What is term life insurance and how does it work?

Life insurance is an important part of planning for your family’s financial future. While no one likes to plan for their death, a little discomfort now can save your family a world of financial stress if you die unexpectedly.

Term life insurance is a type of life insurance that only lasts for a certain period of time — or the term — and does not come with any supplemental features, like a cash value. This no-frills coverage keeps costs low, though there are many other types of life insurance policies for people who are looking for extra coverage or have unique financial planning needs. 

Because of its low rates, term life is a popular life insurance choice compared to other types of life insurance. For a relatively low monthly cost, term life insurance pays out a death benefit to your beneficiaries if you die. The benefit enables your loved ones to maintain their standard of living and pay for any outstanding financial obligations, like a mortgage.

How does term life insurance work?

When you buy a term life policy, your beneficiaries will only receive the death benefit if you die during the policy’s term, which can be anywhere from 10 to 40 years. In exchange, you pay a monthly or annual premium during the policy’s lifetime. 

If you outlive your policy term, your insurance coverage ends and you’ll need to buy another policy if you still need life insurance. “Term policies are renewable but premiums increase with age and upon renewal,” says Mark Friedlander, senior director of media relations at the Insurance Information Institute.   You can also convert your policy into a whole life insurance policy before it expires.

Unlike permanent life insurance, term life insurance doesn’t come with a cash value component and coverage only stays active for a set period of time, or the term — but that’s what keeps costs low. And just because it doesn’t last a lifetime doesn’t mean term life insurance doesn’t offer adequate protection. 

Cameron Ellis, assistant professor at the University of Iowa Tippie College of Business, emphasizes that people getting a term life policy should understand that these policies often stretch over decades.

What does term life insurance cover?

Typically, the death benefit from term life insurance is used to cover funeral expenses, debts, mortgage or replace lost income of the insured party. However, the death benefit can be used by beneficiaries in any way they choose. For example, if your beneficiaries want to use the death benefit to pay for a vacation, they can. 

Who should you list as your term life insurance beneficiary?

You should choose your beneficiaries carefully. For example, if your children are minors, they shouldn’t be listed as beneficiaries because insurance companies won’t pay beneficiaries under 18, which could lead to the death benefit being tied up in court for years. Instead, consider listing a spouse or someone else you trust to be the beneficiary of your policy. You can also list multiple beneficiaries or a trust to receive the money. “[Picking a beneficiary] is a personal choice of each policyholder, but the most common beneficiaries listed on a term life insurance policy are a spouse, children and siblings,” says Friedlander.

Additionally, if certain money should be allocated to specific financial obligations — such as paying off the mortgage or college tuition for children — this should be specified in a will. 

Types of term life insurance

There are several types of term life insurance policies:  

• Level premium: Your premium stays the same for the duration of the policy’s term. Some term life policies give you the option to renew your coverage at the end of the term or convert your policy into a whole life insurance policy.
• No-medical-exam: A type of term life insurance that offers the same robust coverage, but doesn’t require a medical exam during the application process. Premiums are level.
• Online life insurance: Offered completely online, online term life insurance policies provide competitive rates and don’t require a medical exam. Premiums are level.
• Annual renewable term: This gives you coverage for one year with the option of renewing it each year. With this policy, your rates go up every year.
• Return of premium: Return of premium term life insurance pays you back your premiums if you outlive your term life policy. However, you can expect to pay at least 50% more on premiums for these policies.
• Decreasing term: You pay the same premium for the duration of the policy, but the death benefit decreases every year. 

How to get the right term life insurance policy

For most people, a level premium term life insurance policy is the best fit. It’s simple and provides the most bang for your buck. No-medical-exam life insurance and online life insurance fall under the level premium term life insurance umbrella. 

How much term life insurance you need depends on your debts, financial needs, dependents’ needs – and how long you have those responsibilities. When will your dependents reach financial independence? What are your major debts, such as mortgages or student loans? When must they be paid off? Term life insurance is ideal for a younger adult who has major financial obligations such as home mortgage, educational expenses of their children, and other household bills, according to Friedlander.

Your policy’s coverage amount and term length should match these financial obligations. For example, if you have a $250,000 mortgage left that lasts another 20 years, you should think about $250,000 in coverage and a 20-year policy. Consider all of your financial obligations when purchasing a policy. 

Additionally, you should take the following steps to get the right term life insurance policy for you:

• Shop around: Life insurance quotes vary considerably among insurers. Compare quotes from at least three insurers so that you get the best possible price. 
• Be truthful: Answer all application questions accurately. Not only does this help you get the right policy for your needs, it also ensures your policy isn’t canceled later on. 
• Sweat the fine print: An insurance policy is a legal document. Read it carefully and make sure that you understand it before signing anything.

How much does term life insurance cost?

The price of term life insurance varies depending on your age, health, lifestyle choices, and your policy’s coverage amount, but term life insurance tends to be cheaper than most people expect. A majority of Americans overestimate how much life insurance costs by three-fold, according to LIMRA.

Here’s how much you can expect to pay for a 20-year-term life insurance policy if you’re in excellent health: 

Average insurance cost for 20-year-term life insurance policy

$500,000

Age	Gender	$500,000
25	Female	$208
25	Male	$254
35	Female	$243
35	Male	$279
45	Female	$485
45	Male	$607
55	Female	$1,093
55	Male	$1,497
65	Female	$3,448
65	Male	$5,075

$750,000

Age	Gender	$750,000
25	Female	$276
25	Male	$348
35	Female	$332
35	Male	$386
45	Female	$698
45	Male	$880
55	Female	$1,613
55	Male	$2,212
65	Female	$5,141
65	Male	$7,581

$1,000,000

Age	Gender	$1 million
25	Female	$321
25	Male	$422
35	Female	$403
35	Male	$471
45	Female	$868
45	Male	$1,120
55	Female	$2,059
55	Male	$2,867
65	Female	$6,564
65	Male	$9,749

You’ll notice that life insurance gets more expensive every year you age. It also gets more expensive if you have risky lifestyle choices, such as smoking. 

Ellis advises that it’s a good idea to get life insurance as soon as someone else depends on you. Keep in mind that this may not always mean that they depend on your income. 

“If one spouse is ‘stay at home,’ I would still recommend they purchase some life insurance. Even though there is no lost income, replacing the lost childcare and domestic duties can be very expensive,” Ellis adds.

How to shop for term life insurance

1. Use our life insurance calculator to figure out how much coverage you should get: The Insure.com life insurance calculator takes into account your funeral costs, mortgage, income and debt to give you a clear estimate of the ideal amount of life insurance coverage.
2. Choose the right life insurance company for your needs: Insure.com maintains a list of the best life insurance companies, making choosing a reputable insurer easier.
3. Choose the length and coverage amount of the policy: The most common term lengths include 10, 20 and 30 years, while the coverage amount should equal the amount you want your beneficiaries to receive if you die.
4. Sign your policy papers and pay your first premium: After you sign your policy and pay the first premium, your policy is active. 

Term life insurance offers no-frills coverage at an affordable price. It is the best option for most people, though people with complex financial planning needs or long-term dependents may be better suited for whole life insurance. Talk to an insurance agent or certified financial planner to determine the best policy for you.

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