Life insurance is generally purchased to replace the income from someone who has passed away, to cover major expenses, or to create an estate to benefit your heirs or causes that you support. There are many different policy types available, but one of the most popular is term life insurance. Term life insurance offers a specific death benefit in exchange for monthly premiums.
How Does Term Life Insurance Work?
Similar to other types of insurance, like auto or homeowners insurance, term life insurance is designed to cover specific risks for a period of time. When you stop paying the premiums, the coverage ends.
Depending on the size of the death benefit, when you apply for term life insurance you may or may not be required to complete a physical or have blood drawn. For lower policy amounts, many insurance companies only require an application and answers to medical questions.
What Does Term Life Insurance Cover?
Term life insurance covers the life of the insured person for a period of time. The policy can be owned by the insured or someone else, but the insured person must agree to the policy. You cannot buy a policy covering someone's life without them knowing about it or agreeing to it.
Here are some of the most popular reasons why people buy life insurance:
- Replace lost income of the insured
- Create an inheritance for your heirs
- Allow your loved ones time to grieve without worrying about money
- Pay off a mortgage or other debts
- Cover a child's education
- Protect against a business partner or key employee passing away
- Pay for a funeral or other final expenses
- Cover estate taxes
- Make a charitable contribution
- Establish a foundation
Who Receives The Life Insurance Proceeds?
When someone passes away, the life insurance proceeds are given to one or more beneficiaries. The beneficiaries can be anyone you choose and in any proportion you like. Often, a person's immediate family is the primary beneficiary, but it can also be a living trust, friends, or charity.
Beneficiaries can be changed at any time if you change your mind or someone passes away. Most insurance companies will allow you to change beneficiaries online or by mailing in a signed form. A secondary beneficiary may be named on your policy in case your primary beneficiaries have passed away before you do.
Types of Term Life Insurance
Term life insurance is the name for a broad category of life insurance policies. There are a variety of policy types designed to fit your individual needs. While each policy is similar in that they provide coverage for a specific period of time, they have differences that you should be aware of.
These are the most common types of term life insurance:
- Yearly or annually renewable term. Your premiums are guaranteed for one year, then generally increase each year. This tends to be the least expensive term life insurance policy because premiums are only fixed for 12 months.
- 5/10/15/20/25/30-year renewable term. Premiums are level for a specific number of years. After that period is up, the premiums start rising, sometimes dramatically. One of the most popular types is the 20-year term.
- Return of premium. When most term policies reach the end of their term, the policy is canceled or replaced. With return of premium term life insurance, you'll receive all of your premiums paid when the policy expires. Because of this benefit, these policies tend to be more expensive than similar term policies of the same length. These policies have certain requirements you must meet, like making every payment throughout the policy term, otherwise you forfeit this benefit.
- Decreasing term life insurance. This policy keeps your premiums level throughout the term of the life insurance, but the death benefit declines at regular intervals. These policies are often matched to a mortgage balance, business loan, or other debt that the insured wants to cover in case they pass away. Some business loans may require one of these policies to protect the lender.
What Are Insurance Riders And Which Are Most Common?
When you buy life insurance, the insurance company may offer you the ability to add extra benefits to the policy. These are called "insured riders," and the insurance company typically charges an additional fee to add them. The fees vary depending upon the benefits and duration of the rider.
Here are a few of the most popular insurance riders:
- Guaranteed insurability rider. You have the ability to buy additional insurance at predetermined dates without requiring a medical exam.
- Accidental death rider. Pays an additional amount in the event that you pass away due to an accident.
- Waiver of premium rider. The monthly premium is waived due to specific situations, such as disability or loss of income due to injury or illness.
- Family income benefit rider. In case of death, the insured's family will receive a monthly income for a predetermined period of time.
- Accelerate death benefit. When an insured person is diagnosed with a terminal illness, the insurance company will provide a portion of the death benefit to the insured while they are still alive. Any amount provided will reduce the death benefit when you pass away.
- Long-term care rider. This rider provides a monthly income to help cover long-term care expenses should the insured need to stay at a nursing home or receive in-home care.
Comparing Term to Permanent Insurance
Term and permanent insurance both provide a death benefit when the insured person passes away. Term insurance offers covers you for a period of time, while permanent insurance is designed to last your entire life. Permanent insurance typically charges higher premiums to build up a cash value to reduce the amount of insurance (and the cost associated with it) needed later in life to provide the death benefit to your beneficiaries.
How Much Term Life Insurance Do You Need?
The amount of insurance needed varies per person, depending upon what risks they are trying to cover. A common rule of thumb is that you should have 10 times your annual salary to replace lost income, plus additional amounts to cover other expenses (like a mortgage or college tuition).
You can determine your basic life insurance needs using this simple chart.
|Replace income (eg: 10x annual salary)|
How to Buy Term Life Insurance
There are two popular ways to buy term life insurance – through an agent on a site like Bestow. Whichever way you choose to go, the process is mostly the same:
- Complete application
- Submit to health exam and blood draw (if applicable)
- Receive application decision
The timing of payment of your first premium varies by company. Typically, you are fully covered as soon as you make the payment, even if the insurance company has not completed its underwriting decision yet.
The Bottom Line
Term life insurance is a popular way to cover expenses in the event you pass away. Your beneficiaries receive the policy amount when you pass away, as long as you continue paying the premiums. These policies do not accumulate cash value, like a permanent policy, so the coverage ends if you stop making payments.
Frequently Asked Questions
Can I have more than one term insurance policy?
Yes, you may have more than one term insurance policy. While some people choose to have one larger policy, others people choose to have different policies to cover needs for specific periods of time (eg: college tuition in 5 years, 30 years of mortgage payments).
When should you buy a term life insurance policy?
The best time to buy life insurance is when you have a specific need. Many people buy a new policy to coincide with certain life events, like having a baby or buying a home. If your family has a history of medical problems, it is best to buy your policy early to increase your chances of approval.
Do you get your money back at the end of a term life insurance policy?
Most term life insurance policies do not offer cash back when your term expires. Policies that offer your cash back when the term expires are called “return of premium” life insurance. As long as you make every payment, when the coverage term expires, you will receive the total of all of your premiums back in a lump sum. Because of this additional feature, return of premium life insurance policies tend to have higher premiums that a standard term life insurance policy.
Can I cash out a term life insurance policy?
No. Term life insurance policies do not accumulate a cash balance, so there is no money to cash out. If you’re looking for a life insurance policy that builds cash value, then a whole life, universal life, variable insurance life, or other similar policy might be a better fit for you.
What happens to term life insurance if you don’t die?
Life insurance policies offer fixed premiums for a specific period of time (eg: 10, 15, or 20 years). When that term is up, the premiums typically increase each year at a fairly substantial rate. Often, consumers choose to cancel the policy at this time because the premiums become prohibitively expensive at some point. When the policy is canceled, the coverage ends.
Which is better term life or whole life insurance?
Both types of insurance have a place in financial planning, and both can be the best type of insurance policy depending upon your personal circumstances. Term life policies typically offer the largest death benefit for the least amount of money. They protect you with stable premiums for a specific period of time before the premiums start to rise dramatically.
Whole life insurance is a cash-value insurance policy and is designed to cover your “whole life.” Because these policies include a payment into your cash account, in addition to paying for the insurance coverage, the premiums tend to be higher but they usually do not increase throughout your life.