Term Life Insurance
B.A. Risk Management
Life Insurance Agent
What is Term Life Insurance?
Term life insurance is a life insurance policy that offers coverage for a fixed duration of time, or “term.”
The insured pays a pre-determined amount as the premium at periodic intervals during the policy’s term. At the end of the policy term, the insured can explore new rates and conditions prevailing at that time to purchase a new insurance policy.
If the policyholder passes away before the maturity date, the insurance company will pay death benefits as promised in the term life policy to the policy’s named beneficiary.
Term life insurance has two primary benefits:
- It is among the more cost-competitive of life insurance policies (the premium amounts are relatively low compared to the lump sum benefits paid out)
- It guarantees substantial payouts in the unfortunate event of death
How Does Term Life Insurance Work?
Term life insurance works by providing a death benefit to the beneficiary if the insured person passes away.
Here are the steps to securing a term life insurance policy.
Step 1 – Choose Policy Duration
The main purpose of this type of policy is to protect loved ones from large financial burdens following the sudden death of a family’s main financial support provider. Thus, the first step to planning for this coverage is for the applicants to determine how many years they expect their family to be financially dependent on them. This is, ideally, the recommended duration of the policy.
Step 2 – Choose the Amount of Death Benefit
To calculate the right death benefit amount, the applicants will need to determine:
- The number of years the they want to provide financial support for their family following the possibility of their untimely death. Considering what future expenses are expected to be covered by the death benefit will provide an accurate value for the payout sum needed.
- How much premium the applicant can afford, keeping in mind as the death benefit increases, the premium also increases.
Finding a balance of these two values will determine the right death benefit an applicant should obtain quotes for.
Step 3 – Undergo a Medical Exam or Provide Health Information
All fully underwritten insurance plans require a medical exam (including lab tests) of the insured person. Healthy persons typically pay lower rates. For simplified issue policies, insurance companies will only ask a few questions about the applicant’s health throughout the application.
Step 4 – Pay Premiums
Many criteria are factored in when calculating premiums. This is a complicated equation determined by the life insurance companies. But in general, younger, middle-aged policy holders pay a less expensive premium because they considered low risk. Older applicants and senior citizens, thus, pay higher premiums.
Step 5 – Death Benefit Goes to Beneficiary in the Event of Death
The policy beneficiary will receive the death benefit payout amount in the unfortunate event the insured individual passes during the policy period. If policy payments are discontinued, even if still within the policy term, or the policy period has lapsed or expired, no benefits will be paid.
Who Is Term Life Insurance For?
Term life insurance is recommended for anyone who needs life insurance coverage for a set amount of time, though some individuals might benefit more than others. Term life insurance could be an ideal option for those looking for life coverage and are in the following situation:
A Young Family
A young couple with little kids, referred to as a young family, is a great example of a good candidate for term life insurance. Young families have two main expenses—raising children and monthly mortgage payments. If a young family’s main earning member passes away before the children are grown or before the mortgage has been paid off, the family may have to endure significant financial hardships in order to maintain everyday life expenses. Term life insurance coverage can provide protection against such difficulties.
There are other expenses to consider as well, including future costs like college, cars, weddings, etc. Term life is an affordable option that protects young families from such financial hardships. With a term insurance policy, a young family’s main breadwinner can pay a considerably low premium and leave a significant payout for the family should he or she pass away. Read more about life insurance for families.
Single moms and single dads are another example of prime candidates for a term life policy. Considering if something happens to their parent, leaving the children with no one to bring in income or ensure them a safe upbringing, parents can find comfort in purchasing a policy that will alleviate some of their children’s stress during a difficult time. This coverage is perfect for helping single parents protect their children’s future.
The policy also allows for guardianship of the children to be named, so policy holders not only know their children’s well-being is protected, but also that a trusted caretaker selected by the parent will see to it that the children’s needs are met. With its low premium advantage, term life insurance is one of the best options for substantial coverage.
Young Couples without Children
Even for a young couple who do not have children, living expenditures are expensive. In a family with only one income or where two incomes are vital for survival, if one person passes away, the other could fall under financial strain.
