FAQ: What is Term Life Insurance and How Does It Work?
Dan Levenson November 07, 2017
Term life insurance is a kind of time-limited life insurance policy whose value declines to zero after a certain term. This is in contrast to whole life insurance, which pays a benefit at the death of the insured person no matter what age.
Whole life insurance mixes an insurance product with an investment product; the policy holder pays into the policy for a certain payout eventually. In that sense, term life insurance is what they call “pure insurance” because the insured is paying to cover a risk of death.
Term life insurance tends to be less expensive than whole life with lower initial premiums than whole life. Heads of families tend to buy into these term policies that cover them financially while they are in their peak employment years, accumulating wealth in support of their families. They will usually stop paying premiums and the insurance will no longer cover them after the peak employment years when the payout is less necessary.
How Long a Term Do You Need?
When you buy term life insurance you have two decisions to make:
- How much coverage do you need? You want any payout to be large enough to cover needed expenses. Consider, for instance, the cost of your home, the cost of raising your family to the age of 18, how well your retirement savings will cover your retirement.
- How long should your term life insurance last? The duration of the policy should be long enough to continue until your last major obligations are taken care of.
Term life policies are almost always sold with standard fixed terms of 5, 10, 20, 25, or 30 years. They can almost never be customized outside these standard terms. If you buy term insurance for a longer term, you are locking in your premium cost for a longer time even as the probability of death increases.
In a way, it pays to take a longer term. If your longest lasting obligation ends in 17 years, round up and buy a policy that covers you for 20 years.
Kinds of Term Life Policies
There are three main kinds of term life insurance in the marketplace.
Level term insurance are policies where the death benefit is the same for the entire term period. The premiums you pay may also be level for the entire term of the policy. The premiums may also be level only for a period of time and may increase over time.
Decreasing term insurance are policies in which the death benefit decreases over the term period. Premiums may actually increase as the death benefit decreases. This kind of insurance is usually purchased by people who want to cover a financial risk that decreases over time, such as a loan whose principle decreases as it’s paid down.
Annual renewable term insurance policies are short-term life insurance policies which can be renewed for another term without having to demonstrate that the insured person is in good health. As long as the premium is paid, the policy can be automatically renewed up to a certain specified age. Many states end renewability at the age of 80.
Another variation on basic term life insurance is called convertible insurance. These policies include a clause that enables the owner of a term policy to convert the policy to whole life during a specified period of time without having to show that he or she is in good health.
Term life policies will have to stay in force as long as you continue to pay the premiums due. The rules generally state that if you miss a premium due date, you will have a 30-day grace period to pay the due premium. The policy remains in effect during the grace period. Your term policy will terminate if you fail to pay during the grace period.
If you buy life insurance through an employer’s group or another group, the policy is likely to terminate if you are no longer a member of the group, through job loss or other reasons.
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