Term life insurance is a temporary insurance contract between a person and an insurance company. The insurance policy stipulates that in return for payment to the insurance company, the contract will pay a specified death benefit if the named insured dies while the contract is in force. Term life insurance is temporary coverage. It is not meant to last for an entire lifetime, so it is much less expensive than whole life insurance.
Term insurance contracts do not have any cash value, typically are not eligible to receive dividends, and will expire at some point in the future. A term insurance contract is the least expensive type of life insurance coverage that you can buy and it allows for the insured person to provide for their beneficiaries in an economical way. Typically, the low premium payments will be level through the guaranteed life of the policy and are guaranteed by the policy not to rise.
Key Features of Term Life Insurance
Term life insurance is the most basic type of life insurance coverage. It is essentially a rental policy, which pays out a death benefit if a death occurs during the temporary coverage period (the term). Here are the key features of term life:
- Not permanent. Term Life is only meant to last for a set period of years and eventually expires.
- It is the least expensive life insurance coverage because the life insurance company does not expect to pay a death claim. They expect people to generally outlive the term coverage.
- It is renewable annually. You do not need to continue the coverage if you do not want, and there is no charge to cancel the policy mid-term.
- No cash value. It is not considered an asset by the IRS. If you surrender the policy before the coverage expires, you typically do not receive any money back. Premiums are not usually returned, but can be in “return of premium policies”.
- No payout when the policy expires. The coverage ends unless you renew it (at a much higher price) or convert it to whole life.
- The death benefit is treated the same as any life insurance for tax purposes.
- No dividend payments. Whole life is the only type of policy to pay the owners dividends.
- Typically a level death benefit. The amount of coverage does not change over the lifetime of the policy. The death benefit stays the same.
Term Life Insurance Benefits
The biggest benefit of purchasing a term life insurance policy is the death benefit. The large size of the death benefit that an insured person is able to afford for the low cost of insurance makes term insurance coverage the most efficient type of life insurance policy to own as long as you don’t need the coverage to be in force forever. In fact, relatively healthy clients are often amazed at just how much coverage they can receive for so little of a premium payment. Keep in mind that term life insurance policies are only guaranteed for a set length of time, and if the insured outlives the length of the contract no death benefit will be paid. People do not typically get their premium payments back at the end of the policy unless the policy specifically provides for that. This is why term contracts are priced so inexpensively relative to permanent forms of life insurance such as whole life or universal life.
The guaranteed period or “term” that a death benefit will be paid (only upon death of the insured) is the reason that this kind of insurance policy is called “term life insurance”. Term life insurance comes in different coverage lengths and it can typically be converted to a whole life policy at some point.
Term life insurance can also come with additional riders. The most popular rider is the waiver of premium rider, which eliminates premium payments for the policy if the insured person becomes disabled. You can also include a disability income rider, which actually pays supplemental income out if the insured person becomes disabled. These are known as living benefits, and typically expire at a certain age, usually age 65.
Common lengths of term contracts are 10, 20, and 30 years, though other variations exist such as 5-year term, 15-year term, and yearly renewable term insurance until set age such as age 95. Some companies are even selling renewable term until age 105. As people are living longer, life insurance companies are offering longer periods of coverage for term life. It is not uncommon to see 40-year level policies, and this trend will surely continue with longer policies yet.
Sometimes, term insurance contracts allow the insured the right to have the coverage extended after the guaranteed period, but this can be at the discretion of the insurance company and the insurance cost will typically rise after the guaranteed period ends. This is called the renewal period. The renewal period is very expensive, and the premiums may be three to five times as expensive as during the level period. The reason that the premium payments rise so much is because the life insurance company does not require new medical underwriting. If the insured person qualifies for a new policy, it is less expensive to have a new policy issued. Only people who have health issues should pay the renewal premiums to continue coverage. The renewal period does not last forever and may be the same length as the original guaranteed period.
Who Needs To Buy Term Life Insurance?
Some people may need permanent life insurance coverage, but others may not. Term insurance is especially useful for those people that only need life insurance protection a short period of time. For instance, a family may only need life insurance coverage until their children graduate from college, or until a working member of the family retires and no longer needs to provide for the rest of the family beyond their existing retirement savings.
