An In-Depth Look at Term Life Insurance
Term life insurance is a simple, affordable option that offers a lot of flexibility. Here's what to consider when you are shopping for life insurance.
Buying life insurance continues to be number one on the procrastination list. I've worked with hundreds of families and that is often the case.
There’s always an excuse to put it off. You might say things like: ”I’m still young; I’m still healthy anyway, it’s pricy and I don’t have it in my budget yet, I need to learn more about it”.
Well, I've got news for you: that is precisely what term life insurance is for. It’s a procrastination buster and an easy choice because it’s the simplest and most affordable type of life insurance.
As a financial planner, I have to balance perfection with implementation. After all, life is unpredictable, and it won’t wait for you to have your affairs in order. Term life insurance is the quickest way to provide you with peace of mind that your family will be cared for, even if you can’t be there to do it. If you want actionable and straightforward, read on.
It's important to understand that the best insurance policy is the one you have when you need it; both term life insurance and permanent life insurance policies have their use. I have never had a family refuse to claim on life insurance because it’s a term policy or universal life or a whole life plan. I’ve never been asked what type of life insurance policy it was once the claim is being processed.
What Is Term Life Insurance?
"Term" refers to the contractual and guaranteed fixed period that your premium is set for.
Think of a rental agreement where you have the option to lock in for a year, two or three. If you chose a three year fixed term, your rent wouldn’t increase during that period, and you know that you’ve secured your home for at least three years.
At the end of three years, you can decide to renew or to move out.
Let’s use a 10-year term as our example. At the end of the 10 years, you have three options:
- Let it lapse/cancel it/decide not to renew, these all mean the same thing. If 10 years go by and you’ve become fully financially independent, and so have your loved ones, you can choose to let the policy go.
- Renew. Term life insurance contracts have a guaranteed schedule of premiums. The renewal premiums will be indicated in the life insurance policy. If you’re 35 and get a 10-year term, you know what your cost of insurance will be when you are 45, 55, 65 and so on. Unless specified, term policies will continue to renew until you are 85 years old. Regardless of when you start, your term life policy will expire at 85.
- Convert it to a permanent life insurance policy. Good term policies will have conversion provisions; you can swap term life insurance to a permanent plan without a health application. When looking at term policies, consider the companies as if you are buying a permanent plan. Unless you can say, with absolute certainty that you will never need life insurance after 85, you should opt for term plans that allow you to convert it to a lifetime policy. This helps maximize your estate and the inheritance you wish to leave behind.
Term Life Insurance: The Good
You only have to agree on three things with your agent or advisor.
- Who your beneficiaries are— who gets the tax-free money if you die
- How much protection you should get (called the Face Amount or Death Benefit)
- How long your term needs to be
Unlike permanent life insurance options, such as universal life or whole life policies, you don’t have to sort through investment options, dividend treatments, or be mindful of tax consequences. This is because there are no built-in savings or cash accumulation components in a term policy.
The only thing you need to do is to make sure you pay your premiums, which are fixed during the term. No surprises, no hidden costs.
The beneficiaries can do whatever they wish with the tax-free death benefit.
Compared to universal life and whole life policies, term life insurance is a more affordable solution. This is primarily because most people will outlive a term life insurance policy, reducing the likelihood of the insurance company having to pay out the death benefit. However, this is also rooted in simplicity. Just as it is easier for you to maintain a term life insurance plan, insurance companies also have less administrative responsibility keeping up with the tax status of your policy.
Flexibility and Convertibility:
The importance of being able to convert from term life to permanent coverage bears repeating. Permanent life insurance plans are the most tax-efficient way to pass wealth to the next generation. You may believe in the value of establishing an estate and creating wealth for the next generation, but that could be hard to picture when you’re just getting started.
By applying and getting a term life insurance policy with conversion options, you can no longer be denied permanent life insurance at the end of the term, when you can presumably afford it. Even if your health declines or you’ve decided to pursue high-risk hobbies, such as sky diving and heli-skiing, the insurance company cannot turn you away.
Term Life Insurance: Common Criticisms
Price Will Increase Dramatically:
Even though your term policy will not expire until you turn 85, you will have to pay higher premiums every time your policy renews. The increases are exponential, meaning the older you get, the most drastic the price hikes become.
Let’s revisit our 35-year-old purchasing a 10-year term example using standard non-smoker ratings.
Males can start a $500,000 plan for as little as $22.95 per month, but premiums become $113.85 at 45 years old, $318.60 at 55 and $996.75 at 65
Females pay even less and can start a $500,000 plan for as little as $17.10 per month. However, they are subject to the same degree premium increases, with premiums rising to $73.35 per month at 45 years old, $204.75 at 55 and $651.60 at 65.
However, this issue can easily be overcome by foresight. If you believe that you will need the term for longer, don’t start with a 10-year policy. For example, it will only cost $45 per month for women and $58 per month for men.
NOTE: The premiums are based on the lowest cost option at the time of writing, and premiums could change. However, the percentage of premium changes per renewal will likely stay constant. You can get quotes using our free quoting tool.
“Aren't You Just Throwing Money Away?”:
This is the most pervasive criticism for term insurance, but is the most inaccurate. It stems from the fact that term policies have no cash value and you get nothing when your policy expires (or you cancel it), compared to permanent life insurance options where you will get some money back when the policy pays out.
Allow me to go back to the rental analogy. At the end of the lease, you give the keys back to the landlord, and they give you no equity. However, you were not paying for equity, you were paying for a place for you and your family to call home.
When you pay premiums for term life insurance, you are not paying for equity, you are paying for your family’s protection in case of your untimely death. The fact that there is no accumulation inside a term policy is already priced in. Just as renting has a lower upfront cost compared to purchasing a home, there is a reason why one is cheaper.
When to Choose Term Life Insurance Over Permanent Life Insurance
If you are waiting to get a permanent life policy until you have a higher income, get a term policy for now. Having some coverage is infinitely better for your family than having no life insurance.
If your insurance needs will expire, get a term policy. For example, did you have car insurance when you were taking the bus? No? That’s because you didn’t need it.
You don't need life insurance coverage for something you no longer need to have protection for: fixed-term loans and mortgages are the perfect examples. Once those are paid, you no longer need life insurance for it.
Bust procrastination, don’t wait to get a life Insurance policy because life does not wait until you are ready. Term life insurance is the easiest way to get that done.
When shopping for term life insurance, the renewal premiums matter just as much as what you are paying today. Consider just how long you really need the life insurance to be around.
Ready to find the best life insurance policy for you? Get started with our life insurance quoter today.