year term|
|60||$70||$126||Not available||Not available|
As you can see, age affects the premiums for a life insurance policy, particularly after age 50. Some longer term lengths become unavailable as you get older as well.
Example of how term life insurance works
Let’s take a look at how even a smaller term life insurance policy can protect your family. If you’re 30 years old, married, and just bought your first home, you’ve made a couple of large financial commitments already.
Accidents happen and illness can affect any of us. To protect your family, you can purchase a 30 year term life policy to cover the mortgage amount of $300,000.
Luckily, you’re in reasonable health, so coverage only costs about $21 per month.
If you die while the policy is in force, the policy will pay $300,000 to your spouse and in most cases, there won’t be a tax bill. Let’s say the worst happens, and you do die — at age 50.
The mortgage balance is less than $140,000 because you’ve been making payments for 20 years.
Your spouse now has the option of paying off the house with the life insurance proceeds and still has over $160,000 left to meet other expenses or to invest.
Q&A about term life insurance:
What is the best term life insurance company?
There are a number of good choices for buying term life. State Farm scored highest for customer satisfaction in the 2018 J.D. Power Life Insurance Study but Northwestern Mutual, Nationwide, Metlife, and other top-rated companies are solid choices as well.
How long is term life insurance good for?
You choose the length of coverage for your term life policy when you buy your policy. The term of the policy refers to how long the policy will have guaranteed premiums. After the term expires, you may be able to continue coverage but at a higher rate.
Can you cash in on a term life insurance policy?
A term life insurance policy doesn’t build cash value so you can’t surrender the policy for cash. In some cases, the policy can be converted to permanent life insurance and may have value that can be sold.
What is the best age to buy term life insurance?
For all types of life insurance, younger is better because premiums are lower. If you’re in your twenties or thirties, you can often buy a significant amount of coverage for pennies per day.
What happens to term life insurance if you don’t die?
If you don’t die while the policy is in force, the policy won’t pay a death benefit. If you’ve purchased a return of premium term policy, the premiums you’ve paid will be returned to you at the end of the term.
Can I have 2 term insurance policies?
You can have multiple term life insurance policies and many people do. The most common mix is to have a group life insurance policy through an employer and to purchase a separate term life policy to better protect loved ones.
Do term life insurance premiums increase as you age?
For most policies sold today, the premiums are level, which means they won’t change as you get older. Be sure to know how your policy works, however, because some policies do have increasing premiums.
What happens when a term life insurance policy matures?
In most cases, you can continue your term life coverage when your term reaches the end but premiums will increase, often significantly, which leads most people to cancel coverage.
If your health has changed and you are unable to secure new coverage, it may make sense to keep the old policy in place.
What happens when you cancel a term life insurance policy?
Cancelling a term life insurance policy simply ends coverage. There is no cash value to the policy so there is no payout and there are no tax consequences.
Consider your options carefully before cancelling, however. Replacing the policy is likely to be more expensive.
A term life insurance policy can serve a short-term focused goal, like covering the cost of repaying a loan, or it can act as income replacement that can provide for your family for years to come.
Health, behavior, term length, and coverage amount are all factors in the cost of your coverage, but age is often among the biggest factors.
Every passing birthday means it will cost more to secure coverage. If you’re considering term life, now is the time. Coverage will cost more if you wait.