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Term Life Insurance — What It Is & How It Works


It’s human nature to wish for a long, healthy, happy life for yourself and your loved ones. Sadly, that’s not in the cards for everyone. 

That’s why term life insurance, the most affordable type of coverage, factors into so many families’ long-term financial planning. Contrary to one of the most persistent myths about life insurance, most people should at least consider some life insurance coverage during the early and middle years of their adult lives. 

But term life insurance isn’t appropriate for everyone. To determine whether it’s right for you, learn how it works, who needs it, and when it’s just not worth the cost.


What Is Term Life Insurance?

Term life insurance provides coverage if you die during a set period (the term). It pays your family a predetermined amount of money to help them get by financially after you’re gone.


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Unlike permanent life insurance, which remains effective until you die, stop paying premiums, or cancel the policy, a term life insurance policy has set term lengths, frequently 10, 20, or 30 years. 

If your policy is a level term policy, your premium remains constant for the entire term. If it’s a modified term policy — which is less common — your premium may increase in the policy’s later years.


How Term Life Insurance Works

The point of term life insurance is to provide financial protection and peace of mind to your loved ones for as long as they need it. But it’s not as simple as calling an agent and giving them your credit card number. There’s a lot to know about term life coverage to ensure you get exactly what your family needs.

Choosing Your Life Insurance Term

Term life isn’t an open-ended commitment. The hope is that you’ll accumulate enough wealth to reach your financial goals, such as getting your kids through college and ensuring you retire with enough in the bank to support yourself and your partner through your later years. Term life is a backup plan in case you die before you accomplish these goals. 

You don’t know exactly when you’ll no longer need life insurance, but you can make an educated guess. For example, people often buy life insurance to pay for major shared debts, such as a mortgage, and future college tuition expenses. If you have 10 years left on your mortgage and expect your youngest kid to graduate from college in 15 years, you might not need life insurance beyond the 15-year mark.

Figuring Out How Much Term Life Insurance You Need

To figure out how much life insurance you need, you first need to figure out what you’ll use it for and how much those uses will cost.

For example, you might need term life insurance to:

  • Pay Off Debts That Won’t Die With You. Many types of debt survive you. They become your estate’s responsibility, reducing or wiping out your survivors’ inheritance. Or if they’re jointly held with someone else, they become that person’s responsibility.
  • Covering Child Care and Household Expenses. If your kids are younger, they’ll need child care while the surviving parent or guardian works, whether full time or after school and during the summer. Either way, that’s expensive.
  • Cover Future Education Expenses. If you die before your kids get through college, the surviving parent — or your kids themselves — become solely responsible for financing their education.
  • Long-Term Care for Dependents and Survivors. If you have a child with special needs or an older relative who’ll need lifelong care, you need enough insurance to cover those costs.
  • Make Up for Lost Income. If your family is solely or primarily dependent on your income, you may want to ensure they can continue to live at that level for at least until your surviving spouse can get on their feet.

Once you’ve determined your goals, you can calculate the right amount of coverage. To get a rough idea, you can just multiply your current gross (before taxes) annual income by 10. But before you purchase anything, get a more accurate number by picking the right formula in our article on choosing the right amount of life insurance coverage.

Life insurance needs generally decrease with time. If you expect to need less coverage in the future but don’t want to drop it all at once, you can create a multi-policy life insurance ladder. That allows you to get all the insurance you need now and drop policies (step down) as your coverage needs decrease. 

For example, using 10-, 20-, and 30-year policies, each with death benefits of $500,000, you can step down from $1.5 million in coverage during the first 10 years to $500,000 during the last 10 years. And because you won’t need as much coverage for as long, you’ll pay less overall. 

How Term Life Death Benefits Work

If you die during the policy term, your beneficiaries get the death benefit, which is equal to its coverage amount. The death benefit is tax-free, so the stated amount of coverage is the amount your beneficiaries get when you die.

With rare exceptions, such as application fraud or death by suicide during the first two years of the policy, insurers make good on their promise to pay death benefits in full. For this reason, term life death benefits are often referred to as guaranteed death benefits.

What Happens if You Outlive the Policy Term

If you outlive the policy term, the policy expires worthless. Your beneficiaries don’t get the death benefit, and you personally don’t get anything back unless you have a return of premium rider. In exchange for a higher premium during the policy term, this rider returns all the premiums you paid into the policy at its end. 

