No one really wants to think about life insurance. But once you settle into life with a spouse, kids, or both, something funny happens: You have to consider what’s best for your family, not just yourself.
People begin to depend on you, and you on them — for love, for companionship, and, of course, for financial stability.
Unfortunately, sometimes life throws a curveball. If your family would find itself in financial trouble if you unexpectedly passed away, it’s probably worth buying term life insurance — the simplest and typically least expensive type of life insurance.
We’ll cover the basics below, including what term life insurance is, how it’s different than other life insurance, why it’s a good bet, and how much you need to cover your bases.
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What Is Term Life Insurance?
Some insurance can be tough to understand, but term life insurance is about as simple as it gets.
Just like other kinds of life insurance, its primary purpose is to offset the financial burden caused by an unfortunate event — in this case, to make sure your dependents can continue to live comfortably without your income if you pass away. It can also help cover outstanding debt, pay for funeral costs, and even help pay for your kids’ college education after you’re gone.
With term life insurance, your policy is good for a specific period of time — the term. While shorter and longer terms are available, 10-, 20- or 30-year terms are common.
If you die before the term is over, the policy pays a pre-specified amount, called a death benefit, to the person or people you’ve chosen as your beneficiary — typically your spouse, children, or other family members.
Term life insurance can also be convertible or renewable. A convertible policy can be exchanged for whole life insurance of equal value, while a renewable policy can be renewed or extended for additional terms. We’ll discuss these sub-types of term life insurance in depth later on.
So if you have a 20-year, $500,000 term life insurance policy, you’ll pay a monthly or quarterly premium for 20 years, and if you die within that time frame, your family will receive $500,000 (death benefits are generally not taxable as income). If you pass away after the 20-year term, however, and you didn’t renew your policy or convert it to a whole life policy, they won’t receive anything. Before we dig deeper, let’s compare term coverage with another kind of life insurance, called whole life insurance.
Term vs. Whole Life Insurance
Also called permanent life insurance, whole life insurance has two components: the life insurance policy itself, as well as a savings component that grows over the years. Some of the premium you pay every month with a whole life policy is invested on your behalf in an interest-bearing account that you can borrow against without paying taxes.
With term life insurance, unless you die before your term is up, you won’t see a penny of your benefits — you’re simply out the cash you paid in premiums over the years. With whole life insurance, you’re guaranteed your death benefit regardless of when you die as long as you’re paying your premiums.
Term Life Insurance
Whole Life Insurance
|How long does coverage last?||Specified term such as|
10, 20, or 30 years
|Permanent, as long as premiums are paid|
|When is death benefit payable?||Payable only if you die before your policy expires. Otherwise, no payment.||Whenever you die|
|Does policy build cash value?||No||Yes|
|Tax-deferred savings component?||No||Yes|
|Can you borrow against policy?||No||Yes|
|Cost||Varies, but usually relatively inexpensive.||Varies, but typically much more expensive than term coverage.|
Though the guaranteed benefit may make whole life insurance seem like a no-brainer, most experts caution that term life insurance is still a much better deal for most people.
Why? First, term policies are typically much cheaper than whole life policies, making it possible for you to get the coverage you need without busting your budget.
With a term policy, there’s a very good chance you won’t need your death benefit, so this lessened risk means lower premiums. When you buy whole life, your insurer knows that (as long as you keep paying premiums) it will eventually have to pay a death benefit, so the policy costs more. Moreover, commissions are very, very high on whole life policies.
Second, if whole life is attractive because of the savings component, note that you can probably get a better return by simply taking the extra money you’d pay for a whole life policy and investing it on your own. This is especially important if you want to be an active investor — you won’t have much, if any, control on how your premiums are invested with a whole life policy.
How Much Term Life Insurance Do I Need? How Long Do I Need It?
First things first: If you’re lucky, your employer may provide term life insurance as part of your benefit package. However, these policies often aren’t big enough to truly protect your family in case you die.
It’s typical for employers’ group life policies to come with a death benefit equivalent to one or two years’ salary, according to Bankrate. Even if you’re fortunate enough to work someplace where that’s a relatively beefy sum — say $100,000 to $200,000 — that may not be enough.
If you want a very general starting point, you can multiply your salary by 10 to figure out how much life insurance you need.
Of course, you could have a lot of extenuating factors that demand a more precise evaluation. The easiest way to figure out how much life insurance you really need is by using a calculator that will consider your family’s income, savings, debts, and other relevant factors.
There are several of these tools online, but the most comprehensive is provided by Life Happens, a nonprofit dedicated to educating the public about insurance. If you have a financial planner, he or she can also help you figure out what’s best.
You may be surprised by how much life insurance you need. My husband and I recently purchased term life policies when we realized that his employer-sponsored life insurance policy had a paltry death benefit of $15,000 — maybe enough to cover funeral costs.
With two kids, two mortgages, and a host of other expenses, that’s not even close to what I would need to replace his income and live a similar lifestyle if he unexpectedly passed away. Meanwhile, he would need to replace my income as a freelance writer — and incur additional childcare expenses — if I suddenly died. We settled on a $1 million policy for him, the primary breadwinner, and a $500,000 policy for me.
