Term Life Insurance

What is term life insurance?

Term life insurance is a type of temporary, short-term life insurance that pays a death benefit to your beneficiaries should you pass away while the policy is in effect. A death benefit is a monetary sum that can provide a safety net to your family and loved ones in the form of some financial security upon your passing.

The most common term life insurance policy duration is 10 years. If the insured lives beyond the specified period in which the policy is active, the policy simply expires and the insured would need to renew or enroll in another life insurance policy.

How does term life insurance work?

Before term insurance can be finalized, there is an application process the insured must complete. For an insurance company, this is the underwriting period during which your risks as a client are evaluated and then priced accordingly. This typically involves a medical exam, though some companies now offer "no medical exam underwriting."

You will, however, face an evaluation of your lifestyle; insurers will want to know about your occupation, hobbies and more to analyze your mortality risk and set your premiums to what they deem appropriate. Smokers and those who participate in riskier activities — hobbies like scuba diving and occupations on oil rigs, for instance — will pay pricier rates.

During this process, the insured needs to make important decisions related to their term life insurance policy:

• Term length and type: Whether it’s a one-year or 30-year term, you must continuously pay premiums during this period.
• Death benefit amount: Think about your annual salary, proximity to retirement age and your current and future expenses. While it’s never easy to project your beneficiaries’ financial futures, a life insurance agent can help you iron out these details and settle on the best figure for your situation.
• Beneficiaries: When you die, the money will go to your beneficiaries. A term life insurance beneficiary can be one person or multiple people, trusts, charities or organizations. The death benefit can also be divided between entities, i.e., leaving 50% to a spouse and 25% each to two adult children.

Term life insurance is generally preferable over whole life insurance for those who are venturing into adulthood. If you’re at a stage in your life where you’re about to hit some milestones — like getting married, buying a house, starting a family — term life insurance would make more sense than a whole life policy.

There are a few reasons why term life insurance might be a good idea:

1. It’s much cheaper than whole life insurance. Term life insurance is very affordable for people who are younger, and unlike permanent life insurance, you aren’t bound by a lifelong policy and the higher premiums that come with it.
2. It’s a shorter commitment with some flexibility. A term policy will allow you to replace your income over a certain length of time — such as paying a mortgage or raising a family. If your financial situation changes over the years, you can reassess your life insurance needs and adjust coverage after it expires. In addition, should you change your mind and wish to get permanent coverage with a whole life policy, most term life insurance policies can be converted.

What are the different types of term life insurance?

Once you’ve decided that a term life insurance plan is the best fit for you and your family, you’ll also need to decide on the type of policy. Each comes with different benefits (and costs) over the policy’s duration.

• Level term: Your premiums will remain fixed and unchanged over the life of your term policy. This is the most common kind of term life insurance, and may also be known as level premium term life insurance.
• Decreasing term: The death benefit — also known as the policy’s face value — will decrease annually until it reaches zero at the end of the policy. Decreasing term life insurance tends to be very uncommon compared to level term.
• Annual renewable term: This type of term policy only lasts for one year but can be renewed yearly for a set number of years. However, your premiums won’t be level year-to-year like a level term policy — they will increase with the onset of every renewal.
• Return of premium: The premiums you pay will be paid back (in full or a portion) if you outlive the policy and it expires. A caveat to this type of term policy is that it’s more expensive — it costs two to three times as much as a level term policy.

Riders for term life insurance

The terms and conditions of a term life insurance policy can be supplemented with riders (also known as endorsements). These increase your level of protection should unexpected issues or conditions arise.

Common riders, like the term conversion rider, are generally already included as part of a term life insurance policy. Other riders may be added for an additional cost:

• Accelerated death benefit: This allows you to use some of your death benefit while you’re still alive to cover qualifying expenses pertaining to a critical illness. Many policies may already include this rider.
• Critical illness riders: Similar to the accelerated death benefit, critical illness riders help you pay for medical expenses while you’re living. Coverage for chronic illness and long-term care can be added to your policy in anticipation of these situations. If you become disabled, a waiver of premium for disability rider will waive your premiums.
• Accidental death and dismemberment riders: Best for those who engage in riskier hobbies or occupations, this pays out from your death benefit if you die or become dismembered in an accident.
• Family riders: These extend life insurance coverage to members of your family. For instance, a spousal insurance rider will pay a death benefit to you — as if you are a beneficiary — if they pass away. However, family riders don’t include as much coverage as purchasing a separate life insurance policy on that family member.