Options to Extend Term Life Coverage

Because term life coverage goes away at the end of the term, most policies give you the option to extend coverage after the initial term. It’s known as renewable life insurance. 

However, your premium will spike if you extend for any period beyond your scheduled end date. And if you developed a health condition during your initial term, your insurer might decline to renew coverage.

Some policies allow you to convert to a permanent policy, which also significantly increases your premium. It’s known as convertible life insurance or term-to-permanent life insurance.

Neither option makes much sense unless you really need coverage after the initial term. 


Pros & Cons of Term Life Insurance

Before buying a term life insurance policy, carefully weigh the pros and cons. 

Pros of Term Life Insurance

Term life insurance has a lot going for it. It’s affordable, flexible, and provides valuable peace of mind for very little out of pocket.

  1. Affordable, Especially for Younger Applicants. Level premium life insurance is very affordable. A 30-year-old applicant with no known health issues typically pays just $3 to $5 per month per $100,000 in coverage — less than the cost of a streaming subscription.
  2. Potential for Lots of Protection. Because it’s so affordable, term life insurance makes it easy for people who aren’t wealthy to load up on protection. 
  3. Choose Your Own Term or Step Down Coverage Over Time. Term life insurance is flexible. You decide how long you need coverage. And with a multi-policy life insurance ladder, you can reduce your coverage as your net worth grows. 
  4. Nontaxable Benefits. Life insurance death benefits aren’t taxable. Your beneficiaries won’t pay income tax on them, and if your estate is big enough to trigger the estate tax, your life insurance policy doesn’t count toward the total.
  5. Provides Valuable Peace of Mind. Term life insurance can replace your income and cover your debts for years to come. That’s more than a financial benefit. It ensures your loved ones spend less time worrying about what they’d do if you died unexpectedly.

Cons of Term Life Insurance

Term life insurance isn’t appropriate for everyone. If you’re looking for a longer-term investment or simply need life insurance coverage through your later years, it’s not the best choice for you.

  1. No Cash Value. Unlike whole life insurance, term life insurance policies don’t build cash value over time. You can’t borrow against your policy or withdraw funds from it. If you outlive the term, your beneficiaries won’t get anything.
  2. Doesn’t Provide Lifelong Protection. Term life insurance provides financial protection for a finite period. You can renew your policy after the initial term, but there’s no guarantee your insurer will approve your new policy or provide the same amount of coverage.
  3. Renewal Premiums Are Very Expensive. When you renew an expired term life policy, you must generally repeat underwriting. So while your initial term premium might be affordable, that won’t be the case if you renew.

​​


Do You Need Term Life Insurance?

Most people need some kind of life insurance. And term life insurance is often the best option because it’s cheaper than permanent life and doesn’t provide coverage longer than necessary.

Are you among those who’d benefit from term life insurance? If your premature death would cause a financial burden for your loved ones, you probably are. 

If any of these situations apply to you, you should seriously consider term life insurance. 

You Have Children or Plan to Have Children 

Food, clothing, day care, school supplies, extracurricular activities, college tuition (and perhaps elementary and high school tuition as well) — the list of parents’ financial obligations goes on and on. 

That leads to one inescapable conclusion: Children are really expensive. Adequate life insurance ensures your kids’ surviving parent or guardian doesn’t have to raid their savings or go into debt to do right by your kids after you’re gone.

You Carry Substantial Joint or Non-Forgivable Debts

It wouldn’t be fair of you to leave your spouse holding the bag on a joint mortgage or saddle them with debts creditors don’t forgive in death, such as private student loans (a crucial consideration for residents of community property states). 

If you carry or plan to carry substantial debts with your spouse and currently lack sufficient liquid assets to settle them in probate, term life insurance is most likely worth the cost.

You Earn Significant Income for the Household

Even if you’re not the primary or sole breadwinner, your family will miss your income after your death. As a general rule, you need at least enough life insurance to replace 10 years of income at your current pay rate. But depending on the circumstances, you may want more or less.

You Do Significant Unpaid Labor for the Household

Life insurance isn’t only for breadwinners. If you do significant unpaid labor for your household, especially if it involves the care and feeding of children, life insurance ensures your surviving spouse won’t have to do that work after you’re gone — and potentially step back from their own career as a result, negatively impacting the family finances.

