Almost everyone needs some kind of life insurance, whether it is to cover funeral expenses, provide financial support for a family if a wage earner dies, or shield a business partner when a key executive passes.
- For example, stay-at-home parents provide important and valuable services and the cost of paying for those services should be considered when a life insurance policy limit is selected.
- Retirees need life insurance to cover final or burial expenses and any medical bills they may leave so their family is not left with debts and liabilities.
- Even young singles often have car or student loans that should be covered so family members are not left with a financial burden.
To protect yourself in all these situations, term life insurance is likely the ideal type of policy to buy.
What Is Term Life Insurance (and do you need it)?
The basic types are term and permanent life insurance.
Term life, also known as pure protection since it has no cash value, savings or investment feature, is the cheapest kind of life insurance, offering temporary coverage for a specific period of time.
Term life insurance is best used as income replacement for a wage earner who has financial dependents, such as a spouse or kids. Usually with a low, fixed premium, a term policy can provide life protection ranging from 1 to 30 years, and is best purchased by consumers interested in an affordable policy that will expire when debts and liabilities are minimized.
How Does Term Life Insurance Work?
In its simplest form, term coverage provides benefits for a predetermined number of years, usually 1, 5, 10, 20 or 30 years.
In exchange for the life insurance company’s obligation to pay out your death benefit, also known as the amount you are insured or covered for, you promise to pay monthly, quarterly, or annual premiums. When purchasing a policy, you will choose who the death benefit is paid out to – your beneficiaries.
Fixed Premiums – Traditional term life insurance guarantees fixed premiums for the life of the policy, meaning that all premiums are equal payments paid over equal intervals of time; however, certain term policies have different characteristics and premiums may change in specific circumstances.
If the insured individual survives the term period, the policy will terminate with non-payment of the death benefit, and the life insurance company is no longer contractually obligated to pay out. To continue coverage, the policyholder will have to renew the contract, usually at a higher rate to reflect the increased mortality risk of the insured person.
Fixed Death Benefit – Standard term policies also have a fixed death benefit, the amount of which is determined by the policyholder at issuance and affects the premium payments that will be made. Certain types of term life have increasing or decreasing death benefits. With all things being equal, a smaller death benefit will obviously result in more affordable rates. If the insured is alive at the end of your term period, then the beneficiary does not receive the payout of the death benefit.
You should also keep in mind that life insurance is sold by the unit. A unit may be $1,000 or $10,000, depending on the company. The cost per unit of term is considerably lower than the cost of permanent life insurance, allowing individuals to purchase more units of coverage and higher death benefits while remaining within their budget.
Term Period – The term period is the number of years you choose to be covered for. It is chosen when you are first buying your policy. After the predetermined period of coverage ends, you can renew your life policy; however, premiums will readjust and rates may be much higher to account for the additional risk posed by your increased age and the discovery of medical conditions or illnesses.
Term Life Is Flexible
Once a permanent life insurance policy is purchased, the death benefit is fixed and cannot be changed as financial circumstances change. One of the advantages of term life is you can get coverage for a specific time period and increase or decrease the death benefit when you renew the policy after expiration.
While a 30 year-old with financial dependents may need $500,000 in life insurance coverage for 30 years, once his/her children are grown, the need for insurance decreases and the person can adjust the limit upon renewal or let the policy expire altogether.
How Term Rates Are Calculated
Term premiums are based, in part, on the length of the term and the amount of the death benefit. Since the policy only pays a death benefit if you die within the period, the shorter the term of coverage, the lower the risk of death and thus the cheaper the premiums.
Additionally, rates are based on life expectancy. Since younger and healthier individuals are less likely to die, they are offered more affordable rates than older people. Permanent life insurance policies have higher premiums since payment of the death benefit is guaranteed at some point. However, with term life insurance, the policy may expire before the insured person dies so there is a chance the company will retain all premiums.
The complete list of factors that affect your life insurance rates includes:
- Term Period and Death Benefit
- Age, Gender, Height, and Weight
- Current Health and Medical History
- Lifestyle Choices
- Non-Medical Factors – (High Risk Occupation, Foreign Travel, Credit Score and Rating, Driving History)
Even with so many factors, there are many ways to get cheap life insurance.
How Much Life Insurance Do I Need?
The amount of life insurance you need depends on your age as well as current and expected future income, assets, debts and liabilities. You will have to calculate your current cost of living to determine the annual income your family needs to survive, taking into consideration mortgage payments, car and personal loans, daily living expenses, credit card bills, college tuition costs, medical insurance and funeral expenses.
Try to imagine how your family’s lifestyle may change in the future and add or subtract these expenses from your annual budget. You will need to adjust this standard of living for inflation as well, so pick a percentage increase (2-4%) year after year to account for rising costs.
