What is Term Life Insurance?
Term life insurance is a type of insurance policy where your beneficiaries receive a payout from the insurance company if you die within the life of the plan.
Term life insurance, also known as pure life insurance, is the simplest type of life insurance policy. With this type of insurance, the policyholder pays a monthly premium for the entirety of the policy term (usually for 10 to 30 years). If they die while the policy is in place, the insurance company pays to the beneficiaries the amount dictated in the policy. Because term life insurance doesn’t have the savings component as other life insurance products — such as whole life insurance — the premiums tend to be lower.
Suppose Jim purchases a term life insurance policy worth $100,000 and names his wife as the beneficiary. Jim and his wife have young children, and he wants to make sure they’ll be taken care of if he dies. The insurance policy has a term of 30 years. According to the policy, if Jim dies in the next 30 years, and has paid his monthly premiums, his wife should get a check for $100,000.
Buying term life insurance is like leasing a car…
As long as you pay your monthly payment, you get all of the benefits of that car — But only until the end of the contract. Once the contract ends, you either have to renew the lease or give back the vehicle. Likewise, term life insurance covers you until the contract expires. If you die during the contract, you’re covered. But if you outlive the contract, you either have to renew it or lose the benefits.
The purpose of a term life insurance policy is to provide a financial benefit to the beneficiaries if the insured individual dies. This money often pays for medical and funeral costs or is used to replace the income of the person who died. These policies last for a predetermined amount of time, usually between 10 and 30 years. When you sign up for a plan, you designate who should receive the money if you die.
Insurance companies determine an individual’s monthly premium by looking at their age, their health, and their life expectancy. Someone who is older and has medical issues will almost certainly pay a higher premium for the same benefit than someone who is younger and very healthy. Certain health conditions such as a terminal illness will likely result in an insurance company refusing to provide a life insurance policy.
There are other factors that the insurance company considers when determining someone’s life insurance premiums. Certain risk factors such as being a smoker, having a poor driving record, or having a dangerous occupation might result in a higher monthly premium. Depending on the type of term life policy, the premium or death benefit may change over the years.
Because of the characteristics of term life insurance plans (they get more expensive as your age goes up and your health goes down), it is not advisable to wait until you have health issues to sign up for a policy.
Compared to other life insurance plans on the market, term life plans tend to be the most affordable. They have no cash value and the coverage ends after the period outlined in the policy.
When it comes to choosing the right term life plan for you, consider how long your beneficiaries will depend on that money. For example, a father and husband that has a wife who stays home with their children will probably need more insurance than a husband with no children and whose wife also works outside the home. Ultimately, the term you choose comes down to your family’s needs.
When a term life insurance policy expires, the plan simply ceases to exist. You don’t get any of the money back, and you’ll have to sign up for a new policy if you want to continue to have coverage.
You can choose to renew your term life plan. Unfortunately, you’ll have to go through another medical exam. And since you’re a decade (or several decades) older than the last time you signed up for life insurance, your premiums will probably be higher. Even worse, you may have developed a terminal/serious illness during that time, which would make it nearly impossible or expensive for you to get a new policy.
Another option for those with term life insurance is to convert their plan into a permanent life insurance policy, if they have a plan with this option — This is known as a convertible life insurance plan.
There are a few different types of term life insurance available on the market.
Level term policies have a fixed monthly premium and a fixed death benefit. They last for a period of 10 to 30 years, and you have full coverage during those years. Once the plan expires, you’ll have to renew and prove insurability again.
Yearly renewable term policies renew every year rather than every 10, 20, or 30 years. With this type of policy, you don’t have to prove insurability every year through a medical exam. The premium increases as you age, unlike level term policies where you’re locked in at a particular premium for a specific number of years.
With a decreasing term policy, the death benefit declines each year based on a schedule laid out in the policy. Unlike the death benefit, the premium doesn’t decrease. You’ll have to pay the same amount every month for the life of the policy. Many people use this type of plan alongside a mortgage, where the amount they owe on their mortgage decreases alongside the decreasing death benefit of their life insurance plan. That way, if one spouse dies, the other has enough money to pay off the house.
While term life insurance only lasts for a predetermined amount of time, universal policies are a type of permanent life insurance. You can keep the plan for your entire life.
Not only is a universal policy designed to last longer, but there are some extra perks beyond financial security for you and your loved ones. Universal life insurance policies are also referred to as cash-value insurance policies because there is a savings component to them.
