Term Life Insurance: How It Works and Why You Might Need It
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If you’re in the market for life insurance, know that “term life insurance” is the simplest form of life insurance available in the market today.
It is also the cheapest way to obtain large amounts of coverage for a relatively small premium, which makes it the choice of many of us who need coverage but cannot afford, or are not willing to purchase universal life insurance or whole life insurance coverage.
It can be a good option if you want some form of coverage in the event of an untimely passing, but already have all your investments squared away via other means.
In that sense, with a term policy you’re just buying coverage to protect your family if something actually happens, with no payout at the end of the term if nothing does. For the record, you’re going to want nothing to happen…
How Term Life Insurance Works
Term life insurance is similar to other types of insurance most of us are familiar with, such as car insurance or health insurance.
An insurance premium is paid in exchange for a coverage amount over a specific period of time. It’s as easy as 1-2-3.
1. Decide how long you want coverage…typically 5, 10, 20 or 30 years.
2. Choose the amount of coverage you want.
3. Pay your premium until the policy period ends and purchase another policy, convert to a whole life policy, or simply go without life insurance at that point.
Your premium payment can be paid monthly or annually, and should be fixed for the full term of the policy to avoid any surprises.
As noted, no portion of the premiums will be returned to the policyholder unless the insured dies during the policy term. This makes it straight up insurance, as opposed to a sort of hybrid insurance-investment vehicle.
And that can be a really good thing because insurance isn’t an investment. It’s insurance that protects your investments.
How to Choose a Term
Instead of say a 6- or 12-month car insurance policy, you’re going to buy a term that might be as long as 30 years, though it could be as short as five.
With term insurance, you’re basically buying coverage to span your working years, so if you do pass before you retire, the income shortfall from the lack of employment will cover expenses to keep your surviving family members in good shape financially.
For example, if you’re a 35-year old man or woman, and you plan to retire at age 65, a 30-year term life insurance policy would cover your remaining working years. It would also cover the term of a mortgage to ensure it could be paid.
After that point, your retirement accounts would come into play, meaning a life insurance policy wouldn’t necessarily be needed. This is the argument against other types of life insurance.
Basically that you already have investments in place in your 401k, or SEP-IRA, etc., so why would you need yet another investment vehicle that also provides insurance?
Anyway, the term you choose will depend largely on your individual circumstances.
Perhaps you just had a child and want to make sure your family is covered by a life insurance policy until the child is 20 years old and out of the house (hopefully).
Or maybe you’re starting a new business and want to obtain some cheap life insurance for a period of only 5 or 10 years to make sure your family is covered in the event you pass and the business does not provide passive income in your absence.
Obviously there are many circumstances that may guide your decision all which weigh here.
Another important question to ask yourself is how much term life insurance you need. Again, a highly individualized decision. Learn more about how much life insurance you need.
What Should I Do When the Term Life Insurance Policy Expires?
As noted, term life insurance policies have a defined endpoint that is agreed upon upfront. They don’t carry on into perpetuity.
Taking into account the examples above, evaluate your individual needs and unique situation to determine an appropriate time period for coverage.
Remember, the older you get, the higher your premium rate will be when you purchase a new policy (why does life insurance cost more when you get older?).
So purchasing a term policy while you’re younger to lock-in a lower rate might be a good move.
Once the term life insurance policy matures, insurers may give you a discounted rate for renewing a policy with them or maintaining coverage over a certain period of time.
You can entertain such offers or simply begin tapping into your retirement benefits.
Cost concerns as we get older are one of the main factors that influence people to purchase a whole life insurance policy, in which you pay a fixed amount throughout the life of the policy.
You cannot be non-renewed and the policy builds cash value over time that can be borrowed against.
The arguments for both sides can be compelling (and heated).
But at the end of the day, there is no denying that term life insurance is the cheapest way to get high limit life insurance.