Term Life Insurance 101
May 9, 2011
The main purpose of life insurance is to help protect your family from financial hardship in the event you die and they’re left with the same expenses but less income. If that were to happen and you had bought life insurance then they’d receive what’s known as a death benefit, a lump sum cash payment that could help them get by without you around.
There two main types of life insurance, term life and permanent, or whole life – this article is going to look only at term life insurance. One of the main reasons that people choose term life over whole is that the premiums are cheaper, that’s because term only lasts for a specific period of time.
Why Term Life Insurance?
Many of us have the biggest financial obligations to our family when our kids are young. Often during this stage of our life we’re not only paying to raise the kids but also have expenses like car payments, medical bills, and maybe house payments. If you were to pass away it may be tough for your spouse to cover all those costs, particularly if you’re the only one working and they stay at home with the kids.
Now fast forward to twenty years later when the kids have grown up and moved away and your house is getting close to being paid off. The importance of your income to the family has decreased significantly. Although you’d still be sorely missed if you weren’t around, it probably wouldn’t be as financially catastrophic as it would have been two decades earlier.
This is the kind of scenario that term life insurance is designed to cover. If you bought a 20 year term life policy to get you through that period of raising kids, then they would be covered if you weren’t around. Or maybe you’d want a 30 year term to make sure your house was paid off and the kids had made it through their college years.
Life Insurance Costs
As I mentioned earlier, term life insurance typically has much lower premiums than whole life. Your premiums are usually paid monthly so if you are a young family starting out the term insurance option is likely a more affordable payment than a whole life policy would be.
The cost of your policy will vary not just based on the length of the term but also the type of term life insurance you sign up for. There are several different varieties of term life, lets take a look at some of the major ones.
Annual Renewable Term Life Insurance
As the name suggests, each term only lasts for one year. At the end of the year you have the option of renewing your life insurance policy. The premiums typically rise as you get older, often rising at the end of each year. Some policies include a maximum premium to cap the amount you’d have to pay.
Fixed-Rate Level Term Life Insurance
If you know that you want life insurance for a longer period than a year, you can go with fixed rate level term. The nice thing about this type of insurance is that once you sign up for the policy the monthly premiums are the same for the length of your contract. So unlike the annual renewable version, your costs don’t go up each year. Common term lengths for this type of life insurance are 10, 15, 20, or 30 years.
Typically the longer the term, the more expensive your monthly premiums will be. This is mainly due to the fact that the older you get, the higher your chances of death are. So if you want to insure your life for 30 years vs 15 years, the probability the insurance company will have to pay out is higher – so they charge higher insurance premiums.
Decreasing Term Life Insurance
If you like the idea of a fixed premium but would like a longer term and want to pay less you could consider decreasing term life insurance. Your premiums stay the same throughout the life of your policy but your coverage amount decreases annually.
The idea behind decreasing life insurance is to cover big expenses that will shrink over time. The best example of this is a home mortgage. Over the years the amount you owe on your house will go down (as long as you don’t have an interest-only mortgage) so a decreasing term insurance policy assumes that your family will need less money once that big expense is paid off.
Of course this doesn’t take into account any other large expenses you incur over the course of your term, like medical bills or college debt, so keep that in mind if you’re considering decreasing term life insurance.
Convertible Term Life Insurance
One thing you have to do before buying life insurance is to be evaluated for your eligibility. If the insurance company find you to be insurable then you’re covered for the length of your term. If your insurance term expires and you want to buy another term life policy you may have to go through the eligibility process again, depending on your contract.
If you’d like to buy term insurance now but know someday you may want to have permanent life insurance, you can look into a type of insurance called convertible term. This type of life insurance starts off as term but gives you the option of converting to a whole life policy later down the road, without having to go through the insurability process again.
How Much Insurance Do You Need?
The amount of coverage you need varies for each personal situation but here are a few general things to consider when trying to decide how much life insurance would be enough if you died:
- Expenses from an injury or sickness that eventually lead to death – ex: hospital expenses or long term care
- Any debts you would leave behind (credit card, mortgage debt)
- Expenses related to death – funeral costs and/or estate attorneys
- Future cost of living – funds your family would need to pay for daily living
Where Can You Buy Life Insurance?
When you’re pricing life insurance, one option is to work directly with insurance companies, some of the bigger ones are:
If you want to compare options and rates without calling up each company you can also use sites like these to compare term life insurance rates:
All posts by Ben Edwards
Very informative and well presented.
Thanks Robert!