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Term life insurance: How it works
Read the Spanish version: Conceptos básicos del seguro de vida a termino
Term life insurance is easy to understand. When you buy a term life policy, you are buying a promise from an insurance company that it will pay your beneficiaries a set amount if you die during the policy’s term. In exchange, you pay a monthly premium to the company for the duration of that term.
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Touted for its "pure life insurance protection," term life insurance includes none of the cash-value features found in whole life policies. Because of its low cost relative to other types of life insurance, term life continues to be the most popular life insurance choice.
Generally, you purchase life insurance to replace your income if you die, so your loved ones can pay debts and living costs. For example, if you and your spouse own a home and you were to die tomorrow, your spouse would have to pay the mortgage on his or her own. If you had the proper term life insurance policy, your spouse would receive enough money from the policy's death benefit to pay off the mortgage.
Term insurance doesn't just cover specific debts, however. If you have children, term insurance can provide money for college and living expenses if you die before your children are fully grown.
If you outlive your policy term, the insurance terminates and you must buy another policy if you still want to carry life insurance. However, the annual premium for another policy could be quite expensive because your older age and any health conditions will be taken into account. That’s why it’s important to choose a suitable term length early in life.
Compared to other types of life insurance, shopping for term life is simple. The necessary steps include:
- Choosing a life insurance company. Insure.com maintains a list of the best life insurance companies based on customer reviews.
- Choosing the length of the policy. Common terms include 10, 15, 20 and 30 years.
- Choosing the amount of the policy. This is the sum your beneficiaries will receive in the event of your death. The amount you choose should depend on a number of factors, including your income, debts and the number of people who depend on you financially. Many policies amounts range from $100,000 to $250,000, but higher and lower amounts are also common.
Once your policy is in place, maintaining it is a matter of paying your monthly premiums. From there, if you die while the policy is in force, your beneficiaries receive the face amount of the policy tax-free.
Medical exams for term life insurance
When you apply for term life coverage, you’ll be asked a large set of questions about your personal health history and family health insurance. The insurance company will also probably require a medical exam. Don’t be surprised if you’re asked the same set of questions more than once – first by your agent, and then by the paramedical professional who conducts the exam.
The exam typically covers your height, weight, blood pressure, medical history, and blood and urine testing. With the blood and urine tests, the insurer looks for specific medical problems and the presence of nicotine. Positive results could affect your premium, or even your ability to buy a policy.
Nicotine users will pay more for life insurance, although occasional cigar smokers may be able to get less expensive premiums. You don’t have to be a smoker to get what used to be called “smoker” rates. Anything that delivers nicotine into your system, from nicotine patches to e-cigarettes, will garner you higher life insurance rates.
Marijuana users also must disclose their drug use, but those that fail to mention this will likely be caught anyway by the medical exam.
Types of term life insurance
The calculations behind life insurance rates are all about life expectancy. That's why life insurance costs more as you get older. You can lock in low premiums by buying a "level premium" policy. That means for the policy’s time period, say 20 years, your premium stays the same. Many term life policies give you the option to renew your coverage at the end of the term without undergoing another medical exam, although your premiums will rise annually after the level term period – often substantially.
A less popular type of policy is "annual renewable term." This gives you coverage for one year with the option of renewing it each year for a specified duration, such as 20 years. With this policy, your rates go up every year you renew and are calculated based on the probability of your dying within the next year.
If you’d like to have term life insurance protection in place to provide for beneficiaries but you’re confident you’ll outlive the policy, you could consider "return of premium" term life insurance. Under this type of policy, if no death benefit has been paid by the end of your insurance term, you receive all your premiums back. It pays to shop around for a policy like this, but on the low end you can expect to pay 50 percent more in premiums than comparable traditional term life insurance.
If you have trouble finding life insurance because of illness or a troubled medical history, you can turn to a simplified issue term life insurance or "guaranteed issue" policy. These policies require only a few questions and no medical exam, but you pay a much higher premium in exchange for the guaranteed coverage. That's because the insurance company takes on more risk by insuring people without knowing their medical conditions. Guaranteed issue policies often have "graded" benefits that pay only a partial benefit if you die within the first several years of the policy. A life insurance agent can search the marketplace for a guaranteed issue policy that meets your needs, but even if you have a spotty medical history, an underwritten policy like term life still could be less expensive.
If you don’t like answering a lot of questions and you want a small policy just to pay for your funeral, you might consider final expense insurance. This coverage typically pays a lower benefit than conventional term life insurance. You cannot be turned down for this type of policy, but here again you’ll pay more for that convenience.
How much term life insurance costs
According to trade group LIMRA and the LIFE Foundation, the average cost of a 20-year, $250,000 term life policy for a healthy 30-year-old is about $160 a year. That comes to less than $14 per month.
The price of your policy will vary depending on your age and other risk factors, but you should never assume that a policy is out of reach because of cost. Eighty percent of consumers misjudge the cost of term life insurance, according to LIMRA. This is especially true of members of Generation X, who overestimate the cost by 119 percent, and millennials, who overestimate the cost by 213 percent.
Choosing the right term life policy
Figuring out which term you should buy – 10 years, 20 years, 30 years or some other number – requires a review of your debts, financial needs, dependents' needs – and when all those responsibilities might change. When will your dependents reach financial independence? What are your major debts, such as mortgages or other loans, and when must they be paid off?
It's a good idea to review your life insurance needs carefully, both when you buy a policy and when you experience a major life change. To stay on top of your life insurance needs, you should:
- Watch your circumstances. Review your situation yearly to make sure your term life policy still provides appropriate coverage.
- Shop around. Life insurance quotes vary considerably among insurers, so do your homework.
- Sweat the fine print. An insurance policy is a legal document, so read it carefully and make sure that you understand it before signing anything.
- Be truthful. Answer all application questions accurately. Insurance fraud is a serious crime and companies treat it as such.
- Maintain your list of beneficiaries. Don’t wait to change them when it’s necessary. And tell your beneficiaries about the insurance – don't pay for a policy that your heirs can never claim because they don't know about the policy or the name of the insurer.
Choosing the right term life policy requires a small investment of time, but the benefits can be priceless. The first reason for this is obvious: The right policy will help care for your beneficiaries in case you die. But the second reason, which will benefit you even if you outlive your policy, is the peace of mind that comes with knowing that you and your loved ones are covered.
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