Term life insurance offers short- and long-term coverage at an affordable rate compared with other types of policies. This makes it easier for families on tight budgets to have peace of mind knowing their family is taken care of financially if the policyholder were to die. Additionally, since premiums don’t increase over time like some other forms of insurance, you’ll know exactly what you’re paying each month.
Whether you currently own life insurance or are shopping for the best life insurance policy, it’s important to understand the benefits available to you. Here, we at the MarketWatch Guides Team review the potential benefits of a term life policy.
Financial Protection for Loved Ones
Term life insurance offers a death benefit to beneficiaries, providing them with financial support while they grieve and adjust to their new lives without the deceased loved one. With term life insurance, dependents can count on receiving a payout from the policy if something were to happen to the insured person.
The money received from a term life insurance policy can help cover funeral expenses, medical bills or other final expenses that might otherwise be difficult for surviving family members to pay out of pocket. Additionally, it can be used for things such as income replacement. This makes it easier for surviving spouses and children who may have relied on this person’s salary or wages before his or her death.
Affordability and Cost-Effectiveness
When it comes to term life insurance, one of the major benefits is the ability to choose the amount of coverage for a specific period of time to create the best term life policy for you. In many cases, you’re able to pick a term length that can be anywhere from 10 years to 30 years. Some insurance companies will go as long as 40 years in certain situations.
This makes it easier to customize your policy to fit your budget. A term life insurance policy is more affordable than whole life or universal life insurance policies, making it more accessible for those on a tight budget.
An important component of life insurance planning is determining how much you can afford. A good rule of thumb is to consider capping your initial life insurance budget between 1% and 2% of your income. For example, if you are making $50,000 per year as your income, this would set your life insurance budget somewhere between $500 and $1,000 per year. Here are a few illustrations for a healthy 40-year-old male living in Colorado to highlight the differences in price between term and permanent life insurance:
- Term life insurance. He can buy $500,000 of 10-year term insurance for less than $18 per month or $500,000 of 30-year term insurance for $53 per month.
- Universal life insurance. A $500,000 policy of Guaranteed Universal life to age 100 will cost around $257 a month.
- Whole life insurance. A $500,000 policy of whole life insurance will cost between $471 and $706 per month depending on the type of whole life insurance he purchases. Read more: Top whole life insurance policies
With the variety of benefits that come along with term life insurance, it’s easy to see why so many people are choosing this type of policy for their financial protection and peace of mind.
No Cash Value Accumulation
One of the primary benefits of term life insurance is the lower premium payments since it doesn’t accumulate cash value like permanent life insurance. This means that no additional costs are added to the premium, making it an attractive option for those looking for affordable life insurance coverage.
Although there are a few options to have return of premium term insurance, which gives you your money back at the end of your level-term period, generally, if you outlive your policy’s term length, you will not receive any return on investment or benefit from the policy.
Evaluate your needs and the length of coverage that will best meet those needs so you can choose a policy with the right term length for your situation. One strategy is to save and invest the difference between the cost of a permanent life insurance and your term insurance premium. It can be an effective strategy for planning your legacy.
Customizable Coverage for Specific Needs
Term life insurance also offers the ability to customize coverage to meet a wide variety of specific needs.
Mortgage or Other Large Debts
The death benefit on your policy is generally tax-free. This lump sum benefit can help you plan for any number of financial obligations. For example, if you’re searching for a policy to cover your mortgage balance, you can select a term length that corresponds to the expected period in which the mortgage will be paid off.
Income Replacement
Similarly, you can provide for coverage to replace your income. Here’s an example: Your annual income is $50,000. You have two children: A 5-year-old and a 3-year-old. You may want to provide an income for your spouse or kids at least through the point where the children graduate from high school. Your 3-year-old will complete high school 15 years from now. If you multiply $50,000 by 15, this gives you a total need of $750,000. From here you can make this more specific to your planning needs.
College or Continuing Education
Another way to customize your coverage is to consider covering college or continued education. If the unexpected were to happen to you or your spouse, you can utilize the death benefit to fund the expenses for college or continued education for your surviving spouse or children. While we often think of providing this for our children, it’s not uncommon where the surviving spouse may require training and education to enhance their career in order to provide for the family.
It’s important to determine the expected annual cost of education per person and how long you want to provide assistance for each person. From here, the calculation can be as simple as multiplying the cost by the number of years you want to provide education assistance (per person), then add these together. This will give you the total need for educational assistance.
Convertibility and Future Options
The conversion feature in term life insurance policies allows policyholders to convert their policy into a permanent form of life insurance, such as whole life or universal life. These are sometimes referred to as convertible term policies. Since you don’t need to go through underwriting, this makes the process of extending your coverage particularly beneficial if you have health issues later in life.
This is an attractive option for those who don’t want to commit to a long-term policy today but may need longer-term coverage in the future. The conversion feature also gives policyholders the flexibility to choose when and how to convert their coverages, allowing them to adjust coverage as needed.