Low-cost term life insurance can help reinforce the surviving spouse’s income until retirement benefits begin. If planning to have kids in the foreseeable future, young couples can also plan for future payout needs accordingly. Securing a policy at a younger age will ensure premium remains low and affordable.
Young and Single
Single young individuals may not realize the relevance of a term life policy in their situation. Without anyone depending on their income for support, it may not be a priority to young singles. While this is a good point, these individuals should consider purchasing a term life policy if any of the following apply to them:
- He or she plans to get married and/or have children in the future
- He or she has student loans for which their aging parents co-signed. To prevent co-signers from being responsible for these debts in the event something happens, term life will ensure
A term life policy would protect the insured’s future family or parents from financial burdens that would result follow if the policy holder passes away. The best time to purchase a term life insurance policy is now when it is more affordable than it will be in the future since premiums are lower for young people.
Term vs Whole Life Insurance
The two types of life insurance are term life insurance and whole life insurance. The main difference between the two is the length of coverage. Term life insurance provides coverage for a set period of time. Whole life provides coverage for life.
Whole life policies also have an investment component that builds cash value. For most people, it makes sense to buy term and invest the money saved in premiums somewhere else. This is the financial advice many experts prescribe. See our guide for a deep comparison of term life vs whole life insurance.
What Term Length is Best?
Term life coverage is available for varying durations or terms. These terms include the following:
Renewable annually: Requires the policy holder to renew the term annually. The premium rates for an annually renewable term (ART) could increase every year. This coverage is better suited for individuals needing coverage for only one year. For others, it may not be the best choice.
10-Year Term: A 10-year term policy expires after a period of 10 years.
15-Year Term: The 15-year term policy expires at the end of 15 years.
20-Year Term: The policy term is 20 years.
30-Year Term: The policy term is 30 years.
Other terms: A few insurers may offer 5-year and 25-year terms, but these are less common.
It is paramount to note if a policy holder wants to buy another term life insurance policy at the end of the current term, the new premium rate is calculated at current levels, and other terms and conditions could also change.
Factors to Consider while Choosing a Policy Term
Considering the age of children can influence the policy term for most applicants. Childcare, college tuition, etc. may be expenses that need consideration when selecting a policy term.
The policy term should be appropriate to the time period needed for children to complete college or until they become independent adults. For example:
- If your child is four years old, and you are taking a term life policy now, a 20-year term would likely suit your needs.
- If your child is 12, then a 15-year term might be a better option.
- If you are yet to have children, but plan to expand your family someday, you might choose a 30-year term.
Applicant’s Debt Situation
In addition to the time needed for children to become financially self-sufficient, insurance shoppers may also need to consider the time it will take to pay off any substantial loans such as the following:
- Student loans
- Other long-term borrowings
Making sure the policy term runs through the duration of all financial commitments will ensure loved ones do not have to struggle to settle the debts left behind.
Spouse’s Financial Dependence
For individuals or couples who have a mortgage, the best policy term will likely last for the duration of the mortgage. For instance, most people with a 30-year mortgage get a 30-year term policy.
The question to consider, though, is how much the surviving spouse will need to manage if half (or more) of the regular income contributed to the household disappears overnight. The key to life coverage is to make sure the payout is enough to supplement the loss of income.
Keeping in mind post-retirement income is likely to come from sources other than work, it is safe to say less coverage will probably suffice during the retirement phase of life. So, for younger applicants, a 30-year term policy is efficient to provide help to the surviving spouse with living expenses until retirement.
Supporting Parents or Elderly Relatives
If you already support or plan to take care of elders in your family at some point, then your policy term should match the period required for their social security benefits to begin. This way, you can ensure they are reasonably protected financially.
What is your Budget?
One important thing to remember when planning a life coverage policy is that premium payments must be paid on time and for the entire term of the policy to keep the policy active. If the insured defaults on payments, the policy will lapse. Because this is not a short-term arrangement, applicants should choose a plan carefully that fits within their budget now and in the long run.
To save some money on insurance premiums, consider the following tips:
- Start early. Buy the policy when you are younger and healthier. The rate at which premiums are calculated is lower for young, healthy persons.
- Do not over-estimate coverage needs. This will add to the premium burden.
- Choose a reasonable term length.
