Term life insurance, also known as pure life insurance, is a type of life insurance that guarantees payment of a stated death benefit if the covered person dies during a specified term.
Once the term expires, the policyholder can either renew it for another term, convert the policy to permanent coverage, or allow the term life insurance policy to terminate.
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How a Term Life Insurance Policy Works
A term life insurance policy’s annual costs remain the same every year for the level term period, such as 10 or 20 years.
Once the level term period is over, you can generally renew the policy, but at higher rates each year you renew.
The policy expires if you outlive the length of the policy without renewing.
You receive none of the premiums paid into the policy unless you bought a return of premium term life insurance policy.
Many people buy term life insurance for income replacement. They’re looking for life insurance that will provide funds for a family to pay expenses for a certain number of years if they were no longer there to work and earn money.
Term life is good for:
- Covering the years of a mortgage, so another borrower does not have to sell the house.
- Covering other specific debts that would be passed on to someone else.
- Covering the years until children have graduated from college, to make sure there are funds for tuition and living expenses.
The policyholder chooses both the length of the term and the coverage amount, such as $400,000.
If the insured person dies while coverage is in force, the beneficiaries receive the policy’s death benefit.
If the insured person lives longer than the policy’s term and doesn’t renew it, the coverage ends.
You may be able to convert the term life policy to a permanent life policy, such as a whole life or universal life insurance.
This is a useful tactic if you realize you want longer life insurance coverage and don’t want to shop for a new policy, perhaps because your current health would make it difficult.
Example of Term Life Insurance
Thirty-year-old George wants to protect his family in the unlikely event of his early death.
He buys a $500,000 10-year term life insurance policy with a premium of $50 per month.
If George dies within the 10-year term, the policy will pay George’s beneficiary $500,000.
If he dies after he turns 40, when the policy has expired, his beneficiary will receive no benefit.
If he renews the policy, the premiums will be higher than his initial policy because they will be based on his age of 40 instead of age 30.
If George is diagnosed with a terminal illness during the first policy term, he likely will not be eligible to renew once that policy expires.
Some policies do offer guaranteed re-insurability (without proof of insurability), but such features, when available, tend to make the policy cost more.
Types of Term Life Insurance
Level term life insurance
A level term life insurance policy maintains the same premiums and death benefit throughout the term.
Rates won’t increase as you age and the death benefit is consistent whether you die in the first or final year of the policy.
A level term life policy could be good for someone who wants consistency for many years.
Annual renewable term life insurance
An annual renewable term policy’s premiums increase each year you renew it. When you choose this policy, you’re guaranteed to keep coverage and don’t need to reapply.
It may be good for people who want to fill a short gap in life insurance. However, a short level term life policy may be a better choice.
Decreasing term life insurance
A decreasing term life insurance policy’s premiums stay the same over the length of the policy but the death benefit decreases steadily over time.
Mortgage life insurance is a form of decreasing term life. Here the payout is tied to the declining balance of your mortgage, and the beneficiary is the mortgage lender, not your family.
Regular term life insurance is a better bet because your family receives the payout and can use it for any expenses they choose.
Return of premium term life insurance
A return of premium term life policy promises to refund the premiums you paid if you outlive the policy. As you can imagine, the refund feature makes the policy more expensive.
Return of premium term life is available from companies such as Cincinnati Life, State Farm Life and Vantis Life.
Benefits of Term Life Insurance
Term life insurance is attractive to young people with children. Parents may obtain large amounts of coverage for reasonably low costs. Upon the death of a parent, the significant benefit can replace lost income.
These policies are also well-suited for people who temporarily need specific amounts of life insurance.
For example, the policyholder may calculate that by the time the policy expires, their survivors will no longer need extra financial protection or will have accumulated enough liquid assets to self-insure.
Factors That Could Affect Term Life Insurance Rates
The term life insurance coverage amount and term length affect your premiums. Other factors in life insurance quotes include:
- Height and weight
- Current and past health
- Family health history (parents and siblings)
- Nicotine and marijuana use
- History of substance abuse
- Driving record (especially DUIs and moving violations)
- Certain hobbies and activities (such as aviation, scuba diving and other risky hobbies)
- Criminal history
What Is the Difference Between Term Life and Whole Life Insurance?
Term life insurance occurs over a predetermined period of time, typically between 10 and 30 years.
Term policies may be renewed after they end, with premiums recalculated according to the holder’s age, life expectancy, and health.
By contrast, whole life insurance covers the entire life of the holder. Unlike a term life policy, whole life insurance includes a savings component, where the cash value of the contract accumulates for the holder.
Here, the holder can withdraw or borrow against the savings portion of their policy, where it can serve as a source of equity.
Term Life Insurance Alternatives
Term life insurance isn’t the only type of life insurance. There are also multiple types of permanent life insurance policies.
Unlike term life insurance, permanent life policies last your life as long as you make your payments.
So, beneficiaries are guaranteed a death benefit with a permanent life policy. These policies additionally build cash value, which lets the policyholder tap into the policy during their lifetimes.
Here are different permanent life insurance policies:
Whole life insurance
Whole life insurance guarantees a death benefit as long as you make your payments. It also guarantees you a minimum rate of return on the cash value, level premiums and a guaranteed death benefit that won’t decrease.
Universal life insurance
Universal life insurance policies offer lifelong coverage and often build cash value, which grows tax-free. You may be able to adjust your premium payments and the death benefit, within certain limits.
There are multiple types of universal life insurance policies:
- Guaranteed universal life: The cheapest universal life policy typically, a guaranteed universal policy offers cash value, which can be minimal. However, it doesn’t offer flexibility to adjust premiums and death benefit, which are found in some other universal life policies.
- Indexed universal life: An indexed universal life insurance policy connects a policy’s cash value to an index, such as the S&P 500. You can change premiums and the death benefit, within certain limits.
- Variable universal life: A variable universal life insurance policy’s cash value is tied to sub-accounts that can include stocks and bonds. The success of the investment choices impacts the policy’s cash value. You have the flexibility to make changes to premiums and death benefit. A variable universal policy requires the policyholder to manage the investments and can result in gains or losses based on your choices.