Term life insurance is a policy that offers coverage for a specified period of years. If the insured passes away within the time frame, their beneficiary receives the death benefit.
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How does term life insurance work?
Term life insurance policies can be purchased to cover nearly any period and will stay in effect for the entire period as long as you continue to pay the premiums, which can be paid on a monthly or annual basis.
While term life insurance doesn't accrue a cash value over time, meaning you can't borrow against it, a term policy has a low cost by comparison and is still customizable to an individual's situation.
Term life pays out the value of the policy upon death in almost all circumstances. This payout is called the death benefit or face value of the policy, can vary from $10,000 to above $1 million. The amount of coverage you need depends on your particular financial situation. Still, you generally want to make sure your family will be able to cover any outstanding financial obligations, such as your:
- Children's education (including college tuition)
- Funeral costs
- Auto loans
- Student loans
- Living expenses (for several years)
If you pass away within the number of years the term policy is active, then the beneficiary would submit a claim to the life insurance company. Usually, the insurer will request a copy of the deceased death certificate and then pay out the death benefit or protection amount in a lump sum or annual payments.
Make sure to let the beneficiary know about the life insurance policy. They will need to file a claim to receive the benefits.
One exception to that rule is suicide. Insurance companies all handle this differently, so we recommend that all parties read through the terms. In general, suicide within two years of purchasing the life insurance policy is excluded from being paid out.
Types of term life insurance policy
Term life insurance policies vary according to several factors, meaning the best policy for one person may be non-optimal for you. It's essential to understand how policies work to find the right product for your family and your finances.
Length of term
When choosing a term policy, you have to pick how long you want the coverage period or term. If the insured person departs within that time frame, the listed beneficiaries will receive funds from the life insurance company. While some policies are as short as one year, term policies are generally available in periods of:
- 5 years
- 10 years
- 20 years
- 30 years
As an alternative, many insurers also offer the option of term coverage until you reach a certain age, such as 65. This is essentially the same product, as it provides coverage for a predetermined number of years, so long as you consistently pay the premiums. However, age-based term life insurance often builds in flexibility regarding the length of the term.
Level or decreasing term life insurance
The critical question to ask when choosing between a level and decreasing term life insurance policy is whether your dependents would need less coverage should you pass closer to the end of the term than they would should you pass in the next few years. Level term life insurance, by definition, offers the beneficiaries the same payout over the entire length of the term.
Decreasing term life insurance may be more appropriate if you're in the process of paying back loans. If you want coverage to ensure your debts are not transferred to your family upon your death, decreasing term life insurance might be a good option. It works like this: you pay a flat premium throughout the policy, but the policy's face value (death benefit) decreases over time. The idea is that a person may need a higher death benefit earlier in life than they do as they get older.
Renewable term life insurance
Short term life insurance policies often have the option of being renewable, meaning each year (or five years, depending on the term) you essentially purchase a new policy with the same insurer, under the same terms. The benefits of this type of policy are that you can get coverage for a short period and have the option to renew without going through a lengthy underwriting process. But the downside is that your premiums will increase each time you renew, as you're older and in a higher risk bracket.
Simplified issue and no medical exam life insurance
Simplified issue term life insurance, also referred to as "no medical exam" life insurance, may sound great. Still, it is a significantly more expensive product that may not be worth the convenience. These policies may be more costly than others, and a medical exam to get a life insurance policy usually takes less than an hour.
If you think you won't pass a medical exam, simplified issue insurance might be the best route to go. However, you will have to share your medical history with the insurer, and if you don't tell the truth, and the insurer finds you've misstated anything, your policy may be canceled.
A life insurance-related medical exam is relatively short and can often be performed at your home or work.
Convertible Term Life Insurance
Many insurers offer convertible term life insurance policies. This type of insurance allows you to convert the term policy to a permanent life insurance policy without going through a new medical review.
We recommend having a convertible term policy as your financial situation will change over time. For example, if your income rises and you later decide that you want a permanent life insurance policy to take advantage of the tax benefits, that option will be available.
As having a convertible policy doesn't change the insurer's risk while maintaining the term policy, it shouldn't increase your premiums and is generally just beneficial as it offers convenience should your financial situation change. Just make sure to note the period of time during which you're allowed to convert the policy.
Additional scenarios to understand
Riders are essentially customizations to an insurance policy. Rider selection available for a particular policy varies according to the insurer and insurance product chosen. Evaluate riders carefully because the financial benefits may not exceed the actual cost.
For example, you may have heard of a "return of premium" rider which pays back a percentage of your premiums should you outlive the term of your policy. This may sound perfect to a parent purchasing a term policy to cover their children's education if they die. However, this type of rider would increase their premiums. This means that even though you would get that money back, its value would be locked up in the policy, and if you died during the policy term or had a sudden expense come up, it would not be available.
Voluntary and group term life insurance
Voluntary term life insurance refers to the extra coverage that employees can opt-in to purchase, hence the "voluntary" title. Group life insurance is usually offered through an employer as part of a compensation and benefits package. Group and voluntary life insurance is usually term life as opposed to permanent life insurance.
Your employer might suggest a certain amount of coverage at no cost to allow employees to take advantage of a discounted group rate to get additional coverage. While group term life insurance comes at a discount, the policies tend to be less customizable and often are not transferable, meaning that the coverage ceases if you change employers.
Given the median tenure for employees at a particular job is less than five years, you'll likely move to a new company within the term of coverage. It's essential to evaluate the options available and terms of the policy before purchasing group coverage.
Direct term life insurance
Direct term life insurance is a policy taken out by an individual, not a third-party member, like an employer or family member.
Should I buy term life insurance?
Whether you need term life insurance is a personal choice. The decision to purchase term life insurance is often related to life events like marriage or the birth of a child.
Term life insurance offers financial protection to partners, spouses and dependents. If you are single and don't have any outstanding debts that could be passed onto your extended family or estate, you may not need to purchase a term life insurance policy.