Term insurance is also important for people who are on a budget but also require insurance. Examples may include a single parent who would need to provide for a child if they passed, a young family without a lot of discretionary income, or even business partners who want an inexpensive solution to providing “key man” life insurance protection for a business.
Term life insurance is a great way to buy a lot of life insurance coverage for an affordable price. The policy owner just needs to be prepared that the insured person is expected to outlive the policy, which is the reason that the coverage is so inexpensive. There will not be any payout for owning the policy if the insured person outlives the coverage because term does not have any intrinsic cash value.
You may wonder why anyone would purchase a permanent life insurance policy such as whole life. These policies come with other specific benefits for owners such as dividend payments, and the fact that the insured person can not outlive the policy. Whole life insurance can be a very useful tool for estate planning because it guarantees that assets will be passed onto the next generation while avoiding estate tax. Whole life insurance can also be an investment product, which provides a positive rate of return for most people and can fit nicely into a large investment portfolio because of its relatively low risk.
Converting The Policy To Whole Life Insurance
Term life insurance is typically convertible. This means that at the end of the guaranteed period, the owner of the contract has the option to convert the life insurance coverage to a permanent whole life policy. This can be done without any additional underwriting or proof of insurability.
The ability of term insurance to be converted to whole life insurance is another very powerful feature of a term insurance policy. To demonstrate an instance when this feature is especially valuable, let’s say a client takes out a $1,000,000, 30-year term insurance policy at age 35.
The insured may be very healthy when he initially goes through the underwriting process and could be given a premier health rating and a low cost of insurance. Now let’s say at age 63 the insured has a heart attack and survives. Under the original term insurance contract, coverage will expire at age 65. If this hypothetical client did not have insurance coverage already in place and tried to obtain coverage after the heart attack, he/she will likely either be rejected any coverage whatsoever by the insurance company because of the perceived high risk of death or will be charged astronomical amounts for the policy.
If the hypothetical family of the insured is not entitled to the death benefit of a life insurance policy and the hypothetical person passes away, they now are stuck paying for a very expensive burial process, paying taxes on the remaining estate, and dealing with maintaining their lifestyle and providing for their well being.
Underwriting and Pricing
The underwriting for a term life insurance policy is the same as whole life or universal policy, in that you will be placed in the same risk class regardless of the type of life insurance that you are applying for. However, term life insurance is only as affordable as it is because the life insurance company expects that the insured person will outlive the policy, based upon mortality tables and the length of coverage. So, a 10-year term life insurance policy for a 55-year-old person will still be very affordable, because they will be 65 when the policy expires, and unless there are major health concerns most people are expected to live past age 65 today. A whole life policy will be much more expensive because mortality tables might expect someone to pass away in their early 80s or late 70s depending upon health. Similarly, even a 20-year term life insurance policy will be much more expensive than a 10 year policy because the risk of dying before age 75 is so much higher than the risk of passing away before age 65. With life insurance, length of coverage and life expectancy are everything when it comes to pricing.
If you have special health considerations, do not be afraid. It is still relatively easy to get term life insurance even if you are a smoker, or have hypertension or high cholesterol. Term may be your only choice in the type of policy you purchase because permanent life insurance can become very expensive if you smoke, are obese, or have pre-existing health conditions.
Here is sample pricing on term life insurance for a premier health client.
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Because term insurance is convertible, however, the family need not despair about lack of coverage. Even though the insured has a heart attack at age 63, with a term insurance policy in place he/she will not need to be approved for another contract by underwriting after the term insurance expires. The same $1,000,000 death benefit and premier underwriting rating can now be applied to a whole life policy. The insured can convert the term insurance to whole life insurance at the end of the contract and guarantee to his/her family that they will be safely provided for in the event of an untimely passing!
The downside to not purchasing whole life at a younger age is that the premium cost will be calculated as if the whole life policy is taken out at age 65, and the annual cost to be insured will be higher than if the insured took out the same policy at age 35. Nonetheless, the guaranteed insurability after contract expiration and much lower relative cost of insurance are powerful reasons to consider purchasing term insurance.
Whether it is whole life or term insurance you choose, having life insurance coverage in place to provide for your family in the event of an untimely death is crucial to planning and guaranteeing your family’s safest future.