What is Term Life Insurance?
Term life insurance is a type of life insurance that says that if you die within the set term (e.g., 15 years, 30 years), the life insurance company will pay a lump sum of money (the death benefit) to people you choose, like your partner or parents. Term life insurance is the most affordable type of life insurance.
How term life insurance works
Like all life insurance products, term life insurance is a contract-based agreement between you and the life insurance provider. Part of the contract you both agree to (i.e., your policy) sets a term. Most term life insurance policies come with a term somewhere between 10 and 30 years.
If you die within the term, the life insurance company pays the agreed-upon death benefit to your beneficiaries.
But if you outlive your policy, it expires. That means that the life insurance provider is no longer obligated to pay the death benefit when you pass away.
(That assumes that you don’t take any further action as the end of your term approaches. You have options to keep life insurance in effect if you’ll still want it after the term is set to end.)
In most cases, the insured has the option to choose the length of the term they want. If you just sent a son or daughter to college and want to make sure you can pay their tuition, you might choose a 10-year term. Or if you bought a house with a 30-year mortgage, you might choose a 30-year term.
Types of term life insurance
There are several different types of term life policies:
A level term policy maintains the same death benefit and premiums throughout the policy term. The vast majority of all term policies sold are level term policies.
By contrast, the death benefit of a decreasing term policy drops off as time passes. In most cases, the death benefit shrinks on an annual basis. The premium stays the same even as the death benefit decreases, but these policies usually cost less than level term policies.
Renewable term policies
Renewable term policies essentially give you the option to periodically renew your term insurance, usually on an annual basis, for a set number of years (e.g., 20). Some renewable term policies allow the insured to maintain the same premiums throughout the term, even if their health conditions change, but others give the insurance provider the right to raise premiums at each renewal period.
Return of premium policies
These policies return all or a portion of the premiums you’ve paid toward your term life insurance if you outlive the term. They generally cost significantly more than other types of term life coverage.
Understanding term life insurance premiums
Term life insurance is significantly more affordable than other types of life insurance (for example, it can cost roughly $25 per month for a relatively healthy 30-year-old).
The amount you pay to keep your term policy active is called a premium. When you buy your policy, your insurance provider sets your premium. Making your premium payments on schedule prevents your term life policy from lapsing, just like paying premiums to keep your car insurance policy in place.
The premium you’ll have to pay for your term life insurance hinges largely on you. If you’re relatively healthy with a safe job and low-risk hobbies, you’ll pay less. If you smoke, regularly partake in dangerous activities, or have a health condition, you’ll pay more.
The most common type of term insurance is a level-premium term life insurance policy. That means that your insurance company sets a fixed rate for your policy when you buy it, and you pay that amount on a regular basis (usually monthly) throughout your policy term. Your premiums won’t fluctuate throughout the life of your policy, which can make budgeting easier.
Your options at the end of your term
If you don’t take any action as the end of your term nears and you outlive your policy, all of the premiums you paid will have been for nothing (other than peace of mind, which does count for something).
If you want to continue coverage, your other options, assuming your life insurance company will extend them to you, are to:
- Convert it to a permanent life insurance policy
- Re-up it, meaning you keep the policy in place with a new term (be ready to pay higher premiums)
- Let it expire and buy a new policy in its place (this can be a good choice if your current life insurance company isn’t offering you competitive options and rates)
Who needs term life insurance
Term life insurance can be a useful tool in financially planning for a certain season of life. You might get a 30-year policy when buying a home, a 20-year policy when you have a child, or a 10-year policy when starting a new business venture. The coverage gives you peace of mind knowing that if you die unexpectedly, you’ve protected the people who depend on you from money-related stress.
Many people think that the primary purpose of term life insurance is to replace a deceased individual’s income. That is certainly one application of term life policies.
But because the policy’s beneficiaries can use the payout however they want, the usefulness can extend well beyond income replacement. A business partner named as a beneficiary could use the death benefit to fund an interview process to replace their partner who died and hire a consultant in the meantime, for example. Or a family who lost a stay-at-home parent can use the funds to hire child care, supplement their meals, and more.
Because term life insurance costs much less than permanent life insurance, it can be a budget-friendly option for putting financial safeguards in place for the people who depend on an individual’s income, abilities, or expertise.