As for policy length, experts say a good starting point can be to buy a policy for at least as long as you’ll be financially supporting any children. You also want to consider whether you’ll still need life insurance once any big expenses — for instance, your mortgage — are taken care of, or whether you’ll need life insurance once you retire.
My husband and I have young children, and we want to help them pay for college. We also recently bought a house with a 30-year mortgage. Finally, while we’ve recently started saving more aggressively for retirement, we’re making up for some years where we didn’t save as much as we should have. For those reasons, we opted to pay a bit more for 30-year term policies.
What Type of Term Life Insurance Should I Choose?
Though term life insurance is relatively simple, you’ll still need to choose whether you want a renewable or convertible policy. Here’s how they differ.
Renewable term life insurance
“Renewability” allows a policyholder to renew or extend their term life policy for additional terms without medical examination. This is important because it guarantees that you can still get life insurance even as you get older or your health declines. So while you may eventually find yourself unable to pass a company’s underwriting criteria — meaning your health is too poor to get a new policy — the insurer is required to renew your old policy. Most term policies do not allow renewal after age 80.
For example, say you’re a healthy, non-smoking 25-year-old. You can buy a 10-year renewable term policy with a benefit of $100,000 for about $120 per year. In 10 years, you can renew that policy for another 10 years regardless of your health (although the rate may be higher).
Note that your health does still matter when it comes time for renewal: While you’re guaranteed the right to renew, the amount you pay annually for the same amount of coverage will be based on your current health.
So by age 35, if you’ve gained 40 pounds and started smoking, your premium may double for the same coverage based on your age and current health. It’s also possible you won’t be offered another renewable policy, which could leave you uninsured 10 years down the road, when your need for one may be greater.
Convertible term life insurance
“Convertibility” simply means that the policy can be exchanged for whole life insurance of equal value. Typically, this exchange requires neither underwriting nor a medical exam.
This means that if you had a $50,000 convertible term policy, you could convert it into a $50,000 whole life policy without giving a health history. This conversion would, however, increase your premiums.
Usually, policyholders are permitted to convert term policies only until they turn 65, and the period during which conversion is possible is shorter than the period of coverage.
This means you can convert your term policy into whole life insurance even if health begins to decline. The “hybrid” nature of convertible policies proves especially important in this situation, because once in ill health, you’ll have a much more difficult and costly time securing coverage.
It is important to understand that your premium’s new rate will be based on your age, health, and other factors at the time of conversion. You should also remember that the cost of whole life insurance is greater than the cost of term, even if all other factors are the same.
Renewable and convertible hybrid
Some convertible term policies are a hybrid that offer the choice of either renewing for an additional term or converting to a whole-life policy. Health and age factors apply the same way they do with renewable or convertible policies. The options are often available on an annual basis regardless of the length of the initial term.
Which kind of term life insurance is right for me?
As with all things, those increased options often carry a higher cost. Insurance carriers, like car dealers, charge by the option: The more options, the higher the premium.
If cost is your bottom line, note that renewable policies are cheaper. You may be able to renew for more than one term as long as you remain in good health. Just remember that your premium may go up each time.
A convertible policy might be a better bet if you want whole life eventually but you’re afraid you’ll end up in poor health sometime down the road. It will be more costly, however. And unless you have a hybrid policy, you may not be able to renew it without converting.
Life Insurance Calculator
While term life is simple, figuring out exactly how much you need can demand a lot of thought — and math. To ease this process, we’ve built a calculator to help you figure out what you really need. Here’s how it works:
- Fill in the important basics: How much of your income do you want replaced after you die, and for how long? You’ll also need to input your income.
- Next, input details about your assets: Cash savings and investments, as well as any 401(k)s or other employer-sponsored retirement accounts, IRAs, and pensions.
- Third, tell us about your spouse: his or her annual income, expected work hours, and marginal tax rate.
- Finally, input your outstanding debts, including your mortgage balance. Also factor in whether you want to cover your funeral expenses and fund your children’s college education.
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The calculator will tell you the amount of life insurance you’ll need to cover your loved one’s financial needs after your gone, as well as the average cost to cover those needs.
How to Shop for Term Life Insurance Quotes
You can start your search for term life insurance with our online quote tool, which will let you compare offers in your area. This can be a good starting point for your search, and give you a baseline for prices.
You can also buy directly from most companies. For a starting point, check out our picks for the Best Life Insurance Companies of 2016.
One caveat: Some life insurance companies don’t give out quotes online because they would rather you call and speak to an agent. This isn’t inherently bad; after all, agents know their stuff and may be able to provide you with valuable guidance.
However, if you don’t mind using an agent, you may want to stick with an independent agent. Unlike agents who sell only one company’s insurance, independent agents can shop around for you and are under less pressure to steer you in a particular direction.
When you get a life insurance quote, you may be asked for health-related information such as your height, weight, and whether you’ve ever smoked or suffered from any illnesses. Be as truthful as possible when you answer these questions — you may have to undergo a health exam after formally applying, and unfavorable results can mean a big difference between what you were quoted and will actually have to pay.
In general, the younger and healthier you are, the less you’ll pay — but things like gender, career, location, and lifestyle can all affect your rate, too.
Still have more questions about life insurance? Here are some of The Simple Dollar’s past posts on the subject: