What is Term Life Insurance and How Does it Work?
Term Lengths, Coverage Amounts, and Important Considerations
With so many types and variants of life insurance available, life insurance can be a complicated topic. Fortunately, term life insurance is easy to understand, and in most cases, term life insurance is the right choice to meet the needs of many families.
What is Term Life Insurance?
Term life insurance is income replacement — with a time limit.
We buy life insurance to provide for our families and loved ones if we die earlier than expected. Life insurance, in its purest form, is income replacement. Term life insurance serves this goal of replacing income if you die, but it has a time limit. The time limit, the term, is the amount of years you select for your term life insurance policy.
Many term life insurance policies can be continued after the term expires. However, the cost of the term life policy often becomes prohibitive after the term has expired. In effect, your rates are guaranteed for the term you select when you buy your life insurance policy. After that term, premium prices can jump dramatically.
How Does Term Life Insurance Work?
The way term life insurance works is pretty straightforward. You choose a term length, which is the amount of time you will need the policy, and you pay a monthly or annual premium towards your term life insurance policy. If you die before the term has expired, your insurer will you pay your beneficiary a lump sum for the amount of term life insurance you purchased.
When you start your term life insurance policy, you can choose the amount of time, known as the term, that you’d like your policy to be in effect. Most term life insurance policies offer terms between 10 and 30 years. Some term life policies even offer customized terms. So if you’ll need coverage for the next seven years, for example, you can buy a policy that matches your exact needs.
Term limits can be a great thing when it comes to our elected officials. With term life insurance, term limits can work against you if you choose the wrong term length. A term life insurance policy becomes more expensive if you choose a longer term, so you’ll want to consider the term carefully. If all of other rating factors are equal, a 10-year term policy will cost less than a 30-year term life insurance policy. While cost is a consideration and many households, premium cost shouldn’t be your only consideration.
Term Life Insurance Beneficiary
The beneficiary for your term life insurance policy is the person you’ve chosen to receive the lump sum insurance payout if you die unexpectedly within term of your policy. In most cases, your beneficiary is a spouse or loved one. You’ll have the option to change the beneficiary for your term life insurance policy if needed. Life changes, and sometimes beneficiaries need to be changed as well. When you purchase your term policy, you’ll also choose a second beneficiary. The second beneficiary we’ll get the lump sum pay out if you die unexpectedly and your primary beneficiary has also passed.
Premium Payments Keep Your Life Insurance Policy Alive
Your life insurance premium is the money you pay toward your term life insurance policy. If the premium for your policy isn’t paid, your term life insurance policy can lapse. When an insurance policy lapses there is no coverage.
Depending on how much time has passed without a premium payment, it may be possible to reinstate your term life insurance policy when you make a premium payment. However you’ll need to inquire with your insurer about the specific details and time limits of this provision. Generally speaking, insurance companies want you to keep your policy in place and will do as much as they can to be sure your policy does not lapse. This might include reminder calls and reminders by mail or email.
If your term life insurance policy lapses and can’t be reinstated, you’ll need to purchase a new policy, assuming you still need term life insurance coverage. Assuming some time has passed since you purchased the lapsed policy, the new policy will probably cost more because you’re older and because your health condition might have changed.
Happy Birthday! The Cost to Buy Life Insurance Goes up Every Year
Many insurance agents keep a record of their client’s birthdays so they can reach out prior to your birthday and talk about life insurance. While agents do make commission on term life insurance sales, this birthday call practice can be beneficial to consumers because the cost a buying a term life insurance policy increases each year on your birthday. If all other rating rating factors are equal, your term life insurance policy will cost you less money when you are 39 years old vs. when you are 40 years old. As you might expect, a term life insurance policy costs much less for someone in their twenties or thirties as compared to someone in their fifties or sixties.
While it’s less expensive to buy term life insurance when you’re younger, in truth, many younger people don’t need term life insurance, or have only minimal needs and can choose a smaller term life insurance policy. Someone with a mortgage or a family to support has different needs than someone who might be renting and has no dependents.
Choose the Right Term Length for Your Term Life Insurance Policy
Many life insurance companies offer pre-packaged term life insurance policies. What this means is that they offer term life insurance policies with preset term choices and preset coverage amounts. There may be a price advantage to choosing one of these off-the-shelf term life options, but it’s best to inquire about other options.
Offering pre-packaged term life insurance policy choices helps insurers to speed the conversation along toward a purchase, but the options provided may not meet your exact needs.
For example, your insurance agent might bring the conversation to a choice between a 10 year term life insurance policy and a 20-year term life policy. If your needs for term life insurance are really only for the next 15 years, neither of these choices fits.
The 10-year policy leaves you five years short on coverage, and the 20-year policy forces you to pay for an extra five years of coverage you won’t need. You can cancel your 20-year policy at 15 years, before the term expires, but choosing the 20-year policy will increase your monthly or annual premium while the policy is in force. Even if you cancel early, you’re still paying for coverage you don’t need. It may be in your best interest to find a term life policy that better matches your exact needs for life coverage.There are some questions you should ask yourself before shopping for term life insurance: Click To Tweet
- If you have a mortgage, how many years are remaining on your mortgage?