Using an online premium calculator to find out what unnecessary coverage is avoidable can also put these variables in perspective. Adjust policy durations and policy coverage amounts to see how premium amounts change when you manipulate these values.
How much term insurance coverage do you need?
A broad-based way to determine this amount is to calculate the sum of all long-term commitments and then subtract assets from this value. This value is what term life coverage should fill. This calculation is harder in practice than it seems in theory. Below are a few guidelines to help with this value.
The debt, income, mortgage, and education (DIME) formula exhibits the biggest factors to look at when calculating a practical life insurance payout.
- Debt — Include all loans (except mortgage) and expected funeral expenses in this category.
- Income — How long will surviving family members need financial support? For example, if until the youngest child completes high school, calculate the number of years left until that date and multiply annual income by that period.
- Mortgage — Take the total amount needed to pay it off.
- Education — Approximately how much money will surviving children need to get through college?
The DIME formula is a significantly more in-depth approach to calculating financial need and covers almost every major aspect of life’s financial commitment. Nevertheless, it is not a foolproof method.
Rather than considering term insurance amount and length of term in isolation, another effective way to approach it is to consider it as a part of an overall financial plan.
- A financial plan is a framework to meet all future expenses. Account for everything here—college tuition, income levels at each stage of life, etc.
- Make term life insurance a part of the financial plan and prepare to top up the payout sum in accordance with unknown future expenses.
- Try to buy more coverage (not less) than the estimated need calls for.
How Much Does Term Life Insurance Cost?
The cost of a term policy depends on a multitude of factors, but in general, it costs between $15 and $100 per month.
The following factors can have a direct bearing on the cost of the monthly premium for a term life insurance policy.
- Policy term
- Coverage amount
- Age of insured
- Health status of insured (both physical and mental)
- Smoking habits
- Driving history
- Family history of diseases
- Lifestyle—passion for adventure such as flying, sky diving, etc.
How to Choose the Right Term Life Insurance Company?
With all the options for providers available, deciding which life insurance company is the right choice can be difficult. The best company, in general, is the one that:
- Offers suitable products, competitive prices, and useful features
- Is known to provide excellent customer service
- Is in a position to meet the financial obligations of every policy underwritten by them
However, each person has a unique situation, and the best company for one person might not be the best for another. Due diligence is imperative when shopping for life coverage. Responsible consumers carefully consider their individual situation and requirements for a term life insurance policy and choose a company that meets their needs best.
One way to find the right insurance company is to utilize help from a solid and devoted insurance agent. An accomplished insurance professional meets the following criteria:
- Has thorough knowledge about each insurance company and its products
- Has the ability to identify the right benefits for their customers’ requirements and can make suitable recommendations to meet their needs
- Has personal experience and insight into how each insurance company functions
Most people buying insurance choose to go forward through a broker or an agent because of the value and insight they can offer. Buying a term life insurance policy is both a complex and difficult decision to make. A professional can make this process less stressful and provide practical solutions that nonprofessionals may not realize.
The Application Process
Step 1: Complete the Application
After choosing an insurance company and term life policy that meets your needs, the next step is to submit a formal application. Filling out the application takes most people approximately 20 minutes. The application will require the following information:
- Basic details—name, contact info, date of birth
- Unique and confidential information—driver’s license number, social security number, etc.
- Health details—medical conditions, history of family illness, etc.
- Beneficiary details—social security information about the person who will receive the payout in the event of your demise
- Contingent beneficiary details—if both you and the beneficiary pass away at the same time, or if the beneficiary dies before the payout, then the contingent beneficiary will receive the death benefits, such as your children or a trusted family friend.
When filling out the application, make sure you provide complete and accurate information. Incomplete details will cause undue delay in processing, and inaccurate information adds to the risk of provider rejecting the application.
Step 2: Take the Medical Exam
At this phase of the process, you may have to undergo a required medical examination. While there are companies that offer insurance policies with alternatives to a physical exam, some companies do insist on it. Many people feel anxious about this portion of the application, but it is not as bad as it may seem. It is a simple component of the application process. It takes place at your convenience and is free of charge.
