WHAT IS TERM LIFE INSURANCE?

SARAH HORVATH

What is Term Life Insurance?

Term life insurance is a type of life insurance policy that is valid for only a specific period of time. The “term” in term life insurance refers to the number of years that the policy is active. 

For example, if you sign onto a life insurance policy with a 20-year term, it means that your policy is active for 20 years. If you die within 20 years of signing onto the policy, your beneficiaries will receive a payout from your insurance provider. If you do not, the policy will expire worthlessly. 

How Does Term Life Insurance Work?

Life insurance acts as a contract between you and your insurance provider. When you apply for a life insurance policy, your insurance provider will collect some basic personal information that helps them determine your premiums. 

Your premium is the amount of money that you must pay each month to keep your life insurance policy active. If you’re at a higher risk of death, you’ll pay a higher premium.

Some of the factors that your life insurance company will consider when setting your premium may include:

• Your age
• Your driving record
• Whether or not you are a smoker
• Any prescription medications that you’re currently taking
• Your family medical history
• Your occupation and hobbies

In some cases, your insurance company may request that you undergo a medical examination before issuing you a policy. This medical exam will be very similar to the annual physical that you receive at your doctor’s office. However, this is no longer as common for term life insurance policies as it is for whole life coverage.

After deciding what you’ll pay in premiums, your insurance provider will offer you a contract for your coverage. This contract will specify your death benefit, which is the amount of money that your beneficiaries will receive if you die while the policy is active. 

You can find term life insurance policies with death benefits as low as $50,000 and as high as $1 million. The higher your death benefit, the more you’ll pay for your monthly coverage.

You’ll also be responsible for naming beneficiaries on your policy, who will receive your death benefit if you die within the term of the contract. Contrary to popular belief, you don’t need to assign a single beneficiary to your life insurance policy. You can specify within your contract what percentage of your death benefit will go towards each beneficiary. For example, you could specify that 80% of your death benefit goes to your spouse to cover living expenses while the remaining 20% goes toward your favorite charity.

Your beneficiaries can use your life insurance proceeds in any way that they please. Death benefits are also not considered to be taxable income in most circumstances, which means that your beneficiaries won’t need to worry about paying taxes on the money that they receive. However, if you don’t name a beneficiary and your payout is instead issued to your estate, tax implications may apply.

Term life insurance policies are more affordable than permanent life insurance policies because they provide coverage only for a limited amount of time. As the name implies, permanent life insurance policies last throughout your life and guarantee that your beneficiaries receive your death benefit so long as you continue to pay your premiums. 

This makes them significantly more expensive than term life insurance policies because a payout is not guaranteed. Term life insurance policies also do not contain a cash value component like permanent life insurance policies, and they have no value beyond the death benefit specified in the policy. 

Types of Term Life Insurance

There are multiple types of term life insurance policies. The type of policy that you choose will determine how much you pay in premiums as well as the process that you’ll go through when you sign onto a policy. 

Some of the most common types of term life insurance policies that you’ll see include the following:

• Level premium: Level premium policies are the most common type of term life insurance policy. With a level premium policy, your premium won’t change throughout the term — you’ll pay the same amount each month until the policy expires.

• Yearly renewable term: Yearly renewable term policies cover you for one year at a time, allowing you to renew your policy each year. However, these policies can change your premiums each time you renew, which means that you’ll pay more each year you renew your policy. While this type of policy may save you money at the beginning of your term, the annual increases in premiums may end up costing more than a level premium policy that begins with an initially higher rate.

• Decreasing term: A decreasing term life insurance policy is a policy that has a decreasing death benefit each year. With a decreasing term policy, your annual premiums stay the same as you age but the total payout may decline on an annual or monthly basis. Many people who purchase decreasing term life insurance policies do so to mirror a mortgage amortization schedule.

• Guaranteed issue: Guaranteed issue term life insurance policies are the easiest to get and have the least qualifications you must meet to sign onto coverage. These policies may require only a few basic health questions — some insurance providers even offer same-day coverage on guaranteed issue policies.

However, because you’re applying for a guaranteed issue policy, your insurance provider will assume that it’s because you’re a riskier candidate, which increases the price that you pay for coverage. Some guaranteed issue policies also specify in their terms that only a portion of your death benefit will be paid out if you die within the first few years of your policy.

Be sure to thoroughly read through your insurance policy’s terms and speak with an agent before you sign up for coverage. 

Benefits of Term Life Insurance

Some of the benefits that come with term life insurance over other types of life insurance include the following.

• A lower price point: Term life insurance provides you with coverage over a set period of time, which means that a death benefit is not guaranteed to be paid out. This means that you’ll pay significantly less for term life insurance coverage than you would for a permanent life insurance policy with the same death benefit.

• More customizable coverage: Term life insurance is more customizable than whole life insurance policies. You can sign onto coverage for as little as one year or as long as 30 years. Most life insurance companies will help set you up with an insurance agent, who can recommend a policy based on the specifics of your situation. For example, if you have a child going to college, you can take out a life insurance policy specifically designed to cover their tuition if you pass.

• Simpler: Term life insurance is easy to understand, and its policies are usually very straightforward. This can make it a good choice if you’re looking to sign up for a policy quickly or if you’ve never had life insurance coverage before. 

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