Then, choose the number of years you would like to provide financial security for your family. If you are the primary breadwinner of the family and have young children, it would be best to offer coverage until your youngest child graduates college.
For example, if your family survives on a budget of $100,000 per year now and you want to provide income replacement for 20 years, not accounting for inflation or investment returns, your family will need a nest egg of $2,000,000.
Finally, take a close look at your current resources and assets. To avoid buying too much coverage, factor in your savings accounts, investments, retirement accounts, pensions, survivor’s benefits, existing life insurance policies from employers, and other sources of income.
Generally, you will use these assets to lower the death benefit required. Using the example above, if you have $500,000 saved between various accounts and investments, you would choose to buy a policy worth $1,500,000 to make up the deficit.
Age and Gross Annual Income
A more simplistic approach some financial advisers and life insurance agents suggest is to take a multiple of your annual income. See the following breakdown by age to get an idea on how much life insurance you need.
- 20 to 30 Years Old – 15x
- 30 to 40 Years Old – 12 to 15x
- 40 to 50 Years Old – 10 to 12x
- 50 to 60 Years Old – 7 to 10x
- 60+ Years Old – 5 to 7x
The Rule of 4%
Four percent is a pretty reasonable and conservative rate of return on your investments, so if you want a lump sum insurance payout that will provide low-risk, interest income for your family, consider the Rule of 4%.
The calculation goes as follows: if you make $50,000 per year and this income sufficiently covers your family’s financial obligations, then you should buy a policy with a death benefit of $1,250,000. That money, invested at 4%, will yield the necessary $50,000 income.
Similarly, if your financial dependents currently live off of $50,000 per year and you have a $200,000 mortgage, $25,000 car loan, $20,000 in student loans and $5,000 credit card debt, you can add the $1,250,000 required for income replacement to the $250,000 debts, and choose to purchase a $1,500,000 policy.
If you cannot afford to purchase all the coverage you need at once, purchase as much as you can afford to give your family the best protection possible. Life insurance policies are usually long-term contracts, so some financial planning should be involved when selecting the policy limit.
The Different Types of Term Life Insurance
There are over a dozen types of life insurance policies available to you in the United States, and each of these can be further customized with riders and options. Here is a list of the most popular and common term life plans.
Mortgage Life Insurance, Decreasing Term Life Insurance
Some term insurance policies provide additional flexibility by changing to meet fluctuations in your financial liabilities. For instance, families make monthly mortgage payments, and a portion of that payment covers interest and the rest goes to paying down the principal.
Over the course of your loan period, you will eventually fully pay off your home; however, what happens to your family if you die and there is no income? Mortgage life insurance, as well as decreasing term life insurance, both offer protection for your family in cases like this.
Both life insurance policies start with a certain death benefit and premium, and both decrease over time as the need for coverage decreases. This type of coverage is often used to cover your mortgage so your family keeps their home, although it can be applied to any financial situation where the need for protection will decline over time.
For example, decreasing term insurance is also appropriate for individuals preparing for retirement. While more coverage is needed for young families or those who have children in college, the policy self-adjusts over time as your kids become financially independent.
No Exam Term Life Insurance
Becoming popular in the U.S., particularly in California, is no exam term life insurance.
No exam life insurance does not require a medical exam, physical tests or an appointment with a physician to receive life insurance coverage, but will charge higher rates.
The increased premiums are due to the additional risk the insurance company experiences without fully reviewing your current health and medical history (you will have to honestly answer medical questions, though). Finally, most life insurance companies cap the death benefit amount for no health exam policies at $250,000 or $500,000.
Guaranteed Life Insurance
Guaranteed life insurance is very similar to no exam life insurance because you don’t need to undergo a medical examination.
However, guaranteed life takes it a step further and doesn’t even require a detailed medical questionnaire. All you have to do is continue paying your premiums and the company will guarantee coverage. Just keep in mind that rates are usually four or five times more expensive than traditional policies.
Group Life Insurance
Group life insurance is provided by employers, associations, alumni groups, or labor organizations to their employees, workers or members. Group life coverage is offered as a part of a benefits package and, like health insurance, is much cheaper per employee than purchasing an individual policy.
The only difference is that group life insurance has a limit on the death benefit, and supplemental protection may need to be purchased privately.
Return of Premium Life Insurance
While term life insurance policies do not have a savings or investment feature, some policies offer a return of premium option. If the insured person outlives the term period, the premiums paid into the policy, with interest, are returned to you at the end of the term.
The primary difference between return of premium term and permanent insurance is that ROP policies cannot be used as security for loans. The premiums for ROP policies are higher than those of traditional term life insurance, but lower than premiums for permanent.
