Term life insurance is an insurance product that offers a death benefit for the covered party if they pass away during the specified time frame. Since there is an end date for term life insurance, it is generally less expensive than permanent forms of coverage such as universal and whole life insurance, which do not expire.
Understanding the benefits and drawbacks of term life insurance can help you decide what kind of policy 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, your family will receive a death benefit that is generally greater than the sum of the premiums (if you die with an active policy).
Term life insurance, which is considered “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 up to 40 years. Your insurer may allow you to renew your term life insurance policy without having to reapply for coverage once the term expires, but the new premium will be based on your age at the time you renew, which means it will be higher. If a renewability feature does not exist or isn't exercised, life insurance coverage ends when the term does.
Some term policies have a conversion feature that lets you convert the policy into universal or whole life insurance, which doesn't have an expiration date.
How Does Term Life Insurance Work?
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).
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 and for how long. Consider your family’s financial resources, as well as any outstanding debts you’d like to pay off, such as a mortgage. The death 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, sex, and health
- Lifestyle and habits, including things like smoking and high-risk hobbies
- Driving history
- Family medical history
Since age and health directly impact the cost of life insurance, people in excellent health will pay less than their peers, while people with health problems will pay more. Smokers typically pay the most for life insurance coverage.
If you pass away during the policy term, the insurance company will pay your beneficiaries the benefit amount. Life insurance proceeds generally are 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, and there's no renewability clause, the policy is done, and the insurer will not pay a death benefit to your beneficiaries.
For instance, let’s say Pat, a 30-year-old non-smoker in "Regular" health purchases a $250,000, 20-year term life insurance policy for $325 per year. 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.
"Regular" is a classification some insurers use for people who aren't considered in excellent health and have minor health issues.
But as a 50-year-old, Pat will pay significantly more to maintain the same death benefit for another 20-year term. On average, 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 could make it impossible for Pat to qualify for a new policy at age 50.
Pros and Cons of Term Life Insurance
Coverage for the most financially vulnerable years
Coverage is not lifelong
No cash value accumulation
- Affordable: Insurance customers can generally afford higher death benefits with term life insurance compared to permanent life insurance. For instance, a 30-year-old who wants to spend less than $1,000 per year on life insurance premiums might be able to afford a $100,000 whole life insurance policy, but could potentially purchase a 30-year term life policy with a $500,000 death benefit on the same budget.
- 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 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.
- Coverage is not lifelong: Term life insurance coverage is only good for the length of the term, which could leave customers without coverage when they need it. To maintain coverage once the term expires, you will need to requalify for a new policy or renew your existing coverage (if your policy has a renewability clause). In either case, your premium will be higher. And if you've developed health problems, you might not qualify for a new 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. Universal and 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 a higher death benefit for a lower premium with term life compared to permanent coverage.
Permanent insurance, on the other hand, is designed to last your entire life. As a result, insurers charge higher premiums initially to accommodate the increase in insurance costs as you age.
- 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 permanent life insurance.
- Unlike permanent life insurance, term life insurance does not typically provide a cash value. If you don’t die during the term, the money you spend on premiums, in most cases, 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, or renew coverage if it's an option, to maintain the same benefit—either way, your premium will increase.
- Term life insurance is generally a good option to provide financial protection for families with children.