You don’t need to cover the cost of your unpaid household labor forever. You only need a policy until you expect your kids to be out of the house — when they head off to college or perhaps when they graduate from college if you prefer to play it safe. That said, any children with special needs are likely to need support indefinitely, so you need a longer-term or larger policy to protect them.

You Have Dependents Other Than Minor Biological or Adopted Children

Families don’t all look the same. You might have adult offspring with special needs, foster children, aging parents in declining health, nieces, nephews, or grandchildren. And you may be responsible for their care, perhaps long after your own childbearing years end.

The list goes on. Life insurance ensures your obligation to care for those who can’t provide for themselves won’t end with your death.

You Want to Provide a Financial Cushion for Survivors

Life insurance can dull the shock of financial unknowns, such as end-of-life medical care not covered by insurance, funeral costs, and additional child care expenses. Not to mention the permanent loss of your income.

But the truth is, you don’t need a specific financial reason to justify buying a term life insurance policy. If your premature death would be a burden on your survivors’ finances or hurt their standard of living, life insurance could be worth it.​​


Term Life Insurance FAQs

Buying term life insurance is at minimum a decade-long commitment. 

Before you jump in headfirst, ensure you need a policy and that there’s not a better life insurance option for you. The answers to these questions could help you decide whether that’s the case.

What’s the Difference Between Term and Whole Life Insurance?

There are two significant differences between term life insurance and whole life insurance.

First, term life insurance has a finite initial term. Your policy lasts for a set number of years and expires when that’s over.

Whole life insurance lasts indefinitely. As long as you keep paying premiums and don’t cancel the policy, you’re usually covered until you die, whenever that is. 

Second, term life insurance doesn’t have cash value. Your beneficiaries get the death benefit if you die during the policy term, but you can’t borrow against the policy or cash it out while it’s in force. And if you outlive the policy term, your beneficiaries don’t get anything.

Whole life insurance builds cash value. This cash value is guaranteed and usually grows at a predictable rate. You can take loans against it, withdraw it for cash, or use it to pay premiums, though any reduction in the cash value also reduces the policy’s death benefit.

What’s the Difference Between Term and Universal Life Insurance?

Universal life insurance is another type of permanent life insurance similar to whole life. Universal life premiums are higher than term life premiums but lower than whole life premiums.

Like whole life, universal life has an indefinite term and a cash value component, though with fewer guarantees. Unlike term life, simply paying your universal life premium isn’t enough to keep it in force. The policy has a minimum premium you must pay to keep it going. If you don’t pay it on time, the contract allows the insurance company to cancel the policy.

How Much Does Term Life Insurance Cost?

Term life insurance is the cheapest type of life insurance overall, but your actual premium depends on:

  • Your policy size (how much coverage you get)
  • Your age when you apply
  • Your personal health history
  • Your family health history
  • Your lifestyle and habits, including whether you smoke or use tobacco
  • Your occupation
  • Whether you go through full medical underwriting or choose a more expensive no-medical-exam policy

Age is a key factor. As you age, your chance of dying during a life insurance term increases — slowly at first, then quickly. Put another way, you’re likely to spend double or triple on a 20-year term life policy if you apply at age 50 than you would if you’d applied at age 30.

How Much Term Life Insurance Do I Need?

It depends on your objectives. 

If you have a single goal in mind, such as paying off a jointly held mortgage after you die, you might only need enough life insurance to achieve it. If you have multiple or more complex goals, such as replacing a certain number of years of income while ensuring your kids don’t have to take out student loans to get through college, then you need more coverage.

If you’re unsure where to begin, speak with a licensed financial advisor who’s a fiduciary — someone sworn to act in your best financial interests. Don’t base your buying decisions on advice from financial advisors who also sell insurance or insurance agents themselves — both have potential conflicts of interest.


Final Word

You don’t need to be a financial expert to understand that life insurance’s biggest selling point isn’t financial protection. It’s peace of mind.

When you buy term life insurance, you’re not just buying a financial windfall that may never come. Your life insurance costs come with the assurance that if anything happens to you, your family won’t suffer serious financial harm.

In other words, you’re buying better sleep for as long as your policy term lasts. If that sounds like a sound investment, then term life insurance is probably worth it for you.

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