When you have loved ones depending on you for their livelihoods, life insurance can provide invaluable peace of mind. However, not everyone can afford the high premiums and committing contracts of traditional life insurance. Term life insurance, on the other hand, is both flexible and budget-friendly. If you’re looking for immediate, short-term coverage — either because you only need to cover your dependents for a certain number of years, or because you expect your financial situation to change — term life might be your solution. Here’s how to determine whether or not it’s the right fit for you.
What is term life insurance?
Term life insurance is a type of coverage that helps protect against the financial hardship that can be caused by the sudden death of a breadwinner. In exchange for monthly payments, providers pay out a set amount in the event of your untimely passing.
What makes term life insurance unique is that it has an expiration date. With whole life insurance, you keep paying your premiums for your entire life, but with term life insurance, you only pay premiums up until a predetermined end date. At that point, your term coverage ends.
Since most people only need life insurance coverage until they reach retirement age or their dependents are old enough to take care of themselves, they’ll stop paying premiums once they reach that milestone. After that, most people move on to other types of insurance, such as permanent or universal life insurance.
The benefits of term life insurance
From flexible payment terms to lower premiums, term life insurance has plenty of perks. Here are a few of the benefits to consider.
More coverage options available
Unlike a whole life policy, term coverage is temporary. This means you can take out a policy for almost any period of time you wish. Most insurance providers offer policy terms ranging from 5 to 30 years. So, a couple with young children, for example, may want to take out a policy with a 20- or 30-year term, which will cover the kids until they’re out of the house (and/or out of college).
Conversely, a newly married person with student debt might want to take a shorter policy — maybe a 10-year term — to protect their partner in case they pass away before paying off their loans. With term life insurance, you can choose whichever term suits your needs.
Flexible payment options
Some term life insurance providers offer multiple payment options. Policyholders can elect to make their premium payments monthly, quarterly, semi-annually, or even annually. This allows you to select a payment schedule that best suits your budgeting style. (Whole life insurance policies, on the other hand, typically follow a monthly schedule with set payment amounts.)
Because term life coverage is only issued for a specific length of time, it is less costly than whole life insurance. That makes it a great choice for younger families who aren’t interested in permanent life insurance.
For example, a 35-year-old nonsmoker in good health, can get a 20-year term policy with $500,000 in coverage for around $30 per month. The same candidate would likely pay more than $500 per month for a whole life insurance policy with the same coverage.
Certain plans are renewable
Some companies allow policyholders to renew their term life policy at the end of the term. This gives you the flexibility to end the contract or continue as you wish — all without the fuss of reapplying. Renewal may come with a slight premium increase, especially if you’ve gone up an age bracket since you took out your last policy. However, because you have an existing relationship with your insurance company, you likely won’t need to take a new medical exam.
Tax-free death benefit
If you pass away before your term length is up, the insurance company will send your beneficiary a lump sum payout called a “death benefit” or “disbursement.” Term life insurance disbursements are tax-free, so your beneficiary will receive the total amount without any withholdings. This is in contrast to certain whole life plans, which can accrue value over time. In this case, any interest you made on that value will be taxed before the disbursements reach the beneficiary.
Easy to cancel
Most term life insurance policies allow you to cancel at any time without having to pay cancellation fees or any other penalties. So, if your financial situation changes mid-way through your term, you can easily back out of your agreement or pivot to a new plan that better suits your needs.
The disadvantages of term life insurance
While it can have a ton of benefits, term life insurance may not be the best choice for everyone. Here are a few potential drawbacks to consider before you take out a policy.
When you renew, your premiums are based on your current health.
Unlike whole life insurance — which locks you into a predetermined rate for your entire life — your term life policy will be based upon your health at the start of each term. So, even if you choose to renew your term life insurance, your new policy won’t necessarily be an exact continuation of your old policy. If you develop health issues during a term or between terms, you could see a significant rate hike if you take out a new one.
Term life insurance doesn’t have a cash value component, so there’s no investment aspect. You also can’t take out loans against it.
With many types of whole life insurance, your policy will build value as you pay into it. That means you can treat a whole life policy as an investment. You can make money on it via interest, and you can access those funds while you’re still alive. In a term life agreement, however, your policy will not build cash value. You can’t make interest on the money you pay into it, and the amount of coverage won’t grow over time.
You can’t surrender your policy for cash value if you no longer want it.