If you want to avoid the exam altogether, try applying with these companies that offer no exam term life insurance. What to expect: A qualified nurse will typically visit the applicant at home at the scheduled appointment time. The examiner will administer the following tests:
- Blood pressure
- Blood sample
- Urine sample
- Height/weight check
The nurse will ask a few health-related questions as well, and that is usually the extent of the life insurance medical exam portion of the application process.
The result of the exam will have a direct bearing on the calculation of the policy’s premium. Therefore, securing a favorable medical outcome should be the primary goal. Some things applicants can do to improve the result of the medical exam are below.
- Eat healthy food for a few days prior to the examination, get plenty of rest, avoid alcohol for up to a week before, and stay well-hydrated
- Avoid stress leading up to the exam date; if the exam itself causes anxiety, ask the nurse to take blood pressure levels last
- Minimize the risk of any unusual spurt in blood pressure by avoiding alcohol, coffee, smoking, and extended physical workouts on the day of the exam
- Bloodwork is done on an empty stomach, so scheduling your appointment in the morning prevents the need to fast throughout the day
Because the medical exam portion of life insurance shopping is a dreaded by most applicants, many people choose to go through an independent insurance agency to purchase a policy. This is because they only must undergo one medical exam, which will serve sufficient for all insurance provider applications. Thus, if one insurance company declines an applicant, there is no need to repeat the medical test when applying to another.
Step 3: Underwriting the Policy
The underwriting stage of the life insurance application process can take anywhere from four to eight weeks. The policy provider will scrutinize all applicant records and perform multiple checks before determining the rate for monthly premiums. They will perform a thorough review of the applicant’s medical history via the Medical Information Bureau (MIB).
The insurance company will contact the applicant or the applicant’s doctor if the underwriting department needs additional information. A driving history check will also be performed before the insurance company determines the rate at which they will set the premium.
The underwriting department uses the following factors to calculate the final rate for an applicant’s policy premium:
- Physical build
- General health
- Smoking habits
- Driving record
- Family medical history
Step 4: Policy Approval
Within 10 to 15 days from the date of approval of coverage, the insurance provider will mail the policy documents to the newly insured to establish payment and get vital signatures needed to finalize the policy.
The faster the insured party returns the signed documents to the insurer, the sooner the policy is active. Once the provider receives the first premium, the policy becomes active.
For the first 30 days of the policy, the insured can make changes to the policy or change his or her mind all together and receive a full refund and policy cancellation. This is known as the “free look” period.
Useful Tips During the Application Process
During the application phase, there are some things applicants can do to make the process easier. These suggestions are noted below.
- Choose an insurance agency to help navigate the entire process from selecting the right term life insurance product to the application.
- Stay transparent and honest—both with the agent and the insurance company. Dishonesty causes both short-term and long-term problems.
- Perform well in the medical test. The test results affect the premium directly.
- Sign a conditional receipt to ensure coverage from the date of approval, which protects applicants during the document processing and phase.
- High-risk category individuals should ask their agent to attach a cover letter to the application. The letter should disclose the information below.
Learn more about life insurance approval times
- Details about the applicant’s condition
- Severity of condition
- How the applicant is managing the condition
This information will help less-than-healthy applicants secure a better rate.
Term Life Insurance Beneficiary
A term life insurance policy holder will need to specify a beneficiary who will receive the death benefit in the event of the insured’s passing. The list below explains the different types of beneficiaries.
- Primary beneficiary–This individual or group of persons will receive the payout in the event of the insured’s death. The policy holder may nominate anyone of his or her choosing as beneficiary.
- Contingent beneficiary–Another common term for this kind of beneficiary is “secondary beneficiary.” If the primary beneficiary dies before the insured person, the death benefit goes to the contingent beneficiary. In case the primary beneficiary is still alive at the time of the insured’s passing, the payout goes to the primary beneficiary only. The contingent beneficiary will not receive any money in that situation.
One of the safest approaches is to name both a primary and a contingent beneficiary in the policy, leaving no question for dispute.
In any term life insurance policy, the naming of beneficiaries may fall under two classes:
- Revocable beneficiary–Under this category, the insured person can change the beneficiary of the term life insurance without informing the person previously designated as the beneficiary. This can be done at any point during the policy term.
