The Basics of Term Life Insurance

If you’re the primary breadwinner in your household, what happens to your family if you die? Even if your spouse or another adult in your household works, it’s likely that you depend on both incomes to maintain your lifestyle. 

Where would they get the money to live if your salary were suddenly gone?

That’s where life insurance comes in. It’s literally an insurance policy for your life. You sign up for the policy, and when you die, your beneficiaries get a lump sum death benefit to use as they see fit. 

Depending on the type of policy you buy, you may get this payout in certain situations without dying — such as if you become seriously and permanently injured. However, the benefits of life insurance usually aren’t for you — they are your final gift to your family.

Curious what it’s all about? Wondering if buying life insurance is a good choice for you? Let’s learn all about this important type of insurance. 

What Is Term Life Insurance?

There are two main types of life insurance, term life insurance and permanent life insurance. 

As the least expensive form of life insurance, term life insurance is a good option for most people. Unlike a permanent life insurance policy, it doesn’t cover you for your entire life. Rather, you choose a set number of years, or term, that the policy will be active — hence the name.

For example, if you choose a 20-year term life insurance policy, as long as you remain current on your premiums (your monthly payment), your beneficiaries will receive a payout in the event of your death if it happens during the 20 years of your policy’s term. 

How much will they get? Well, that depends on the size of the benefit you choose. You can choose to purchase term life insurance for $50,000, $500,000, or even $1 million or more. The larger the policy you choose, the larger your premium will be, but no matter how you look at it, the monthly cost of a term life insurance policy is pocket change compared with the amount your family may receive. 

Benefits of Term Life Insurance

Term insurance offers many benefits to policyholders, which is why it is such a popular type of life insurance. We’ll break them down here to help you understand how it can help you. 

Simple and Straightforward

First off, term life insurance is easy to understand. While permanent life insurance policies have cash values, loan options, investment options, and more to wade through, term life policies are cut and dried. You sign up for a set dollar amount of death benefits that will be good for a certain number of years and that’s it, easy-peasy. 

Peace of Mind

Life is expensive, and many families struggle to meet all their financial obligations. While we don’t always lay awake at night thinking about death and how to pay for it, the topic can still be a considerable source of stress. 

The cost of the average funeral in the US ranges between $7,000 and $12,000 dollars. How is your grieving family going to come up with that money? And keep paying the bills once you’re gone?

A $250,000 insurance check will be more than enough to cover the cost of your funeral, as well as help pay the bills. 

Tax Benefits

While life insurance premiums are not tax deductible, the good news is that the payout is not considered taxable income by the IRS. That means your beneficiaries will receive the entire death benefit free and clear, without Uncle Sam holding back his share.

Most of the time, you’re free and clear of taxes when receiving a death benefit. However, you’ll find some occasions when taxes kick in and must be paid on the death benefit of a life insurance policy—for example, when your estate exceeds the estate tax threshold, or when three or more people are involved. Best to check with the IRS for those instances.

Affordable

With such great benefits, you might think that term life insurance is expensive. However, term life is surprisingly affordable. 

The premium you’ll pay varies based on factors such as your age and general health at the time you purchase the policy, the policy term, and the amount of coverage. In general, a young (under 40), healthy individual who doesn’t smoke can take out a policy that covers them for 30 years and pay what amounts to a couple of fancy cups of coffee from Starbucks each month. 

Drawbacks of Term Life Insurance

As with any financial product, there are also drawbacks to purchasing term life insurance. Let’s explore what you should be aware of. 

Use It or Lose It

Term life insurance does not accumulate a cash value like permanent life insurance policies do. Instead, it follows a “use it or lose it” philosophy. You could pay into a term insurance policy for 20 years, but if you don’t use it during that time you won’t receive any benefits. There are some life insurance companies that are beginning to offer a premium return option, but these plans are more expensive. 

Premiums Get More Expensive

The affordability of term life insurance is based on your likelihood of dying. In other words, the younger (and healthier) you are when you apply, the cheaper it will be. When your term is due to expire, you are given an option to renew. However, since you are now 20 (or however many years your terms was) years older, you are not likely to be offered the same affordable price. For this reason, at a certain point, term life insurance gets to be cost prohibitive and not worth it anymore. 

Who Should Get Term Life Insurance?