How to determine how much term life insurance you need

Death benefits amounts can range from $20,000 well into the multi-millions. When you apply for life insurance, your income, assets and overall net worth are used to evaluate how much coverage you qualify for.

Many life insurance agents and financial planners recommend multiplying your yearly income by 10 to 15 to get a preliminary baseline of how much life insurance you need. However, this is a very basic assessment that doesn’t completely account for the full picture of you and your family’s finances. You will need to consider any dependents and outstanding debts — especially if you’re the primary source of income — the cost of end-of-life care, education or schooling expenses for any children and more.

The DIME formula — which stands for debt, income, mortgage and education — can help furnish a more thorough understanding of how much term life insurance you need:

• Debt: Calculate all of your debts with the exception of your mortgage — so any car loans, student debt, credit cards and any other sources of debt should be summed up.
• Income: Multiply your annual income by the number of years your family will need support for if you’re gone. This can be difficult to answer especially if you have children; in these cases, multiply your income by how many years it will take for your youngest child to graduate high school.
• Mortgage: How much do you have left on your mortgage loan? This figure should be factored into your calculations so your family is not left financially underwater on the mortgage.
• Education: If you have kids, a good rule of thumb in calculating their future education costs should they pursue college is $100,000 per child.

If you add up all four of these figures, this will determine an estimate as to how much life insurance you need to take care of your beneficiaries’ future expenses, effectively alleviating the financial gap left behind if you are no longer able to provide income.

What’s the difference between term and whole life policies?

The key differences between term and whole life insurance can be summarized by whether or not there’s a cash value component and for how long each type of policy is active.

Death benefit only vs. death benefit + cash value

Term life insurance is straightforward in that it’s the most basic level of life insurance, and provides a death benefit only. Whole life insurance policies can get complex, as it provides both a death benefit in addition to a cash value component. Many whole life insurance clients use the accrued cash value to supplement retirement income while they are living; however, it should be noted there are better alternative investment vehicles than cash value, as it accrues slowly — especially during its infancy — over the insured’s lifetime.

Temporary vs. permanent coverage

Another significant difference between term and whole life insurance is the period of time covered. Term life insurance is a short-term policy that covers the owner for a fixed number of years and must be renewed to keep coverage in place. While premiums for term life insurance start low and level during the policy, they will increase in the future at every renewal period.

Whole life insurance (also known as cash value life insurance) covers you for the rest of your entire life, so it provides permanent coverage with level premiums while the policy accumulates cash value. With every premium payment you make, a percentage of it is diverted as cash value. The cost of whole life insurance is much higher than term life insurance, however, because coverage is in place for your lifetime and typically comes with more bells and whistles when it comes to a policy’s terms and conditions. And unlike term life insurance, there are also different types of permanent insurance — like universal life insurance — that allow some more flexibility.

Tips on how to shop for term life insurance

Buying life insurance can be daunting — with so many factors to consider, we recommend you take it one step at a time to figure out your needs before diving into shopping. Here’s a step-by-step guide on how to buy a term life insurance policy.

Determine how much life insurance you need

A good rule of thumb is to multiply your annual income by 10 to 15. Calculate all over your outstanding debts, like your mortgage, credit cards, student loans, car loans and anything else that you owe money on. You will essentially need to identify how much of a financial gap will be left if you pass away. Using the DIME formula — and consulting a life insurance agent — will be helpful in determining a complete look at you and your family’s financial needs, along with their future expenses. During this time, you should also decide on how long of a term you’d prefer for your policy, and if you’ll need any additional riders to supplement your coverage.

Research life insurance companies and rates

Once you’ve decided on a death benefit that you and your beneficiaries are comfortable with, it’s time to start looking for the best life insurance company. Every company rates policies differently, and although term life insurance is quite affordable, you’ll still need to put some time into researching what a fair rate looks like.

Shop around and apply

Get life insurance quotes from the providers of your choice, and weigh each of their pros and cons. The cheapest option is sometimes not the best — it’s important to do some research into each company’s customer service and how they handle and process claims.

Once you’ve selected your life insurance company, you must complete the application and follow through on the rest of the application process — it usually involves a medical exam or physical and an evaluation of your lifestyle and hobbies. These are used during the underwriting process to finalize your policy and what you’ll be paying in premium.