It’s important to understand the deadline, sometimes called the conversion date, on your existing or new term life insurance policy. This date is the last time you can convert your existing term policy to permanent coverage.
From here, your existing term insurance policy can remain active if you continue to pay the premiums until the end of the term. For example, let’s say you had a $500,000, 20-year term insurance policy. You are in year 10 and decide to convert $200,000 of it into a permanent policy. You will have your new permanent policy and its premium, but your existing term policy will be reduced to a $300,000 death benefit, and your premium on that policy will reduce as well. You can keep paying that reduced term insurance premium and potentially convert more in the future. If you no longer want the term insurance policy, you will need to request that the remaining term insurance policy be canceled.
Term Life Insurance vs. Permanent Life Insurance
Term life insurance is designed to have a level death benefit and a level premium for the duration of the fixed term of your policy. Example durations are 10-year term, 15-year term, 20-year term, 25-year term or 30-year term insurance.
When the term period has expired, the term policy can often change to an annual renewable term life insurance policy with adjusted pricing for the premium. This pricing will be listed in your policy that is delivered to you. For most, this new pricing beyond the term duration is extremely expensive. You are not obligated to take this new coverage.
The Advantage of Cash Value
This is where permanent life insurance can gain attractiveness. Permanent life insurance gains cash value inside the policy and can gain death benefit as the cash value grows. The policy is designed to last your entire life, but this will depend on the product type, the design of your policy and how much in premiums you choose to pay.
The real purpose of cash value in a life insurance policy, regardless of the type of permanent policy, is to offset the cost of insurance as you age. For example, let’s say you have a $100,000 death benefit and $10,000 of cash value in your policy. The net amount at risk is what your cost of insurance is based on. Here’s how to calculate it: Take your death benefit minus your cash value, and this is your net amount at risk. In this example, $100,000 minus $10,000 equals $90,000 net amount at risk. Now fast forward 20 years and let’s say you are 75 years old and have $75,000 in cash value with the same $100,000 death benefit. This would make your net amount at risk $25,000. As you can imagine, the cost of insurance for a 75-year-old is very different from the cost of insurance for a 40-year-old.
Choosing the Best Option for You
Both a permanent life insurance policy and a term life insurance policy have a level premium and a level death benefit (though permanent can have an increasing death benefit). So how can you choose between the two?
A major advantage of term insurance is that it is the more affordable option. So if you have a tight budget, it’s often better to have the proper amount of life insurance coverage versus overthinking how much should be term or permanent coverage. As your budget becomes more flexible, you can consider converting some term insurance to permanent coverage or adding permanent life insurance to your insurance plan.
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Frequently Asked Questions About Term Life Insurance
The main benefit to level term life insurance is that it is very affordable, with low monthly premiums and the ability to cover you for the period of time most important to you. Your beneficiaries can use the death benefit to pay for anything from a mortgage to education expenses. You may also be able to convert your policy to a permanent life insurance policy later.
The biggest advantage to term life insurance is the affordable life insurance rates. You won’t see premiums increase during your term length. The main disadvantage is that term insurance is designed for fixed periods of time and some of your life insurance needs may last your entire life. If you outlive your policy, then the death benefit won’t be paid out.
Term life insurance coverage is designed to last through the fixed period of time you chose when you purchased the policy, typically between 10 and 30 years. At the end of the term period most term life insurance policies are canceled.
Methodology: Our System for Rating Life Insurance Companies
Our team researches and ranks life insurance companies using an in-depth scoring system that considers the factors most important to consumers like you. Our analysis includes a comprehensive review of each provider we feature based on available coverage, customizability, availability, customer service and company reputation. Here are the factors we take into consideration when rating life insurance providers:
- Brand trust (40%): Life insurance payouts can exceed $100,000 or more, which makes choosing a reputable and trustworthy insurance provider important. To assess brand trust, we use J.D. Power and Associates customer satisfaction surveys, AM Best credit rating scores and the National Association of Insurance Commissioners (NAIC) complaint index. The higher a company scores in each area, the more points it receives.
- Coverage (33%): The more policy options a life insurance company offers, the more opportunities you have to obtain the right coverage for your specific needs. For this reason, we give companies the most points for offering multiple types of life insurance, including various term, permanent and no-exam options.
- Availability and ease of use (19%): Since life insurance coverage options can be complex, we consider the ways a customer can reach a company — and how easy communication is. For this category, we research how many communication channels a company offers for general customer support, claims processing and the application process. Companies earn the most points for offering various ways to interact with an agent, both in-person and online.
- Riders (8%): Companies offering various life insurance riders or endorsem*nts allow policyholders to better customize their coverage. In this category, we determine how many riders a company offers and award the most points to providers with more than 10 options.
We use our rating system to compare and contrast each company against key factors to help us determine the best life insurance companies in the industry. To learn more, read ourfull life insurance methodologyfor reviewing and scoring providers.
AM Best Disclaimer
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