- Irrevocable beneficiary–As per this category, the policyholder cannot make any changes with respect to beneficiaries without getting the consent from the person(s) already named as beneficiaries in the existing policy.
Of these two, most experts favor the revocable option since it offers maximum flexibility to the insured individual in the long run.
Choosing the Beneficiary
Policy holders have a range of choices to consider when it comes to identifying a beneficiary including the following:
- Family member
- Beneficiaries can be minors with legal guardian named
Term Life Insurance Riders
A rider is an add-on that attaches to a term insurance for an additional, nominal charge. The rider provides supplementary protection in addition to the sum assured, under stipulated conditions stated in the rider.
Each insurance company offers different types of riders, and charges vary as well. The conditions under which they apply are also different. The same factors that affect the premium rate also affect rider rates.
Some common riders are found below.
In the Event of a Disability
Waiver of Premium Rider
As per the waiver of premium rider, if the policy holder becomes totally disabled and unable to work, payment of premium becomes unnecessary, but the policy remains active. This rider typically applies until 60 or 65 years of age.
Disability Income Rider
The insurance company will pay a regular sum if the insured becomes completely disabled and unable to work. The rider will specify how much money it will pay, as well as the duration for which payments will be made, for instance, if for the duration of the disability or for a fixed time period only. The cause for disability—sickness, accident, etc.—may also determine if payouts will be made or not paid.
If the Insured’s Health Deteriorates but More Coverage Is Necessary:
Rider Guaranteeing Insurability
Under normal circumstances, a person in poor health may have to pay hefty premiums to renew his or her term life insurance. In some cases, the insurer may refuse to renew the policy citing ill health as a major risk.
With the guaranteed insurability rider as an add-on, the insured can extend his or her term life policy:
- Without submitting any new documents to support insurability
- Without fresh medical exams
- Buy additional insurance at preset times
If the provider offers the option for this rider and the policy holder fears their health will deteriorate with time, this rider serves as a convenient opportunity for extension of coverage beyond the original term.
Converting Term Life Coverage into Permanent Coverage:
A conversion rider allows for a term life policy to convert into a permanent life insurance policy without updated medical tests. While the premiums for permanent insurance are usually higher, this rider allows younger applicants with entry-level income get an affordable policy.
In the Event of a Serious Illness:
Accelerated Death Benefit Rider
This is now a standard add-on provided for free or at a nominal charge. If the policy holder falls terminally ill and has a shortened life expectancy, he or she can withdraw a fixed part of the death benefit in advance with this rider.
The amount available will range between $250,000 and $500,000, but even if the rider came at no extra cost initially, the provider may charge a certain fee when the insured claims the amount made available.
Rider for Critical Illness
If a policy holder is diagnosed with a critical illness included in this rider (cancer, heart attack, renal failure, etc.), the insurer will pay a comprehensive sum to the insured to be used to pay for medical treatment related to that illness.
In the Event of Death from an Accident:
Accidental Death Benefit Rider
In case of death due to an accident, the beneficiary will receive an additional sum, in excess of the sum insured under the conditions of this rider. If the additional disbursement is equal to the death benefit, it is known as “double indemnity.” The beneficiary may have to pay a fee to receive this amount. Loss of limb or vision can also be compensated under this rider.
Term Life Insurance Claims and Taxation
Here are a few points to remember regarding tax implications:
- Because premiums paid under term life coverage are considered a personal expense, they are not eligible for federal income tax deductions
- When coverage exceeds $50,000, the insured may be taxed for employer-paid premiums. While the payment towards the first $50,000 is not taxable for the insured, and he or she does not have to declare the premium amount as income earned, for every dollar of premium paid, for coverage beyond $50,000, tax must be paid, as the amount is treated as part of annual earnings.
- In most cases, death benefits paid out posthumously are non-taxable. Both state and federal laws exempt the benefit from taxation. Therefore, if the sum assured is $500,000, then the beneficiary will not need to pay taxes on the overall amount.
- If the death benefit is paid out in installments, different rules apply. The principal is non-taxable, but any interest accrued on the installments is taxable at an ordinary rate.
- Loans taken against the policy may also be tax-free.
See our guide on life insurance payouts and taxes for more information.