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If you have dependents, you may want to protect them from the financial fallout of a sudden loss of income or unexpected funeral expenses. That’s where life insurance comes in. A term life insurance policy can help your spouse pay off your mortgage or pay for your child’s educational costs in case you aren’t around to see those financial obligations through.
“If you have someone who is dependent on your income to live, you should have term life insurance,” says Jeremy Schneider, founder of Personal Finance Club, a financial literacy company. Here’s what you need to know about how term life insurance works, how much it costs, and how to buy the right policy for your needs.
Term life insurance protects your family for a specific period of time, typically between 5 and 30 years. It’s intended to cover your financial obligations during a time when your family still relies on your income. For example, if you’re still paying off your mortgage or other debts, or if your family needs your income to cover their necessary expenses, term life insurance can give your family the resources to take over your financial responsibilities.
For example, let’s say you still have $200,000 in mortgage debt that you won’t have paid off for another ten years. Your spouse may only be able to cover half of the mortgage payments with their income. A 10-year, $100,000 life insurance policy would help your spouse handle that obligation should you die during the term. Although, experts typically suggest purchasing policies that can cover at least 10 times your annual take-home pay.
When you apply for a term life insurance policy, you’ll choose the term (how long the policy will last) and the death benefit (how much your family will receive if you die). Those factors, along with your age and health status, will determine your premium. Your premium is the amount you’ll pay at regular intervals to maintain coverage.
You may be able to save money on term life insurance by laddering more than one policy. For example, you might buy a 20-year policy plus a 10-year policy to add extra coverage initially.
There are two types of term life insurance: level term and decreasing term. Level term, which is the most common type, means that the death benefit stays constant for the duration of the policy. With decreasing term life insurance, the death benefit drops at fixed intervals over the course of the policy.
In an ideal world, the beneficiaries would probably prefer that their loved one does not pass away. But like any type of insurance, term life insurance is meant to provide a financial safety net in the case of unexpected events. By paying your life insurance premium now, you’re giving your beneficiaries peace of mind that, should you die prematurely, they will be financially supported.
“You pay a premium every year and that premium basically allows you to transfer the risk of a premature death to an insurance company,” says Jill Schlesinger, a Certified Financial Planner and business analyst for CBS News.
If you outlive that term, you won’t get your premiums back, nor will your family receive a death benefit. But you can choose to extend the term at that point, let it expire, or convert it to permanent life insurance.
For the majority of people, financial experts we spoke to recommend term life insurance as opposed to the whole, or permanent, life insurance. “Generally speaking, permanent life insurance is more complicated and far more costly than the term alternative, and for most people, they really only need life insurance for a particular period of time,” Schlesinger says.
Cost: Term life insurance typically costs less than whole (or permanent) life insurance. That could leave additional room in your budget each month to invest more money into a brokerage account or retirement account. So long as you designate your family or whomever you’d like as a beneficiary of those accounts, they should receive any funds if you were to die unexpectedly. Pros and cons: Both types of life insurance ultimately give you peace of mind that your beneficiaries will be taken care of should you pass away. However, there are specific benefits and drawbacks to term insurance.
Schneider is particularly a fan of this strategy. “If you die before the term is up, you’re covered. If you don’t, your investment will have grown to much more than the whole life insurance would have provided,” he says. “Untimely death or not, you’re better off buying term and investing the rest.”
Coverage length: While term life insurance covers you for a particular period, whole life insurance lasts for your entire life and has a guaranteed death benefit. A whole life insurance policy also accumulates cash value, and some providers pay dividends to policyholders.
Some people may need permanent life insurance to fulfill a specific need. For example, you may require coverage for your entire life for estate purposes or you may have a special needs child or a much younger spouse. In those cases, whole life insurance might make sense, adds Schlesinger.
Whole life insurance premiums can vary dramatically according to your age and the face value of the policy, “for people under 40, you’ll likely see quotes in the $20-$50 [per month] range,” says Schneider. In general, whole life insurance costs significantly more than a comparable term life policy. You can also expect to pay more for term life insurance if you’re a smoker or have health conditions that make you a greater risk to insure.