An easy way to determine if you need life insurance is to ask yourself if you have any financial obligations that would fall on someone else if you died? If yes, you probably need life insurance. People who often benefit from life insurance include:

•     Parents of young children
•     Adult children caring for their parents
•     Those with a spouse who depends on their income
•     Adults with student loans whose cosigner would be responsible for repayment
•     Business owners 
•     Older adults with no savings who will need money for burial expenses

Something to keep in mind is that even if you don’t work, and therefore don’t support others with your current income, you may still need life insurance. For example, what if your spouse is the sole breadwinner and you care for the children and take care of household duties? You might not earn an income, but the work you do would become an expense if you weren’t there to do it. Would your spouse be able to afford childcare or housekeeping expenses on their income alone?

Wealthy individuals looking for an investment vehicle or an additional way to save for retirement might be more interested in a type of permanent life insurance policy. Most other people will benefit most from term life. 

How Much Life Insurance Do You Need?

One of the biggest determining factors of the cost of your premium is the amount of life insurance coverage you take out. For this reason, you won’t want to take out an amount of coverage that goes above and beyond what you really need. However, the opposite is also true — you don’t want to skimp on your coverage amount. By trying to save a few pennies a month, you could cost your family several thousand desperately needed dollars. 

So how do you figure out how much life insurance you need?

As a general rule of thumb, most experts recommend choosing a coverage amount that is 10-12 times your annual salary. So, if you make $50,000 a year, you should choose between $500,000 and $600,000 for your policy. 

However, this is only a general guideline, and your individual situation may vary. For example, if you just bought a house, you might want to take out enough coverage to pay off the mortgage and have enough left over for funeral expenses and other family financial obligations. If you have a special-needs child or foresee other large ongoing expenses, you may wish to take out a higher amount. 

Conversely, in some situations, you may feel comfortable choosing a lower coverage amount. For example, if your income is supplementary to your spouse’s and your family can live comfortably on that income alone. But don’t forget to factor in any childcare or domestic duties you are in charge of that may become expenses if you are not there. 

The policy term you choose is dependent on how long you foresee needing insurance. For example, if you have small children and want to cover them through college, you’ll need at least a 20-year term life policy. If you are closer to retirement and have almost paid off your mortgage, you may only need a 10-year policy to provide coverage until your home is paid for and retirement benefits kick in. 

How Much Does Term Life Insurance Cost?

For the amount of coverage that term life policies offer, premiums are surprisingly inexpensive. The actual cost is dependent on your age and health factors, and can vary widely among applicants. However, most healthy, young, nonsmokers will pay around $20 to $30 per month for a 20-year, $500,000 policy. 

So, for the cost of a couple of large pizzas a month, you can ensure your family is taken care of. 

The Takeaway

What does all this mean for you? Well, if you’re like most people, you need life insurance. Whether you have student loans that someone else would become responsible for paying, a house, or small children, the people around you are counting on you to meet your financial obligations so that they can meet theirs.

Term life insurance is a cheap way to ensure that you do, even if life doesn’t go the way you had planned. It’s the best gift you can give your grieving family. 

Term Life Insurance FAQ

Can you cash-out a term life insurance policy?

Term life insurance is not an investment, and it does not accumulate cash value like a permanent life insurance policy does. You can’t borrow against it, and you can’t cash it out. It is simply life insurance that covers you if you die. 

That’s part of what makes it so affordable. Few people die during their terms, and with no other benefits to pay for, the life insurance company is able to charge a small fee for hundreds of thousands of dollars of coverage. 

What type of life insurance is better, term or whole?

It’s hard to say that one type of life insurance is better than another. They each offer different benefits, and one or the other might be more useful to you depending on your situation. 

For the vast majority of people, term life insurance tends to be a better choice. The premiums are inexpensive, and you get peace of mind knowing that your family is covered. 

However, for wealthy individuals looking for an investment vehicle, whole life fits the bill nicely. It all depends on your financial situation. 

What happens if I outlive my term life insurance?

Term life insurance is simple and straightforward. If you die within the predetermined term and are current on your premiums, your beneficiary gets a payout. If you outlive the policy, however, your coverage simply ends. If you die the day after your policy expires, your family will get nothing. 

In order to avoid a lapse in coverage, a few options are available. Most term life policies have a term conversion rider, which allows you to convert your term policy to a permanent policy. The main advantage to this option is that you won’t have to go through all the underwriting and can keep the same rate class. However, your premium payments will go up significantly upon conversion, since permanent insurance is several times more expensive. 

You may also choose to purchase a new term policy. This is usually a better option if you’re still relatively young. Term policies become significantly harder to qualify for as you get older.

Regardless of what you decide, begin the paperwork at least 6 months before your policy expires. You cannot convert a term policy to a permanent one after it expires. If you decide to buy a new term policy and are rejected, you’ll need time to convert your current term policy to a permanent one.