Benefits and Disadvantages of Term Life Insurance

Term life insurance is both flexible and budget-friendly. Here’s how to determine whether or not it’s the right fit for you.

Updated: April 27, 2023

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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.)

Generally cheaper

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:

Search and compare to get the best rate and save.

Age

Maximum Life Insurance

18-40

30 times income

41-50

20 times income

51-60

15 times income

61-65

10 times income

66-70

1 times net worth

71-75

0.5 times net worth

Source: Guardian

How getting term life insurance works

Essentially, a term life insurance policy is a contract between the policyholder and the insurance company. The specific term (typically 10 to 30 years) dictates how long that contract will last. Here’s how to go about finding a policy:

  1. Start shopping around: Shop around between multiple providers to see what kinds of life insurance rates they can offer you. Some may require you to fill out a form or questionnaire before they can give you a life insurance quote.

  2. Compare life insurance quotes: When you’ve checked with a handful of providers, you can then compare quotes and choose the company that will give you the best deal.

  3. Fill out an application: When you’ve made your final choice, you’ll then fill out a formal application. During this process, the insurance company will find out more about you. Insurance agents may request medical records or schedule a medical exam to assess your health. They may also want to know more about your occupation and hobbies. Someone who works as a lumberjack will certainly carry more occupational risk than someone who works as an accountant, for example. Likewise, if your hobbies include dangerous sports like riding motorcycles or scuba diving, you may see higher rates.

  4. Choose your policy details: Now you’ll choose your term length and amount of coverage. These numbers will depend on your age, income, and specific needs.

  5. Name your beneficiaries: Beneficiaries are the individuals who will receive the payout if you pass away before the end of the term window. Usually these are the same people you list as dependents on your taxes, but they don’t have to be. You can either choose a single person — such as a spouse, sibling, or child — or you can choose to divide the death benefit between several beneficiaries. 

Other types of life insurance

There are many different types of life insurance. Here are a few of the alternatives to term life insurance:

Whole life 

A whole life insurance policy carries lifetime coverage as long as you make your payments. Although the payment amounts remain the same for life, they are typically more expensive than term life insurance premiums — even on a policy that provides the same amount of coverage.

Unlike term life, whole life policies can accumulate cash over time, and you can borrow the funds as needed. However, if those funds go unrepaid, the policy’s value and death benefit will decrease accordingly. 

Universal life

Universal life insurance is similar to whole life insurance in that they both provide lifetime protection while building cash value. However, a universal life policy is more flexible in that you have the option to raise or lower your premium as needed. This can make it less expensive than whole life insurance. However, if you make lower payments for too long, this can negatively impact the policy’s death benefit and cash growth potential.  

Variable life

Variable life insurance is another type of permanent life insurance: as long as you pay your premiums, you’re covered for your entire life. However, variable life policies are unique in that they give you the option to reinvest any accumulated cash value. You may choose to reinvest the money into stocks, bonds, or an index. Because the cash is invested, variable life policies can be riskier and may carry higher fees than other types of life insurance. 

Indexed universal life

Indexed universal life insurance is a permanent life insurance policy that pays interest based on the fluctuation of the stock market. Unlike variable life insurance, you can’t invest your cash value into stocks or bonds. Instead, you’re tied to a specific stock market index. That means your funds will be subject to the volatility of the stock market as a whole. (However, there is usually a floor or cap to minimize the impact of large swings.) 

Explore term life insurance on Navient Marketplace

If you’re the sole or primary breadwinner in your family, term life insurance can be an affordable way to protect your dependents against financial destitution. With term coverage, you can elect to be covered for a specific period of time and cancel your policy any time you wish. This makes it one of the most flexible options for life insurance on the market.

If you’re ready to shop for term policies — or just get a feel for what life insurance products are available to you — head over to Navient Marketplace. This comprehensive platform makes it easy to compare different providers. Click through, browse your options, and find the one that meets your life insurance needs. 

Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

Information in this blog, including the rates advertised, are current as of 04/27/2023 and subject to change. 

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