What Is Term Life Insurance?
Term life insurance offers a death benefit to beneficiaries if the insured passes away within a set period, known as the term. This is usually 10, 15, or 20 years. When the term expires, the policyholder can either renew it for another term, possibly convert it to permanent coverage, or allow the term life insurance policy to lapse.
Term life insurance differs from permanent life insurance, as it does not have cash value and is typically more affordable. Understanding the different types of term life insurance and their pros and cons can help you choose the right policy for you.
How Term Life Insurance Works?
When you buy a term life insurance policy, the insurance company determines the premium based on the policy's value (the payout amount) and factors such as age, gender, and health. Other considerations affecting rates include the company’s business expenses, how much it earns from its investments, and mortality rates for each age. In some cases, a medical exam may be required. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, family history, and similar information.
If you die during the policy term, the insurer will pay the policy's face value to your beneficiaries.
This cash benefit, which is not typically taxable, may be used by beneficiaries to settle your healthcare and funeral costs, consumer debt, mortgage debt, and other expenses. However, beneficiaries are not required to use the insurance proceeds to settle the deceased's debts. There is no payout if the policy expires before your death or you live beyond the policy term. You may be able to renew a term policy at expiration, but the premiums will be recalculated based on your age at the time of renewal.
Advantages of Choosing Term Life Insurance
Term life insurance is attractive to young people with children. Parents can obtain substantial coverage for a low cost, and if the insured dies while the policy is in effect, the family can rely on the death benefit to replace lost income. These policies are also well-suited for people with growing families. They can maintain the coverage needed until, for example, their children reach adulthood and become self-sufficient. The term life benefit may be equally useful to an older surviving spouse. However, premiums for people who wait until they are older to apply for insurance will pay higher premiums than if they’d gotten a level-term policy when they were younger. Each insurance company sets a maximum age for its term life insurance coverage, which usually ranges from about 80 to 90 years old.
How Much Coverage Do You Need?
A common guideline is 10–15 times your annual income, but coverage should reflect your family’s actual needs, including debts, mortgage, education, and future expenses. The DIME formula (Debt, Income, Mortgage, Education) can help calculate an appropriate death benefit.
Cost of Term Life Insurance
Premiums vary based on age, health, term length, and coverage amount. For example, a healthy 30-year-old might pay around $45 per month for a 20-year, $500,000 policy, while a 40-year-old could pay about $49 per month for a 30-year, $500,000 policy. Smokers or those with health conditions may pay higher rates.
The Bottom Line
Term life insurance is a good option for people who cannot afford or will not pay the much higher monthly premiums associated with whole life insurance. Term life is somewhat similar to car insurance. It's statistically unlikely that you'll need it, and the premiums are money down the drain if you don't. But if the worst happens, your family will receive the benefits.