Insurers offer many types of life insurance policies, but in the end, most choose either a traditional whole or term life option.
Term life insurance lasts for a “term.” So, you get coverage for a defined period. Whole life insurance is a type of permanent type of life insurance that’s active for your life (as long as you pay the premiums).
Let’s take a look at term life insurance and the different types that might interest you.
What is term life insurance?
Term life insurance policies offer coverage for a specific period. These periods range anywhere between one and 30 years.
You can structure term life policies in a variety of ways. They’re often a more simple option, and much more affordable than permanent life. Your premiums go toward a death benefit for beneficiaries when you die — in a lump sum, monthly or as an annuity.
“A term life insurance policy is designed to provide a specific amount of life insurance protection over a certain number of years,” said Mark Hill, a life insurance expert at MassMutual. “Most policies have a level face amount of coverage and premiums are generally level over the term period.”
Term life insurance policies generally run about $30 to $40 per month for a 30-year, $500,000 policy if you’re healthy and in your 20s or 30s. The exact costs vary and can be a bit higher if you don’t fit into that standard.
Term life comes in two basic varieties:
- Level term — Premiums and death benefits remain the same.
- Decreasing term — Death benefits decrease over time.
Loretta Worters, vice president of media relations at the Insurance Information Institute (III), said most people buy level term.
Insurers can customize policies with features. Besides either a level or decreasing death benefit, policies can offer a renewable option, a convertible option and various riders. Riders are essentially policy add-ons that offer additional coverage at a cost.
Hill added that for shorter coverage needs — say for five years or less — there are term life insurance policies with premiums that increase each year.
Nevertheless, Norman Boone, CFP senior advisor at Private Ocean in San Francisco, said the multiple-year term life insurance option usually has flat premiums for the full period.
“We often use that for insurance for a particular purpose,” said Boone, “such as coverage until a kid graduates from college, or to cover a specific time period, such as the 10 years until you retire.”
How many years is term life insurance?
When you’re searching for a term life insurance policy, and choosing between your options, you’ll often hear the phrase “term length.” Well, it’s just that — the policy’s length.
The most common term life insurance policies last 10, 20 or 30 years. The concept is simple; if you’ve chosen a term life policy of 20 years, and pay the premium, your beneficiaries receive your death benefit if you die during that time.
If you expect to outlive the term, you’d better get another one, extend it or convert to a permanent policy. Otherwise, your beneficiaries get zilch if you survive your term life policy.
Types of term life insurance policies
Now that we’ve given an overview of term life policies, let’s dig deeper into six different types of term life plans:
Guaranteed level term life insurance
The most common type of term life insurance, guaranteed level premiums and death benefits are set for the specified term.
Most policies come with a renewal clause. Be careful to read thoroughly before signing, as you may need to renew your policy at some point.
“The guarantee has to do with the cost of the insurance (the premium) staying at the same level for the period of coverage, such as 10 years,” said Boone. “Obviously, the other guarantee is that the face value of the policy will be paid to the heirs upon death.”
Here are the average annual rates for a 20-year, $500,000 level term life policy for nonsmokers in regular health:
Source: Compulife Quotation System, August 2020
Return of premium term life insurance
With a return of premium policy, you pay the insurer for a period. If you keep up with those payments during the full period, the insurer returns the premiums at the end of the term. Insurers charge much higher premiums for these policies.
These types of policies may interest people who want term life, but don’t like the idea of loved ones not benefiting from the policy if you outlive the plan.
“It used to be that some ‘cash value’ policies would, after a period of time, return the full amount of all premiums paid over the life of the policy to the client,” explained Boone. “I imagine some of these still exist, but I haven’t seen any in a long time. They are usually not a good deal; you could pay the lower amount for term insurance for the period and save/invest the difference and have more money at the end of the period than if you used the return of premium approach.”
Make sure to read the fine print if you’re interested in this policy.
“Some policies will return the base premium but not the extra premium (for the return benefit), and others will return both,” Worters said.
Here are the average annual rates for a 20-year, $500,000 return of premium term life policy for nonsmokers in regular health:
Source: Compulife Quotation System, August 2020
Not many companies offer return of premium policies. In fact, the above quotes are only for five companies. That’s compared to hundreds for guaranteed level term policies.
Return of premium costs much more than guaranteed level term insurance. That said, we’ve seen the average annual premium decrease in the return of premium market over the past year, so those policies are cheaper than they were a year ago.
Annual renewable term life insurance
Annual renewable term life insurance (ART) is a short-term life insurance policy that’s renewable every year for a period. Every time you renew the policy, the premium increases, even more after you’ve hit the 20- or 30-year mark.
“With a term life insurance policy that is annual renewable, the term renews each year with a premium that increases,” said Hill. “However, the premium may be guaranteed for 5 to 10 years.”
American Automobile Association offers annual renewable term life for AAA members and spouses. The policies are called Direct Term Life Insurance. Here are the monthly rates for AAA members and spouses for $200,000 annual policies that can last until the age of 80.
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Source: AAA, January 2020 rates
Boone said one-year renewable policies were once the standard. Instead, Worters noted that it’s no longer a top seller. The most popular type is 20-year term now.
“Most companies will not sell term insurance to an applicant for a term that ends past his or her 80th birthday. If a policy is ‘renewable,’ that means it continues in force for an additional term or terms, up to a specified age, even if the health of the insured (or other factors) would cause him or her to be rejected if he or she applied for a new life insurance policy,” she said.
Decreasing term life insurance
Decreasing term life insurance is a renewable policy in which the coverage reduces through the policy’s life, usually with a term of between one to 30 years.
The premiums for these usually remain constant. They’re also far less expensive than payments for a permanent policy with similar face-value coverage. The “decrease” we’re talking about in the coverage come at you either monthly or annually.
“With a term life insurance policy with a decreasing term, coverage decreases,” said Hill. “These types of policies are generally used to cover loans.”
This policy may interest you if you believe you’ll be better off financially in the future or may have fewer debts.
“This might be useful if your need declines over time, as most needs do. For example, as you get older, you probably have more savings or more in your retirement account; you also have fewer years to live. Another example — if you are providing insurance to make sure your kid gets through school, as they get older, they have fewer years to go, so the coverage amount could be lowered,” Boone said.
Modified term life insurance
Modified insurance plans have premiums that change over time, usually in 5- to 10-year intervals.
For instance, you may dish out $12 a month for your term life policy initially. Then, in five years, premiums jump to $16 per month.
The protection is the same, but the premiums aren’t level.
Think of modified term life insurance as a combination of three types of insurance:
- Life insurance that covers funeral costs and things of that nature
- Term insurance that provides coverage for the policy’s duration
- Modified insurance in which the premium payments increase over time
Modified insurance would appeal to someone who doesn’t have much money for insurance now, but likely will in the future. For example, people with kids or a new graduate who hasn’t landed his or her dream job yet.
This insurance can be set up to automatically renew and convert into permanent life insurance, too.
“This and any other kind of ‘whole life’ policy has two elements: the life coverage (e.g. term insurance) and a savings component that accumulates in the early and middle years and then depletes in the later years as the savings are used increasingly to pay the slowly increasing cost of the premium,” explained Boone. “Modified life is a form of this. Most whole life policies have a level premium (much higher than term because it’s presumably for one’s whole life and because you pay not only for the term coverage but also for the accumulation of the savings portion of the policy).”
Most term life insurance policies can be converted to permanent coverage for a period, usually 10 years or the term period, explained Hill.
“Some term policies are convertible. This means that the policy’s owner has the right to change it into a permanent type of life insurance without additional evidence of insurability,” Worters said.
Worters said this option might be the right alternative if you think your financial needs may change.
“These allow you to convert to permanent insurance without a medical examination in exchange for higher premiums. Keep in mind that premiums are lowest when you are young and increase upon renewal as you age. Some term insurance policies can be renewed when the policy ends, but the premium will generally increase. Some policies require a medical examination at renewal to qualify for the lowest rates,” Worters said.
Which term life insurance is best for you?
There’s no one-size-fits-all term life insurance policy. Instead, choose the one that matches your specific needs.
Boone suggested people first talk to a financial planner before contacting a life insurance salesperson. The expert will help you analyze your long-term financial needs.
“Life insurance salespeople are well trained and can be very convincing about their products, but the more you buy and the more it costs, the higher commission they get. So, you need someone objective to review it for you,” Boone said.
Key things to consider while shopping for a life insurance policy:
- How much life insurance do you need (it’s likely to change over time, so you may want to combine policies)?
- Why do you need life insurance (and how will that change over time)?
- How long do you need life insurance?
Boone said he most often recommends 10-, 15- or 20-year term policies, usually in a combination. This coverage reflects the expected need at the most reasonable cost. If you’re still alive at the end of the term, coverage stops unless you convert the policy or buy a new one. Unlike permanent insurance, you won’t typically build equity in the form of cash savings.
Once you have a game plan in place, make sure to compare companies. Hill suggested people look for high-quality policies that meet their specific needs. Get a policy from a reputable company that will be there in the future. Check out Insure’s Best Life Insurance Companies.
When might a permanent life insurance plan be a better choice? You should consider permanent life insurance if you want to make sure your loved ones get something when you die. Keep in mind that permanent policy premiums are generally higher than term insurance. However, the permanent policy’s premium remains the same no matter your age, while term can go up substantially every time you renew it.
A permanent policy will pay out a death benefit whether you die a year from now or live to be 100 or more. But as Noone explained, whole life insurance tends to only be necessary or attractive in relatively few situations, such as having a large estate that will result in hefty estate taxes. Another reason you might want a permanent policy is you have a loved one who needs constant care, which you’ll need to find after you die.
Expects like Worters suggest buying a term life policy and investing any money you’d spend on a permanent policy. You can then use the money saved for any reason.
“The savings element can be used to pay premiums to keep life insurance in force if you can’t pay them otherwise, or it can be used for any other purpose you choose. You can borrow these funds even if your credit is shaky. The death benefit is collateral for the loan. And if you die before it’s repaid, the insurance company collects what is due the company before determining what goes to your beneficiary,” said Worters.