In the event of your death, a life insurance policy will pay out a death benefit to your family or other designated beneficiaries. While this concept may seem simple, actually choosing an appropriate life insurance policy is much more complex, in part because there are multiple policy options, including whole and term life insurance.
Here's what you need to know about term life insurance so you can make the best decision for your needs.
What Is Term Life Insurance?
Term life insurance is a policy that covers a specific period of time, also known as the term. When you purchase a term policy, you agree to pay premiums to the insurer for the duration of the term. If you die during the term, the insurer will pay the agreed-upon death benefit (also known as a face value) to your beneficiaries. However, if you outlive the term, then the policy lapses, meaning your beneficiary will not receive a death benefit when you do pass away, and you do not get any of your premium payments back.
Since term life insurance is designed for a specific coverage period, the cost of this insurance tends to be relatively low. Insurance companies expect most customers to survive their term, so they make the policy premiums for term life insurance affordable. Though your family will receive no death benefit if you outlive your term, you can use a term life insurance policy to protect your loved ones from the financial fallout of your death during the years when your family and dependents would most need your income.
Term life insurance is cheapest for young and healthy adults because those insurance customers are the least likely to die. Purchasing a policy at a young age will mean you can get a higher death benefit for a lower premium cost.
If you outlive your term, you can expect a higher cost if you want to buy another term life policy. And if your health has changed since you first purchased your policy, you may not be able to qualify for a new term life insurance policy after the previous one has expired.
How Does Term Life Insurance Compare?
Term life insurance is not the only type of life insurance product available. Whole life insurance also offers a death benefit to your designated beneficiaries upon your death. But unlike term life insurance, whole life insurance is in place for your whole life, meaning you will be covered no matter how long you live, provided you are up-to-date on paying your premiums.
Since whole life insurance, by definition, will pay out a death benefit no matter what, it is much more expensive than term life insurance. The insurance company knows that it will need to pay out the death benefit, so it increases the premiums.
In most cases, insurers will charge a level premium for whole life insurance in order to keep the policy affordable for more people. With a level premium, you will pay the same premium amount over the life of the policy. But what you pay in premiums in the first few years is more than the amount that would be required to pay a death benefit claim. The excess money from those early years is generally invested in a cash account that will help offset the cost of your insurance as you age.
Whole life insurance policies can also offer certain benefits that are not available for term policies. For instance, insurers are legally required to offer policyholders access to the cash value of their premium overpayments. This means that whole life insurance policyholders can use the policy both as a means of protecting their family against their early death as well as a potential source of income as they age.
What Is Term Life Insurance Designed to Do?
Though term life insurance does not offer the same kind of iron-clad guarantee of a death benefit that whole life policies offer, this kind of insurance is designed to serve an important need.
To start, it's helpful to think of term life insurance as being similar to homeowners or auto insurance: You pay premiums in order to prevent financial loss, not to guarantee a payout. If you don't use the insurance, the premiums are gone — but that also means you have not needed to make a claim, which is a positive outcome!
In addition, since term life insurance provides policyholders with a higher face value for a smaller premium, this product is a good method of protecting your family in the event of your untimely death — rather than providing your family with an inheritance after your inevitable demise. Term life insurance premiums can generally fit comfortably into a regular budget, and they ensure that your family will be financially taken care of if something happens to you.
To qualify for term life insurance, you usually need to complete a medical questionnaire and possibly an exam for the insurer's underwriting. There are some health conditions that can disqualify you for life insurance underwriting, which is why it's smart to get a term life insurance policy in place while you enjoy good health.
Life insurance terms are generally sold in five-, 10-, 15-, 20-, 25- and 30-year terms, although there are some with shorter or longer terms. You may be able to renew your term life insurance without further underwriting. Renewability is a common clause in term life insurance policies, but you will often need to pay a higher premium for the new term.
Pros and Cons of Term Life Insurance
While there are a number of benefits to getting term life insurance, this kind of policy may not be right for everyone. Make sure you understand what you're signing up for.
- Premiums tend to be affordable, especially for younger adults.
- Compared to whole life insurance, there are higher death benefits available for less money.
- Your family is protected when they are most financially vulnerable.
- There is potential for renewal when your term expires.
- Not everyone can qualify (which is also true of whole life insurance).
- If you outlive the term, you and your family will receive no payout.
- There is no cash value associated with your policy.
How to Decide If You Need Term Life Insurance
Determining whether a term life insurance policy will be the right product for you requires some careful thought and depends a great deal on your personal situation. It's important to ask yourself the following questions:
- Will my age and health affect my insurance choices? The younger and healthier you are when you apply for a life insurance policy, the more affordable it will be, for both whole and term life insurance.
- What financial needs will my family have now and in the future? If your family and dependents will be able to handle their own financial matters once they have reached adulthood or finished their education, that may indicate that a term policy is sufficient. But if you have dependents who will need lifelong care or support, you may need to explore a whole life policy.
- What can I afford? While cost cannot be the only factor in deciding on a life insurance policy, it can help you make a decision.
The Bottom Line
While term life insurance only provides coverage for a certain time period, that can be enough to protect your loved ones at an affordable price. Understanding exactly what is term life insurance and how it works can help you make the best decision for your family's needs.