If you cancel a whole life insurance plan prematurely, you may be able to receive a percentage of the funds that have accrued during the active policy period. However, term life insurance policies don’t have a cash value component to them. So, if you cancel your agreement, you won’t receive any cash back.
Term life doesn’t cover pre-existing conditions.
If you have pre-existing medical conditions, you may not qualify for term coverage. To find out, you can check the insurance provider’s list of exclusions before you apply. If you have a pre-existing condition, you may want to look for a “guaranteed-issue” policy, but be prepared to pay much higher premiums.
If you die outside of the term, you won’t receive a death benefit.
Term life policies have specific, rigid term lengths. If your death occurs outside these parameters, you will not receive a death benefit. If you reach the end of the term, it is important to renew your policy quickly to avoid any lapse in coverage.
Types of term life insurance
Before you shop around with different life insurance companies, first educate yourself on the different kinds of policies available. Different policies carry different term lengths and payment structures. Here’s how to figure out which life insurance option is best for you.
Level premium: Also referred to as “level term,” this is one of the more common types of term life insurance. With this kind of coverage, your premium will remain the same for the duration of the policy. That can make these types of policies easier to work into your regular budget, since your rate won’t change over time.
Yearly renewable term: A yearly or annual renewable-term policy covers you for a year at a time. This type of life insurance coverage gives you the option to renew your policy every 12 months without a medical exam. However, each renewal comes with a premium increase. Yearly renewable term policies can look tempting because they start out with lower premiums than level term policies do. However, they often end up more expensive in the long run because of the annual premium increases.
Return of premium: With this type of term policy, you will receive a payout of all or a portion of your premiums if you live to the end of the policy term. However, you can expect premiums to be much higher (two to four times higher) than they would be with a level term policy. Additionally, if you allow the policy to lapse, you may only receive back a portion of the premiums, if anything at all.
Guaranteed issue: As the name indicates, you cannot be turned down for this type of life insurance. You won’t have to take a medical exam, and the insurance provider typically asks very few — if any — health questions. Because this type of policy is available to riskier candidates, it typically comes with higher premiums and provides less coverage than other policy types. Additionally, most brokers won’t pay the full death benefit unless the insured lives for two or three years after the policy is created. So, if a policyholder passes away suddenly within those first years — even from natural causes — their beneficiaries may not get the funds they need.
How much does term life insurance cost?
Term life insurance is usually less expensive than whole life insurance. Because term life insurance only lasts for a specific number of years, it isn’t uncommon to see term life premiums five to fifteen times lower than whole life policies with the same coverage amount. However, there’s still some variability within term policies. To find a good price, you need to understand what factors determine the cost. These include:
Your health: Your health is one of the biggest factors insurance providers use to determine your premiums. Because healthier people are at lower risk of dying, insurance providers tend to offer them lower premiums. To evaluate your health, insurance agents will ask you about your medical history and health habits and may request a medical exam. Family history — especially related to cancer, diabetes, alcohol dependence, or heart disease — may also impact the way issuers determine your personal health risk.
Your age: Age also affects the underwriting for your loan policy. The older you are, the more likely it is that an insurer will have to pay out on your policy, so insurance providers almost always charge older policyholders higher premiums. This is why it can be advantageous to take out a policy when you’re still young.
Your coverage amount: Your coverage amount — i.e., the payout you’ll receive in the event of death — will also determine how high your premiums are. Average coverage amounts range from $250,000 to $1,000,000. The higher your coverage amount, the higher your premium payments will be.
Your term length: Typical term life insurance policies range from 10 to 30 years. If you select a policy with a longer term length, you’ll be paying into the plan for longer. Because of this, your individual premiums will be lower.
How much life insurance coverage do I need?
Determining how much life insurance you need depends on your personal situation and timeline. There are a few methods you can use to figure out what you need:
Multiply your salary by 10: This is one of the simplest ways to determine a good life insurance threshold. However, if you have children, this method may not account for added expenses such as college tuition.
Multiply your salary by 10, then add college costs: Adding $100,000 to $150,000 per child for college expenses (on top of the salary multiplier) can give your kids some extra financial cushion and help them afford a college education.
Use the DIME formula: The debt, income, mortgage, and education (DIME) method accounts for additional financial obligations. With this method, you first determine the amount you expect to pay annually toward your mortgage, debt payments, and any tuition. Then, add these on top of your salary multiplier to calculate your total coverage.
Calculate your lifetime earning potential: This method considers what you’re making now, as well as what you expect to make down the road. This calculation changes based on age, but you can get a rough illustration in the table below: