Types Of Term Life Insurance: How To Choose The Right Policy
Getting a life insurance policy can be confusing, especially since there are so many types to choose from. If you don't pick the right one, you may find yourself with a policy with a coverage period that's shorter than what you need. You can also end up buying an insurance policy that costs more than you can afford.
In this short guide, we'll cover the different types of term life insurance, as well as the factors you should consider in choosing a policy. We'll also help you choose the correct term life insurance length and inform you about the costs.
Defining Term Life Insurance
Term life insurance gets its name from the fact that policyholders are only insured during a specified term, usually for about 30 years. Since the policyholder is only insured for a set number of years, premium payments are usually less expensive compared to whole life (or permanent life) insurance.
Term life insurance policies usually don't have a cash value, except for the guaranteed death benefit (usually around $100,000 to $1,000,000). If the policyholder dies within the coverage period, the beneficiaries will receive the death benefit payout, usually tax-free. On the other hand, if the policyholder dies after the insurance has expired, the insurer doesn't have to pay the beneficiaries any money.
Once the policy expires, the owner can choose to renew it for another term. The premiums will be recalculated during the time of renewal.
Keep in mind that the insurance company can refuse to renew the policy – this usually occurs if the owner has developed a serious health condition. If you want to avoid this situation, you should ask about convertible term life insurance policies, which guarantee you the right to convert the policy to whole life insurance while it's still active.
Term Life Insurance vs Permanent Life Insurance
The main difference between term life insurance and whole life insurance is the coverage period. Whole life insurance provides permanent coverage for the rest of the policy owner's life, as long as premiums are paid. Because of this, the cost of premiums is typically higher.
For permanent life insurance, a portion of your premiums goes toward the policy's cash value. This allows it to become a savings or investment vehicle over time. Withdrawals and loans are also usually allowed in the case of whole life insurance.
When choosing between whole life and term life insurance, try to get a cost comparison from your insurance agent. This allows you to see if your savings can make up for the fact that your policy comes with an expiration date.
The Different Types Of Term Life Insurance
Yearly Renewable Term (YRT) Policies
As its name implies, a yearly renewable term policy (YRT) is a type of term life insurance that you will need to renew annually. Premiums will change each time you renew the policy and will be calculated based on your age, health, and other factors upon renewal.
Annual renewable term policies are attractive for people who require a very low-cost policy for a short period. For example, if you're traveling in the near future, this type of insurance may be useful to you.
Level Term Policies
Depending on the insurer, this type of policy may also be known as a pure term plan, level premium insurance plan, or a guaranteed level term policy.
Level term policies offer coverage for a set number of years, usually within a 20-year or 30-year period. Premiums don't increase over the coverage period, but they're typically higher than other kinds of term life insurance because the insurer has to account for the increasing costs of insurance over the years.
Level term policies are typically described as the simplest form of term life insurance because the premium and the death benefit don't change throughout the life of the policy. You know how much you have to budget for insurance each year, and you also know how much your beneficiaries will get in case of your passing.
When getting a level term life insurance policy, check with your insurance company about the renewal terms and conditions. In case you outlive the 20-year or 30-year term length, it's best to be able to extend the coverage.
Return Of Premium Policies
For this type of term life insurance, you'll pay the insurance company only for a specific number of years. If you keep up with all your payments, the insurance company will pay you back the premiums once your policy expires. Since you're guaranteed to get your premiums back if you outlive the policy, the premiums are typically higher compared to level term policies.
Decreasing Term Policies
Decreasing term policies come with a death benefit that decreases each year. This type of life insurance is normally bought in conjunction with taking out a mortgage. For that reason, it's usually known as a mortgage term insurance.
When you’re insured under this plan you won't leave your family with a financial obligation if you pass away before you get a chance to pay off the home loan. If you expect to have a higher net worth in the future (and therefore won't be needing as much coverage), you may also benefit from getting this type of term life insurance policy.
The premiums for decreasing term policies remain constant. They're also more affordable than level term or permanent life insurance because of the decreasing death benefit.
Increasing Term Policies
As its name suggests, an increasing term policy can be seen as the opposite of a decreasing term policy. The death benefit gets higher each year that you have the policy in force. The increasing coverage usually comes at a fixed percentage, between 2% to 10%.
The death benefit of this type of policy increases to account for inflation. In the case of typical term life insurance, the insured amount may not be adequate to cover your needs as the years go by, leaving you underinsured. That's not something that happens with increasing term policies.
One important thing to keep in mind about an increasing term policy is that your monthly premium may also increase later in life.
Modified Term Policies
Modified term life insurance policies come with premiums that change over time. For example, you may pay a premium of $15 per month for the first five years. Then, it will increase to about $20 per month.
Usually, the coverage period and amount for modified term life insurance remain constant. That makes it similar to a level term life insurance, except that the premiums increase over time.
This type of term life insurance policy is attractive to young people who can only pay a small premium each month but expect to pay more in the future.
Convertible Term Policies
If you're ready to get term life insurance now but think you'll need permanent life insurance in the future, then a convertible term policy is a great option! It allows you to gain permanent coverage without having to provide additional evidence of insurability, like a medical exam. Because of this, the monthly premium for this type of life insurance is typically higher than the others.
This is an attractive option for people who believe they're likely to outlive the initial term of their policy. Keep in mind that you can only convert your insurance policy during a specified number of years, usually within the first decade. Review your policy before the convertible period ends, so you can switch to permanent life insurance if you choose.
