Some people look for ways to provide for their loved ones long before they are gone. Of course, we want them to recover from the loss fully and without much disruption, especially in the household’s finances. Term life insurance is one of those ways. However, not all people are keen on investing in this type of policy.
Why do you need to invest in term life insurance? Is it for you, or should you turn your attention elsewhere?
Below are some of the most important things to know about term life insurance. Read on!
What is term life insurance?
Term life insurance is probably the simplest life insurance form out there. The insurer, or insurance company, pays out a fixed sum of cash called death benefit to the policyholder. Before so, the policyholder must pay fixed monthly premiums to the insurer.
This life insurance type has a fixed contract length, often from one to ten years. The beneficiaries are guaranteed the death benefit so long as the stipulated conditions in the contracts are met.
What are the features of term life insurance?
- Pays death benefits only, no cash value
- Pays benefits if you die while the policy is in effect
- Purchased for a term (i.e., 1, 5, 10, 15, 20, 30 years)
- Becomes more expensive with age and health condition
As such, there are two things to understand about term life insurance. First, the coverage exists over the contract period provided that the policyholder does no relapse from his or her monthly obligations. Second, the beneficiaries are paid if death occurs within the contract period; otherwise, they would not be.
Essentially, this life insurance type is purely for the protection of the policyholder’s beneficiaries – the loved ones that would be left behind in case the insured person dies unexpectedly.
Other than death benefits, however, there is no other mechanism to utilized for extracting other financial benefits from the policy. The ultimate goal lies in transferring the risk of death to the policy during its active life.
In a study published in the European Journal of Operational Research entitled On consumer preferences and the willingness to pay for term life insurance, some respondents mention their desire to pay for relatively high monthly term life insurance premiums. However, a greater fraction of respondents are not willing to pay for these because of the absence of the necessity for mortality risk coverage.
That’s the thing with term life – you are only covered for a specified period, which is the term, with no cash value accumulation.
Some people hesitate to get this policy because of these cons in exchange for other policy types. This only tells us that the term life policy suits specific people and needs.
When should you get a term life insurance?
Financial advisors suggest starting with the term policy as soon as they can financially support the monthly premiums. It means as soon as you have a stable job or steady source of income. Starting it younger allows you to get maximum coverage for the least amount of money. Term policies get more expensive, the more you put it off.
While getting a whole life or term life policy is a personal decision, the basis of getting a term life insurance should be the financial needs of your beneficiaries. Additionally, the good rule of thumb is to aim for a term that is between 5 and 10 times your monthly income. Of course, your financial goals also matter.
For example, if you have a long-term loan and you suddenly met your demise, who will pay for it? Would you want your family to bear the financial burden when you’re gone? Of course not!
The same goes if you have children, wherein the consideration for the term length must depend on their age. The term length should cover the time when you foresee them completing college. If not the children, your spouse’s needs that will be left behind after your passing.
You might want a term life insurance policy with the lowest monthly premiums but enough to cover final expenses. As you age, consider the changing needs and terms when you renew or convert the policy.
How to decide on the term length?
Above are some scenarios you should consider when getting a term life insurance. You may perceive this policy as eventually ending – it may be true, though, they technically end when you reach the age of 95 years.
It is crucial to get this part right because of three things:
- When the term policy ends, the rates increase (up to 10 times higher). This is also the reason why some policyholders just let it expire without doing anything about it when it should not be the case.
- If you decide on a longer-term, you might end up paying more than you should. Part of the premium payment is the rate guaranteed- that it will be fixed at that rate for a specific period. The longer rate guarantee costs more.
- If you decide on a shorter-term, you could be left without any coverage when you and your family need it the most.
There is what you call the annual renewable term (ART), which can be renewed every one-year interval. While it may sound the cheapest option, it is not, especially when compared with a 10-year policy and what more with a 20 to a 30-year term.
It boils down to answering simple questions as:
- How many years until our mortgage loan is paid off?
- How many years until our youngest child finishes college?
- How many years until my spouse and I retire?
- How many years until my other debts are fully paid off?
- How many years until …?
Your answers should guide you in deciding for the term length. The rule of thumb is to choose a term life insurance based on the largest number of years until all obligations are fulfilled or met.
You can never shortchange your decision by compromising with the average years of meeting mostly financial obligations. You will surely regret it in the end.
What happens if you outlive the term policy?
- Can be renewed for term length extension
- Can be used as an additional temporary coverage (with a permanent life policy)
- Can be converted into whole life insurance
Speaking of which, you have several options upon the expiry of the policy. Kudos to outliving your term life policy! But what you must do with it now.
First, you may extend your coverage. Term life insurance does not technically expire until you reach 95. You may keep on paying for the premiums to it continues to be in force, although it is best to ask your agent about this.
Coverage extension is a worthwhile option more so if you need coverage for shorter periods (about 2 to 3 years). This could be your only option if there are health changes that limit you to obtain other health insurance products.
However, unlike the actual term length with fixed monthly premiums, the extension might require additional cost. This may also increase as you age. You might as well check the policy provisions on estimated annual premiums and the years following the expiry.
Second, you may renew your coverage, which is technically the least expensive option. Your choices are renewing with the same company, which could also give you the same terms, such as the fixed monthly premium or with another company.
The concern here is you still need to undergo the same exam to show you are still in good health. Changes in your health, or what they call insurability, may also mean adjustments to the term life insurance. You might be denied coverage if health has already deteriorated.
Third, you also have the option to convert the coverage. Nonetheless, you need to check the contract because this option may not be considered if the policy took effect more than ten years ago.
Then again, your choice of conversion is from term to permanent life policy (also called universal life insurance) or whole lie insurance. In brief, both whole life and permanent life offer guaranteed death benefits and cash value. However, whole life has a fixed premium, while permanent life has a flexible premium. Be sure to check with your insurance company what options are available to you.
Conversion guidelines generally vary, and these will depend on at least three factors:
- Entire term – allows policy conversion before the policy expires
- Period – allows policy conversion for a specific period like five years at the start or end of the term policy
- Specific age – allows policy conversion up until a certain age (usually 70 years)
If you are considering conversion, you should start the process long before the policy expires. It is also good practice to reread the contract regularly, say bi-annually. Through this, you may decide on the best option as the policy term draws near.
Things to remember about term life insurance
- Term life extension, renewal, and conversion vary from one insurance company to another. Check your options with them always.
- Prepare a copy of the term life insurance policy when approaching an agent or any company representative. Have the documents reviewed by an expert.
- Decide on your options only when you fully understand them. Ask questions and clarifications.
- Conversions are not reversible, so give it some thought before you decide for anything.