What Is Term Life Insurance?
Definition & Examples of Term Life Insurance
Term life insurance is an insurance product that offers a death benefit for the covered party if they pass away during the specified timeframe. Since there is an end-date for term life insurance coverage, it is generally less expensive than whole life insurance, which does not expire.
Understanding the benefits and drawbacks of term life insurance can help you decide what kind of life insurance can give you the best protection for your family’s needs.
What Is Term Life Insurance?
Life insurance is a bit of a misnomer, as this kind of insurance pays out upon the death of the covered individual. Purchasing a life insurance policy is one strategy you can use to protect people who depend on you financially in case you die unexpectedly. In exchange for monthly or annual premiums, when you die, your family will receive a death benefit that is generally greater than the sum of the premiums.
Term life insurance, which may also be called “pure life insurance,” offers this death benefit if the covered individual passes away during the specified policy term. Insurers generally offer terms ranging from as little as one year to up to 30 years. When the term expires, the insured person may either let their insurance lapse, renew the insurance for another term, or convert the policy into whole life insurance, which does not have a specified end date.
How Does Term Life Insurance Work?
If you’re thinking about buying a life insurance policy, you’ll need to start by coming up with an idea of how much of a death benefit you would like to provide your beneficiaries. Consider your family’s financial resources, as well as any outstanding debts you’d like to pay off, like a mortgage. The benefit amount, or the policy value, is a big factor in determining how much you’ll pay in premiums. The insurer will also consider factors like your:
- Term length
- Age, gender, and health
- Medical exam
- Lifestyle and habits, including things like smoking and high-risk hobbies
- Driving history
- Family medical history
Not all term life insurance providers will use all of these factors to determine the price of your premiums, but you can generally expect to pay less for term life insurance if you’re young and healthy.
The vast majority of term life insurance is “level term,” meaning the value of the benefit remains the same throughout the term. However, some policies offer a “decreasing term” benefit, which means the amount of the benefit decreases at regular intervals (usually once per year) throughout the term.
If you pass away during the policy term, the insurance company will pay your beneficiaries the benefit amount. Life insurance proceeds are (generally) not taxed by the IRS, which means your family can count on the full value of your policy as a benefit.
However, if the term expires before you do, the policy is done, and the insurer will not pay a death benefit to your beneficiaries. Your insurer may allow you to renew your term life insurance policy, but the new premium will be based on your age and other factors at the time you renew, which means it will likely be higher.
For instance, let’s say Pat, a healthy 30-year-old non-smoker, purchases a $250,000 20-year term life insurance policy. The average premium cost for such a term life policy is between $314 and $368 per year, according to data from August 2020. If Pat passes away during the 20-year policy term, the beneficiaries will receive the full $250,000 death benefit. However, if the policy expires, Pat will have to purchase a new policy to maintain the death benefit. But as a 50-year-old, Pat will pay significantly more to maintain the same death benefit for another 20-year term: between $955 and $1,225 per year. And Pat’s ability to purchase a new policy may depend on uncontrollable health factors. A serious medical diagnosis (such as cancer) during the term of the first policy may make it harder or impossible for Pat to qualify for a new policy at age 50.
Pros and Cons of Term Life Insurance
Large death benefits available for a smaller cost
Coverage for the most financially vulnerable years
Must requalify at the end of each term
Premiums increase with each new term
No cash value accumulation
- Affordable: Term life insurance is generally more affordable than whole life insurance. That’s because insurers are counting on the likelihood that you’ll still be alive at the end of the term, whereas if you buy a whole life (or permanent) policy, insurers know that they will have to eventually pay out a death benefit. If you simply want to ensure your family will be financially taken care of if the worst happens while you’re still relatively young, term life insurance is a relatively inexpensive option.
- Large death benefits available for a smaller cost: Insurance customers can generally afford higher death benefits with term life insurance compared to whole life insurance. For instance, a 30-year-old who wants to spend less than $1,000 per year on life insurance premiums would likely be able to afford a $100,000 whole life insurance policy, but could purchase a 30-year term life policy with a $250,000 death benefit.
- Coverage for the most financially vulnerable years: Term life insurance typically provides a safety net during the years when a family needs it most. If you buy a multi-decade term life insurance policy for your family’s primary wage earner when your children are young or when you have a large mortgage, you can feel confident that there will be enough money for your children’s education or to pay off the house even if you pass away.
- Limited coverage: Term life insurance coverage is only good for the length of the term, which could leave customers without coverage when they need it.
- Must requalify at the end of each term: To maintain coverage, you will need to requalify when your term expires. This can become more onerous as you age and experience potential health problems.
- Premiums increase with each new term: Since premiums are partially based upon the covered individual’s age, they will increase when you purchase a new term life insurance policy.
- No cash value accumulation: With term life insurance, you won’t recoup the money you spend on premiums unless you pass away during the term. However, whole life insurance has a cash value in addition to the death benefit. The premiums you pay toward your permanent life insurance policy go toward both the death benefit and an investment or savings account that you may access after a certain amount of time has passed.
Term vs. Whole Life Insurance
Term life insurance is the more economical option, since the insurance company is betting on you surviving the term. That means you can expect higher benefits for lower premiums with term life compared to whole life insurance.
Whole life insurance, on the other hand, will pay out a death benefit no matter how long you live. To ensure they don’t go bankrupt paying out inevitable death benefits, insurers charge higher premiums for whole life insurance policies, and often package whole life insurance policies with savings and investment options.
- Term life insurance offers a death benefit to the beneficiaries of the covered individual during a specified term.
- Since term life insurance only pays out if the insured individual dies during the policy term, it is less expensive than whole life insurance, which pays out the benefit no matter how long the covered individual lives.
- Unlike whole life insurance, term life insurance does not provide any kind of cash value. If you don’t die during the term, the money you spend on premiums for term life insurance is simply gone.
- The best prices for term life insurance policies go to young and healthy individuals, and costs go up with age and the presence of medical conditions.
- Once the term has expired, you will need to purchase another term life insurance policy to maintain the same benefit. You’ll need to requalify for the insurance, and the new policy will cost more.
- Term life insurance is generally used to protect families when they are at their most financially vulnerable: when they have younger children that rely on the wage earners’ income.