As the name implies, term life insurance, also known as “term assurance” or “pure life insurance,” is a type of life insurance coverage that expires after a certain length of time, or “term.” Until its expiration date, the policy guarantees payment to a beneficiary (or beneficiaries) if the insured dies. Terms typically range between 5 and 30 years, with the most popular being a 20-year term.
How Does Term Life Insurance Work?
- Term life insurance is cheaper to buy than whole life insurance and other types of permanent coverage
- Term life insurance has no cash value
- With term, there are three main types of life insurance policies: level term, decreasing term, and renewable term
- The recommended death benefit is an amount equal to at least 10 to 15 times your annual income
- Younger and healthier individuals secure the lowest insurance rates
- Life insurance premiums are more expensive for men than for women, due to women’s longer life expectancy
Where most types of insurance benefit you, life insurance benefits the people who survive you. Perhaps because of this, or because it reminds us of our mortality, we tend to avoid buying it, at least until we feel compelled to do so.
That trigger is usually a major life event, according to David Gastwirth, an insurance strategist who works for American Business and specializes in life insurance, disability insurance, and long-term care planning.
“When people are beginning a new stage of their life — whether that’s getting married or partnering with someone, having a child or adopting one, or even starting a business — there is a risk associated with their premature passing that I suggest they attend to,” says Gastwirth. Term life insurance, he adds, can play a big role in creating a benefit that helps mitigate the financial costs and consequences of a death.
The Death Benefit
Term life policies provide what’s known in the industry as a “death benefit.” If you die within the policy’s term, your beneficiary (or beneficiaries) will receive a lump-sum payment for the amount specified within your contract. If you outlive that term, the policy will not provide a death benefit.
Some insurers offer a “return of premium” rider, which allows you to recoup the amount you paid throughout the years at the end of the term if you survive your policy, but that feature doesn’t come cheap. According to Gastwirth, adding this kind of rider could increase your monthly premiums by 10% or more.
Duration of Coverage
Term life insurance typically lasts for a specific period of time, although some companies offer policies that you can renew annually. Once the term ends, you can renew the policy, turn it into a whole life policy, or simply allow it to lapse. If you decide to renew your term policy, though — whether every year or after its term is up — premiums will increase even if you choose the same death benefit, since you’ll be older, and so considered to be riskier.
Term Life Insurance Cost
Several factors will determine your term life insurance quote:
- Age – the younger you are, the cheaper your premiums, as a rule
- Medical history – and not just yours, but your parents’ as well. If you or one of your parents suffers from a chronic illness like diabetes or hypertension, you’ll end up paying more for your policy
- Habits – if you’re a smoker — or even former smoker — your premiums will be higher than those of non-smokers
Since term life insurance policies only offer a death benefit, with no investment value, premiums are much more affordable than those of whole life insurance.
When purchasing a new policy, you’ll have to disclose details, such as your age, height, gender, employment information, medical history, and lifestyle (whether you smoke, drink, have a high-risk job, or practice any extreme sports), in order for the insurer to determine your eligibility for coverage.
However, if you develop a terminal illness or serious chronic disease, you may not be able to renew your policy unless you have a “guaranteed insurability” rider.
Types of Term Life Insurance
There are three main types of term policies to choose from:
- Level term insurance – Most consumers go for this policy. In fact, the Insurance Institute of Information says that 97% of all term policies are level premium. With this type of policy both the premiums and the death benefit remain the same for the duration of the term.
- Decreasing term life – This policy is usually cheaper to acquire upfront than level term policies, but there’s one caveat: although premiums remain the same, the death benefit decreases in one year increments.
- Renewable term – If your family has a history of medical conditions, then a renewable term policy may be a good option to explore. With this type of policy you can extend coverage without undergoing a medical exam. However, premiums are assessed annually, usually increasing as you age.
Why Go with a Term Life Insurance Policy?
The main reason to buy a term policy over other types of policies is its financial efficiency in delivering a death benefit. “Permanent life insurance is going to be 10 to 15 times more costly than term insurance,” says Gastwirth. “If the purpose of that insurance is death benefit protection…. term insurance is the best choice,” he adds.
In other words, if you’re only interested in leaving money for your loved ones, whether it’s to settle funeral costs, pay off debt, or replace income, then term life insurance is the best and most affordable option.
If creating an investment is part of your goal in buying life insurance, you might of course want to consider a whole life policy. But Gastwirth says a policy should only be used as an investment to accumulate and distribute cash in a tax-efficient manner when you have maxed out all of your other investment vehicles, such as your 401k and IRA.
Choosing a Policy
Assuming you’ve settled on a term policy, the first step to shopping is to settle on the death benefit you want the policy to deliver. And that depends in large part on what you now make, and so what income will need to be replaced by the policy.
According to experts (Gastwirth included), you should purchase a term life policy that’s worth between 10 and 15 times your annual income.
As of 2019, the Bureau of Labor Statistics reported that the average full-time worker in the US earned a weekly salary of $919 ($47,788 a year).
The average working American will then need between $477,880 and $716,820 worth of coverage. However, the amount of coverage is rarely that specific, so you’ll most likely end up purchasing a policy that’s between $500,000 and $1,000,000.
How much will that cost you?
Gastwirth tells us that the annual cost of a 30-year term policy worth $1,000,000 for a 35-year-old male with the second-best health rating comes down to $900 a year, or $75 a month. While the same policy for a female has an annual cost of $800, or roughly $67 a month.
Dale M. Brown, senior executive vice president of Salem Investment Counselors, believes that the answer to this question relies on your personal and financial circumstances. However, he stresses that finding a trustworthy and reputable insurer is just as important as the policy itself, as this will determine their ability to payout any claims.
“You certainly want to use a good quality life insurance company, and you can do that by simply looking at the A.M. Best ratings that are easily accessible online,” says Brown. He also advises to be wary of insurance agents that try to sell you miscellaneous products, since these are often unnecessary and are only being offered to you as a way of obtaining a commission.