Guaranteed/Simplified Term Life Policies
While most insurers will require you to take a medical exam, you won't need one if you're buying a guaranteed/simplified policy. At most, you'll need to fill out a questionnaire related to your health. The catch is that premiums for a guaranteed term life insurance policy can be quite expensive. If you're in relatively good health, it's best to opt for other types of life insurance.
Voluntary Or Group Term Insurance
Some employers offer group term life insurance to their staff. They have the option to offer the policy for free or at an additional cost to their employees. The benefit of this type of term life insurance is that it's quite affordable since the employer typically pays part of the premiums. However, once you are no longer connected with the employer, you will lose your coverage.
How To Choose A Term Life Insurance Policy
Pick A Term Life Insurance Length
The insurance term length is one of the most important things to consider when buying term life insurance. Typically, you can choose among a term period of 1, 5, 10, 20, or 30 years. Ideally, your need for insurance should end by the time your policy expires.
For individuals who are buying term life insurance to help their beneficiaries pay off a loan in the unlikely event of their death, a 5-year or a 10-year term coverage is enough. A decreasing term life policy will usually come handy in this case.
Meanwhile, people who need insurance to replace lost income in case they pass away or become disabled will likely need coverage with a 20-year or 30-year term. A level term policy can be useful for this purpose since it provides you with predictability in terms of premium payments over the next few decades.
Always check if you have special considerations, as well. For example, if you have a child with special needs, you'll need insurance to support them for many years, even after you're gone.
Decide How Much Coverage You Need
Term life insurance policies are used to cover both immediate and future financial obligations. These may include the following:
Credit card debts
Childcare and tuition
Before buying a life insurance policy, it's important to consider how much coverage you'll need to pay for these expenses. If you buy a policy with very high coverage (about $1,000,000), you may end up having to pay premiums that are unnecessarily expensive.
Some people advise that the easiest way to compute how much coverage you need is by multiplying your annual income by 10. This will help you determine how much insurance you'll need for the next decade. Others also use the DIME method, which will have you add up your debt, mortgage balance, and education expenses in the near future.
Finally, some financial representatives also compute how much coverage you'll need depending on your income potential. They consider your age, occupation, working years, and current benefits to come up with the right amount for you.
Once you've determined how much coverage you need, you can begin selecting what type of term life insurance is best for you. Increasing term and modified term policies are useful for people who need something with very high coverage, but can't afford to pay large premiums right away.
Life Insurance Policy Riders
Depending on the insurer you buy a policy from, you can customize your life insurance policy to include riders. Riders are additional features that provide more extensive coverage. Here are some of the riders you can choose from when buying life insurance:
Child: This rider allows an insured parent to claim a death benefit upon the death of an eligible child.
Spouse: This pays a death benefit upon the death of the insured person's spouse.
Disability income: If the insured person gets a disability that prevents them from continuing to work, they can get a monthly income that's about 1-2% of the policy's face value. Note that disability may be defined differently depending on the insurer, so be sure to read the fine print.
Guaranteed insurability: This allows you to buy additional insurance without providing proof of insurability.
Accidental death benefit: This allows the beneficiaries to receive additional monetary benefits in case the insured person dies from an accidental injury.
Terminal illness: This allows the insured person to withdraw a percentage of the death benefits if they're diagnosed with a terminal illness and have less than a year to live.
Travel insurance: Some insurers provide additional coverage in case something unforeseen happens to you outside the country.
Funeral benefit: This allows your beneficiaries to claim a cash advance within the next 48 hours after your passing.
Return of premium: This allows you to get your premium back at the end of the term, minus the additional cost of getting this additional feature.
Term conversion: This allows you to convert your policy into a permanent life insurance plan without having to go through a medical exam.
Waiver of premium: This allows the insured person to waive the premium completely in case they become disabled. Despite the waived premium payments, they'll get to keep the coverage until their term life insurance expires.
Term Life Insurance Costs
The cost of term life insurance largely depends on your age. Here is the average monthly premium for each age group:
Aside from your age, here are some of the factors that determine how your premium will be computed.
Sex: Women statistically have a higher life expectancy compared to men. Because of that, they pay a lower premium.
Medical history: Insurers typically require people to answer a set of questions about their health and medical history. Healthy individuals with a very long life expectancy are usually rewarded with lower premium payments.
Family medical history: Insurance companies ask individuals to pay higher premiums if they find that their family members have a hereditary disease.
Occupation: Some types of jobs are riskier than others. These include mine workers, pilots, firefighters, trash collectors, roofers, and truck drivers. The riskier your profession, the higher your premium payments will be.
Health-risk habits: Risky hobbies like racing and mountain climbing can translate to higher premium payments. Tobacco usage is also considered a high-risk habit that increases a policy owner's monthly premium.
Term life insurance can help you achieve the peace of mind of knowing that you and your family will be protected in the worst case scenario. It's more affordable than whole life insurance and is usually available for a 10, 20, or 30-year term.
There are several types of term life insurance, like level premium and annual renewable. All of these types come with pros and cons, so there's no one-size-fits-all policy for everyone. It's best to compare the different options to pick the type of life insurance that suits your needs.
If you need advice on which policy to buy, contact Wesley LLC. We'll help you compare different plans and find your ideal fit.