Term Life Insurance Basics

By Gary Bangstad on March 15th, 2010

Many financial experts believe that life insurance is an important part of a solid financial plan. The main reason most people purchase life insurance is to cover the financial needs of their loved ones in the event of unexpected or untimely death.

How Does Term Life Insurance work?

Term life insurance covers you for a specific period of time. It may cover you from one year to 30 years, with the premium rate locked in for the time period you choose.

A term insurance policy pays a death benefit only if the policyholder dies within the specified term period. The longer the insurance company guarantees the death benefit, the more expensive your policy is. So, a 20-year term policy is more expensive per year than a five-year term policy, because your risk of death increases.

What Are the Different Types of Term Insurance?

There are many kinds of term insurance policies to choose from:

  • Level Term: According to the Insurance Information Institute (III), 20-year level term is the most popular type of term policy, but term lengths range from 1 year to 30 years. Your level term premiums are locked in for the time period that you choose and are based on your age, health, family health history and lifestyle (such as dangerous hobbies)
  • Adjustable Premium: In order to make a policy more affordable, some insurance companies may charge a lower premium at the beginning of a term policy. However, because insurers may have to guarantee death benefits over long periods of time, they reserve the right to raise premiums.
  • Annual Renewable Term: These policies can be renewed each year without proof of insurability. This can be a great advantage because insurance coverage is guaranteed regardless of your future health. However, higher premiums are usually charged at renewal.
  • Convertible Term: If you have this type of policy, your term insurance can be converted into a whole life policy during a specified conversion period. Once converted, the policy will have a higher premium that reflects your age as well as the lifetime coverage that whole life provides. According to the New York State Life Insurance Resource Center, convertible term life insurance "provides the maximum protection with the smallest amount of cash outlay."
  • Decreasing Term: Premiums remain the same throughout the life of this policy, but the death benefit decreases over time at a predetermined rate. Decreasing term insurance is often called mortgage life insurance because it is often purchased by those who have financial obligations that decrease over time.
  • Return of Premium: Some term life insurance policies offer a return of premium. If you survive the term length of the policy, your premiums are returned. However, prices for return of premium term insurance are much higher than regular term life insurance.

What is the Difference between Term and Whole Life Insurance?

While term insurance is designed for a specific time period, whole or permanent life insurance is designed to last a lifetime and includes an investment component called "cash value." Term life insurance is more affordable than whole life insurance. This is because term insurance provides pure life insurance coverage for a specified period of time.

A permanent life insurance policy allows you to access or borrow funds from cash value. However, if you pass away before the loan is repaid, the loan amount is deducted from the death benefit.

Who Is Best Suited for Term Insurance?

Most people need some kind of life insurance to protect their loved ones from the financial blow after their death. You may want to consider term life insurance under the following circumstances:

  • Limited Income: You need life insurance to protect your family but have limited income. Term insurance is less expensive than permanent life insurance and offers you the most insurance protection for your premium dollar.
  • Temporary Need: If your life insurance need is temporary, such as covering mortgage payments, you should consider term life insurance. Keep in mind temporary does not necessarily mean short-term. For instance, you can buy a 20-year level term insurance policy so that your children have the funds needed to go to college.

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