Learn more about return of premium life insurance.
Level Term Life Insurance
Level term offers traditional coverage with guaranteed level, fixed premiums for a given number of years. Where some types of life insurance readjust premiums after one or five years, level term maintains a constant rate for the life of the policy.
High Risk Life Insurance
High risk life insurance refers to a policy that covers a high risk individual.
Whether you are “high risk” due to a hazardous job or occupation, the dangerous activities or hobbies you engage in, are a smoker or have a health condition such as diabetes, high blood pressure, cholesterol, or bipolar disorder, you pose additional risk to the insurance company underwriting your contract.
If the life insurance company decides to issue you a policy, the rates will be higher than someone else who does not have a risky profile.
Survivorship, Joint, and Second-To-Die Life Insurance
Survivorship life insurance, also known as joint or second-to-die life insurance, protects two people, who are usually married, with one policy.
Unlike other types, these policies pay out their death benefit only when the second, or last surviving, spouse dies. Because the surviving spouse does not receive the death benefit, survivorship protection is primarily used for estate planning and intended to help heirs pay estate taxes or cover final expenses, such as funeral, burial and medical costs. Remember that agents, brokers, and insurance companies use “survivorship”, “joint” and “second-to-die” life insurance interchangeably.
Learn more about second to die life insurance.
Renewable Term Life Insurance
When a term policy expires, the insured person usually has to reapply for life insurance coverage and undergo another medical exam.
With renewable term life insurance, the person can renew the coverage at a slightly higher premium without having to reapply for insurance. Longer term policies of 20 or 30 years may not offer a renewal option, but short term policies often allow the policyholder to renew the policy multiple times without having to go through the application process again.
One Year Renewable Term Life Insurance
Since premiums are partly determined by the length of the term, one year policies provide very inexpensive protection for young families.
If the policy is renewable, there is no need to reapply for term life insurance and the policy can simply be renewed for a slightly higher premium. If you wish to change the death benefit or the term period, you may have to apply for a new policy. If the current policy continues to meet your needs, you can simply continue to renew annually.
Convertible Term Life Insurance
Some people like the investment or savings features offered by permanent policies, but cannot afford the higher premiums of whole or universal life insurance. In this case, you can buy term life insurance for 1, 5 or 10 years, or you can purchase a longer term policy with an option to convert it into permanent coverage when financial circumstances change.
Convertible term life insurance eliminates the need to apply for permanent protection when an individual can afford to make the switch.
Increasing Term Life Insurance
Young families with tight budgets may not be able to afford the amount of coverage they need for a growing family. Increasing term life insurance starts with a lower death benefit and premium, but allows both to increase over time as the young family’s income and financial obligations rise.
Typically, the death benefit will increase anywhere between 2% and 10% per year, though additional coverage is directly proportionally to higher rates.
Supplemental Life Insurance
While permanent life insurance has some advantages, the death benefit is fixed and may not provide enough coverage as a policyholder’s financial circumstances change. A term life insurance policy can be used to provide additional protection for families when the need is greatest.
Since term life can be purchased to cover a specific time period, the policyholder does not have to pay for the extra life insurance once the need for it has passed and inexpensive premiums make term life an excellent option for supplemental coverage.
Buying Life Insurance
Most potential consumers looking to buy life insurance frequently ask three primary questions. These questions are extremely important in determining your life insurance rates, policy type, coverage, and terms, and thus need to be carefully considered before purchasing protecting.
- What is the right amount for a death benefit? How much will my beneficiaries need to survive or maintain a certain lifestyle?
- How long do I need life insurance coverage? Based on my current health and lifestyle choices, realistically, how long will I be alive to take care of my family? Do I engage in any high risk or hazardous hobbies and behavior?
- Who should I buy life insurance from? Which term life insurance company is best?
The following are some tips to help you answer these questions.
- Most individuals, on average, need a death benefit about 10 times their annual income, but your financial situation may need extra attention. How much life insurance you need is a discussion best had with a licensed insurance agent or financial adviser/planner.
- Wage earners or breadwinners should buy coverage for at least as long as it takes for them to reach retirement, allowing them to maximize their protection and avoid reapplying for a policy. Homemakers need to purchase life insurance coverage for at least as long as there are dependents/children who require care at the home. Remember that stay-at-home parents offer services that would otherwise need to be paid for.
- Only buy life insurance from a financially stable and reputable company who is likely to be around in the future.
While life insurance for young individuals is fairly cheap, consumers can save even more money by comparing term life insurance quotes online.
We offer term life insurance quotes from several different providers so consumers can compare the rates of various companies side by side. It only takes a minute to get a free term life insurance quote, and as with any major purchase, it pays to shop around.