Every month when you pay your universal life insurance premium, some of the money goes toward death insurance, and some of it goes toward savings. As you get older, your premium stays the same, but more and more of your money goes toward death insurance instead of savings.
The money that goes into savings is invested and earns interest. That money is yours, so you can withdraw it to help pay for expenses — many use this amount to pay the premiums for their life insurance later in life. You can also utilize the money from the cash-value portion of the policy to increase the death benefit, so your beneficiaries receive more money when you die.
There are downsides to these plans, though. First, they are more expensive than term life insurance policies. On top of that, your premium can increase as you age if the policies do not perform as expected. Additionally, for some types of universal life insurance your returns can fluctuate with the bond market, meaning your earnings will be lower in years when the market is down. But often insurance companies will guarantee a certain return.
The bigger risk, especially with traditional universal life policies, is that shrinking interest rates may result in higher premiums for policyholders.
The biggest downside to these accounts is what happens to your cash value when you die. Your beneficiaries receive the death benefit amount, but the money in the savings portion disappears — or, more accurately, it goes to the insurance company.
Whole life insurance is a lot like universal life insurance. Both are permanent policies, and both have an investment and an insurance component. Some of the money you pay goes into a fund for your beneficiaries when you die, and the rest gets invested and is available for you to withdraw later.
One way in which whole life plans differ from universal plans is that the monthly premium and the death benefit both stay the same for the entire life of the policy. This consistency can give you peace of mind because you know how much you’ll be paying every month, and you know that your family will be guaranteed that money when you die.
A convertible term life insurance policy is one that the policyholder can convert into a permanent life insurance policy like whole life or universal. Usually, there are some conditions you’ll have to meet, such as making all of your payments on time. If you meet the terms outlined in your policy, you probably won’t have to go through a new health screening for the new policy.
Often people select a term life insurance plan, hoping that by the time the policy expires, they’ll no longer need life insurance. Maybe their kids have grown and are no longer financially dependent on them, and they’ve put enough money in savings that their spouse will be financially set either way. But things don’t always go according to plan, and sometimes you find you still need life insurance coverage. Converting to a permanent plan is often far cheaper than renewing your term life policy.
One of the benefits of these convertible policies is that term life insurance tends to be more affordable than permanent life insurance policies. So you can pay the lower amount for the first 10, 20, or 30 years before converting to a more expensive plan.
Convertible term plans can also be extremely advantageous if you’ve acquired a new health condition since you’ve had your term life policy. Usually, when you sign up for a new life insurance plan, you’ll have to undergo a medical exam. But when you convert from a term plan to a permanent policy, you can skip the exam and won’t end up paying a higher premium for your medical condition.
You also don’t have to convert the entire amount into a whole life or universal life insurance policy. Instead, you can do a partial term conversion and only convert some of the money. Let’s say you have a term life insurance policy for $500,000. Your term life insurance policy is set to expire, so you decide to convert to a permanent policy. But instead of converting the entire $500,000 into your whole life or universal life policy, you convert only $250,000. One reason you might do this is that permanent life policies are quite a bit more expensive, so you may not want to pay the premiums for a $500,000 permanent policy.
It’s impossible to say what the best form of life insurance is, and it varies for every person. Many financial experts argue that term life insurance is the best option and that you should avoid permanent life insurance policies.
The purpose of life insurance is to replace your income for your family if you die. And theoretically, there’s only a particular window in your life when this is necessary.
Think about someone in their 30s or 40s. They’re often married and might have kids at home. They’re a decade or two into their career and have a stable job. They’ve bought a house, and they are saving to send their kids to college someday. If that person dies, the financial blow to their family is huge. For this person, life insurance is critical.
But then think of someone 30 years later in life, in their 60s or 70s. They might still be working, or they might be retired. Their kids have grown and are financially independent. The house they bought years ago might be paid off, or at least almost paid off. And, ideally, they’ve been saving and investing with their spouse and have a financial nest egg that will allow them to live comfortably for the rest of their lives.
You can see why financial experts often recommend term life insurance — It protects you during the time you most need it without costing you a monthly premium when you no longer need it.
There are upsides to permanent life insurance plans. Someone who has lifelong dependents, such as a spouse or child with special needs, might need that financial safety net for their entire lives. But most people probably aren’t in this situation.
If you aren’t sure which type of life insurance policy is right for you, consider seeking the advice of a financial advisor, who can help identify the right choice based on your lifestyle and financial goals.
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