What Is Term Life Insurance: Your Comprehensive Guide
Buying life insurance isn’t often a financial priority for the average person. Between balancing mortgages, paying-off student loans, credit card bills, and the costs of daily living, taking on a policy just seems like an extra expense that doesn’t bring any immediate value.
In reality, life insurance is actually one of the most responsible financial decisions you can make – especially if you’re the main provider for a family. As grim as it is to think about, being prepared for the worst will actually ensure that your beneficiaries will have a safety net in the event that the unthinkable occurs.
There are many different kinds of life insurance policies, but in this guide, we’re going to focus on one of the more affordable options: term life insurance. Today we’re going to answer the question “what is term life insurance” and see if it’s the right policy for you.
Term Life Insurance: The Basics
For those not yet familiar, life insurance basically refers to a contract with an insurance company. In the event of the insured person’s death, the insurance company will provide the insured person’s beneficiaries a lump-sum payment (called a death benefit) dependent on what kind of policy was chosen. In exchange for this assurance, the policyholder will have to pay for a monthly premium that is set beforehand.
There are two main types of life insurance policies: permanent life (or whole life) insurance and term life insurance. The fundamental difference between these two is that whole life insurance will cover the entire period of your life from the moment you signed the contract until your death, whereas term life insurance refers to a specific agreed-upon insurance period that lasts anywhere between 1-30 years.
Basically, term life insurance is the better option for those who are only looking to cover a certain period of time (like say, until the kids have graduated from college) while a whole life policy is a more general and flexible option that can accumulate cash value. We’ll cover the more specific differences later on.
How Does Term Life Insurance Work?
Buying a term life policy means that you’re paying for the assurance that your beneficiaries will be paid a set amount of money if you die during the policy’s term. In exchange, you will pay for a monthly premium throughout the duration of the term. The premium you will have to pay will be determined beforehand based on the risk factors associated with your lifestyle, state of health, age, and medical history.
If you make it to the end of your term policy, you will then have to either forego the insurance or apply for another term. However, some insurance companies offer term life insurance plans that can be converted into permanent plans if you so wish. The important thing to note here is that applying for another term policy after your first one has already finished might incur a higher premium due to you being older.
Difference Between Term Life Policy And Whole Life Policy
Term life insurance is a popular option because it can be much cheaper than permanent life insurance. You will be assured a set death benefit right from the beginning that won’t need time to grow. However, the premiums associated with term life insurance policies will go up every time you renew, unlike permanent life policies that stay the same throughout the entire duration.
In the event that you do pass during the duration of your term life insurance policy, your beneficiaries can receive the death benefit much faster since term life insurance policies do not have a waiting period. The payout received is typically used to cover funeral expenses, debts, or to replace lost income. However, there is actually no legal requirement for your beneficiaries to spend it on what you planned, so choose them carefully.
Lastly, a huge difference between the two options is that permanent life insurance provides you with cash value that can be utilized however you want once it matures. Cash value is a savings component that grows the longer you pay into your policy. Term life policies do not accumulate cash value because they do not have a savings component.
Types Of Term Life Insurance
There are different types of term life policies that each have their own pros and cons, depending on the needs of the policyholder. Here are some of the more common policy options that you might encounter when shopping for term life insurance.
Annual Renewable Term Life Insurance
Annual renewable term life insurance is just like the name suggests: it’s a simple term policy that covers you for a year before needing to be renewed. The premium paid will then be based on the expected probability of the policyholder dying in that one year. This means that people who have more dangerous jobs (such as a firefighter or a cop) will have to pay higher premiums than those with relatively safer occupations.
Just remember that the premium will rise as every year passes, so it might be better to look into more long term options if you want to be insured for a longer period of time. Insurability also becomes an issue with this type of term life insurance. For example, getting diagnosed with a terminal illness will most likely leave you uninsurable and unable to renew for another year. Nonetheless, this is a great option if you only need a few years of insurance.
Convertible Term Life Insurance
Some insurance companies offer convertible term life insurance plans. In this type of policy, the insured person has the option of converting it into a permanent whole life insurance plan once the initial term expires. The main benefit of choosing a convertible term life insurance policy is that applicants typically do not need to undergo a medical exam to qualify.
A convertible term life policy is also a good option for people who are interested in eventually turning their plan into an investment. Converting your term life policy into a whole life policy will allow you to gain cash value which can be liquidated like a savings account later on in life.
Increasing Term Life Insurance
Increasing term life insurance policies allow you to increase both the death benefit and premiums as time goes on. This allows you to start your policy by initially paying smaller amounts early on life when you have other more pressing financial responsibilities. Your premiums will then go up as your savings go up and your debt goes down.
The main benefit of choosing an increasing term life insurance policy is that you won’t have to qualify for another insurance policy once you’re older and it becomes harder to find one with agreeable rates. Since the death benefit is much smaller in the early stages of the policy, this type of insurance plan is best for those who are looking to cover a sizable period of time without committing to a permanent insurance plan.