- If you have kids at home or at school, how many years will it be before they on their own and financially independent?
- If your kids will be going to college or a trade school, how many years away is their graduation?
- If you have any auto loans, credit card debt, or other debt, how long will it be before that debt is paid off?
The answers to these questions can help you determine the proper term length for your term life policy. If your financial obligations will be met within the next 15 years, there may not be much benefit to buying a 30-year term life insurance policy. When you purchase your policy, your life insurance agent may raise some additional considerations, but it’s best to understand your basic needs before you sit down at the table.
Many modern households are two income households and the loss of one income if a spouse dies unexpectedly can be financially devastating. If two incomes were required to pay the mortgage and monthly bills and one income is lost due to an unexpected death, loved ones left behind maybe forced to sell the family home or make other drastic financial decisions and sacrifices at an already difficult time. Choosing the proper term and coverage amount for your term life policy can prevent these undesirable situations.
Choose Your Term Life Insurance Coverage Amount
Choosing the proper term life insurance coverage amount is just as important as choosing the proper term for your life insurance policy. Remember, a term life policy is your income replacement if you die unexpectedly. A coverage amount of less than your family or loved ones will need to replace your income is only doing part of the job.
A well-planned term life insurance policy will account for the following, if they apply:
- Mortgages and second home loans
- Credit Card debt or personal loans
- Auto Loans
- Education costs
- Burial and funeral costs
- Continuing cost of living
- Cost raising children or costs for other dependents
You may add some additional considerations to your list depending on your specific situation, but the items listed above are the largest priorities for most families.
Make a list of your ongoing financial obligations and note how long you’ll have those obligations. For example, if your mortgage will be paid off in 10 years and your other financial obligations will be met by that time, you have a starting point for the length of your term for your term life policy. Choose an insurance coverage amount to cover the amounts on your list or as close to that figure as your budget will allow.
What Happens to the Premiums Paid for Term Life Insurance Insurance if I Live?
Still being alive is a priceless reward in itself, but your life insurance company will keep the premiums you’ve paid toward your policy if you don’t die within the term covered by your policy. Term life insurance is a financial tool to provide income replacement for families and loved ones. Other life insurance types are not limited by a term, but can be considerably more expensive.
Some life insurance companies also offer a type of term life insurance policy called a return of premium policy. With a return of premium policy, if you don’t die before your term has expired, not only are you still alive but the life insurance company will return the premiums you’ve paid over the years. A return of premium term life insurance policy will be more expensive than a standard term life insurance policy, but some consumers see considerable value in this type of policy.
Reasons to Keep a Term Life Insurance Policy After the Term Expires
Most term life insurance policies are designed with a guaranteed premium for the term and coverage amount you chose when you purchased the policy. After the term has expired, many term life insurance policies provide you with the option to keep the policy in place. However, your life insurance premium will be considerably higher than the guaranteed premium you were paying before the term expired.
Many people will cancel their term life insurance policy when the rate changes after the guaranteed premium term has expired. Be careful if you use automatic debits for your premium payments. Your life insurance company will happily take the higher premium amount from your bank account if you don’t cancel the policy when the term has expired and premiums increase.
There may be situations in which you’d want to keep the policy in place. If you’ve developed health issues that will make you uninsurable or make the cost of a new insurance policy price-prohibitive, it may be in your best interest to continue paying the higher premium for your term life insurance policy after the term has expired.
Rating Factors and No-exam Term Life Insurance
Term life insurance policy premiums are determined by the length of the term and the amount of coverage provided by the policy, as well as by your age, health, and habits such as smoking or drug use.
Some life insurance companies offer no-exam life insurance. No-exam life insurance allows you to purchase a term policy without medical exam, but your insurer will still require honest answers to health questions.
Be aware that term life insurance policies include a two-year contestability clause. What this means is the insurance company can dispute or deny life insurance claims because of health or medical issues not disclosed on your life insurance application.
No-exam life insurance bypasses the medical exam, but is typically more expensive than a policy that requires a medical exam. Occasionally, some insurers offer no-exam promotions for customers in preferred age brackets for policies that usually would require an exam.
Insurance companies can become super-sleuths if they think something is amiss with an application or insurance claim. As in much of life, honesty is the best policy.
Term Life Insurance Provides Income Replacement, Simply.
Keep it simple, Sherlock. Term life is often the best choice for many families who are watching their budgets but who still wish to provide for their family in the event of the unexpected.
Other types of Life Insurance, like whole life insurance or universal life insurance, can contain an investment element as well as functioning as life insurance. They also cost more money, but the additional features of these other types of life insurance policies may fit the goals of some families or individuals.
Term life insurance simplifies the process of insuring your family’s financial needs and providing income replacement if the insured dies unexpectedly. For many families, term life is the only life insurance they will ever need.