Decreasing Term Life Insurance (Mortgage Term)
A decreasing term life insurance policy is the exact opposite of increasing term life insurance. This kind of policy is specially structured to run alongside an ongoing mortgage. The idea behind it is that it will function as a safety net for your beneficiaries to still be able to pay off the mortgage in the event of your untimely demise. The longer you are in the term, the less the total amount of your mortgage remains unpaid.
Return Of Premium
A return of premium policy is perhaps one of the more expensive types of policies on this list. This type of insurance policy will pay you back the premiums you paid in the event that you outlive the duration of the term. However, do expect to pay for premiums with at least a 50% upcharge. Shop around extensively before committing to this kind of life insurance plan.
When Should You Choose Term Life Insurance?
With so many life insurance options on the market, how do you know which one is for you? The best way to decide between permanent life insurance and term life insurance is to settle on how long you think you’re going to need to be covered and how much you want to grow cash value.
If you think you need to be insured for a long time, then permanent life insurance is definitely the way to go. The policy will have no expiry date and should cover you and your beneficiaries from the moment you sign the contract until you die. It also comes with the added flexibility of building cash value that can be used later on in life once you’ve made enough payments. Think of permanent whole life insurance as more of an investment.
If you think you only need the insurance for a more specific period of time, then saving some money and going for a term life insurance policy will be your best bet. This kind of policy is perfect for those who are on a budget but still want to make sure that their dependents will have an easier time if the unthinkable ever happens. It’s also a great option for those who started investing in insurance at a much later point in their life.
When Should You Apply For Term Life Insurance?
Contrary to what most people tell you, there isn’t really a “magic number” when it comes to deciding on when to purchase life insurance. You can honestly buy life insurance whenever you want, but a term life policy will definitely benefit certain people more than others.
Here are just some scenarios where you may want to consider investing in a term life insurance policy over a whole life policy.
When You Have Dependents
Raising kids is a huge financial responsibility that, unfortunately, doesn’t stop after death. The loss of income is a huge problem that can often catch a mourning family off guard. Preventing this from occurring is probably the number one reason people buy life insurance in the first place.
If you’re the bread-winner in your family, then life insurance is crucial to make sure that they can stay afloat even when you’re gone. Getting a solid term life insurance plan will ensure that your dependents will receive a death benefit that can help them finish school or pay for living necessities before they’re financially independent. This is one reason why many parents choose to invest in a term life insurance policy until their kids graduate.
If You Have Debt
Taking out a life insurance policy will give you the peace of mind that any debt you may have incurred will not be an issue for your immediate family. This is because a lot of common loans (such as student loans or mortgages) are not canceled by your death and will still need to be fulfilled by your next of kin. Taking out term life insurance that covers the duration of the loan will ensure that the debt incurred will not be passed on if you die.
When You Have Other Investments
Buying a term life insurance policy is a great option if you already have other financial investments. Since term life insurance is much cheaper, you can focus on funding investments while still having the peace of mind that your family’s finances will be taken care of even when you’re gone. It also ensures that your family will still receive a significant death benefit without you having to wait for your other investments to mature.
Having other investments to grow your money also means that you might not really need the long term flexibility of building up a cash value. Basically, it’s better to choose a term life policy if you don’t really need the added benefit of building up long-term cash value.
Tips On How To Improve Your Life Insurance Premiums
Maintain a healthy weight. Being overweight adds risks of developing many medical conditions later on in life that are linked to higher mortality rates. This is one of the first things insurance companies will check when you apply for insurance. The main rule of thumb is the more overweight you are, the higher your premium will be.
Quit smoking. Smoking is the number one cause of preventable deaths in the world and cutting the habit before you turn 40 reduces the risk of associated complications by 90%. Your premium will improve the longer it’s been since your last smoke.
Avoid dangerous hobbies like skydiving or rock climbing. As exhilarating as they are, people who regularly engage in these activities come with a much higher risk for life insurance companies. Cutting these activities will help improve your premiums.
Improve your driving. Your insurance company will bring up your past records to see if you have any history of vehicular accidents. Frequently getting into accidents is a huge red flag that most companies want to steer clear off.
Get your existing medical conditions in-check. Chronic noncommunicable diseases like high blood pressure or asthma doesn’t necessarily mean you can’t qualify for better premiums. Taking your medication regularly and scheduling frequent checkups will normally be enough to qualify for better premium rates.
Avoid drinking excessively. People who habitually drink alcohol put themselves at a higher risk of death. Your insurance company will want to get a good idea of your drinking habits by checking your medical exam and your driving record, so quitting the habit will heighten your chances of qualifying for better premiums.
If you think permanent whole life insurance is too big of a commitment, then term life insurance might be the compromise you’re looking for. Term life insurance provides you with an affordable and accessible alternative to whole life insurance that can future-proof you and your family’s finances!
We understand that buying life insurance can be a long and scary process, which is why you won’t have to go through it alone! If you’re interested in learning about affordable and customizable insurance options, then get in touch with Wesley LLC. Secure your family’s future and contact us today!