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Term Life Insurance: Defined And Explained

Sarah Li Cain4-Minute Read
May 20, 2021

Taking out a life insurance policy helps to protect your loved ones if you die. It’s especially important if someone like a spouse or child relies on your income for their daily expenditures. Term life insurance is popular since it offers this type of coverage at an affordable price. Plus, it’s easier to understand when comparing term versus whole life insurance.

What Is Term Life Insurance?

Term life insurance guarantees a payout (also called a death benefit) in case you die during a predetermined period, meaning the term of your policy. If this happens, your beneficiary will receive a lump sum of money that’s tax free, to be used for virtually any purpose. Common usage is toward funeral costs or to pay bills.

A term life insurance policy is a type of income replacement for your loved ones when you’re not around. Terms can range from a couple of years all the way to 30 years, with the opportunity to renew the term (specific qualification criteria will depend on the insurer). The policy expires once the term is up.

How Does Term Life Insurance Work?

When you apply for a policy, insurers will ask for your personal and health-related information to determine your term life insurance premium. Details you may need to provide include your age, smoking and/or drinking habits, and your family medical history. In many cases, life insurance companies will also require you to complete a medical exam to determine your current health. These results plus any answers you provide will be used to determine whether the insurer will approve your application.

Once you have your life insurance policy and you pay the premiums, your policy is in effect. What you’ll be covered for will depend on your policy. For instance, most insurers will cover you in the event you die from a car accident, whereas someone who dies from a long-term illness may not be covered.

If you die within the term of your life insurance policy, the insurer will give your beneficiary a cash payout. This amount is not taxable, and the policy doesn’t hold any value other than the death benefit. If you die after your term is over, there will be no death benefit.

How Much Does Term Life Insurance Cost?

Average rates can range from $10 – $70 per month; your exact term life insurance quote may be higher or lower. Costs vary by type of policy, features within the product. The final price you pay will also ultimately depend on factors such as the following:

  • Health: Insurers require you to go through a medical exam to determine if you have any health risks. If so, you may have to pay more.
  • Age: The older you are, the higher your premiums will likely be
  • Gender: Men tend to pay higher rates since they’re perceived to be riskier.
  • Lifestyle habits: If you smoke, drink or work in a riskier profession, it could affect your rates.

What Are The Different Types Of Term Life Insurance?

There are two main types of term life insurance: level and decreasing. Although level term life insurance policies are more popular, you should shop around and consider which type best fits your needs and budget.

Level Term Life Insurance

When people talk about term life insurance, it’s mostly likely about level term life insurance. This type of insurance guarantees that you’ll pay the same amount for your policy throughout the term. The death benefit will also remain the same. 

Decreasing Term Life Insurance

Decreasing term insurance decreases your coverage at a predetermined rate throughout the life of your policy. You can renew this policy and premiums tend to remain the same, with reductions in coverage occurring annually or monthly You can typically purchase plans from 1 to 3 years.

This type of coverage is best for those who know that their financial obligations (like paying back debt, making mortgage payments and paying for their child’s college education) will go down with age.

Term Life Insurance Vs. Whole Life Insurance

Whole life insurance terms won’t expire as long as you’re alive. Term insurance, on the other hand, will only last as long as the agreed-upon term. Plus, whole life policies have a cash value component that acts like an investment account, growing in value over time. Term life insurance is only meant to pay out a death benefit and doesn’t have the investment component.

Whole life insurance can get complicated because of how you can accumulate cash value and the premium may not remain the same throughout your policy. That’s why it’s important to read the fine print and ask your insurance company to make sure you understand the ins and outs of your policy. 

The Pros And Cons Of Term Life Insurance

Before purchasing a term life insurance policy, you’ll want to consider both the benefits and drawbacks.

The Pros Of Term Life Insurance

The main benefit of term life insurance is to provide significant death benefit coverage for a low, temporary cost. It’s also less expensive than whole life insurance with similar coverage.

Plus, term life insurance provides flexible coverage, in that you can add insurance riders to provide more protection in the event of your death.

The Cons Of Term Life Insurance

The short time period of term life insurance can be a disadvantage to policyholders. If you outlive your policy, you won’t get the money back. If your policy expires, you may be able to renew it, but insurers may require that you go through another medical exam and even pay a higher monthly premium.

Who Benefits The Most From A Term Life Insurance Policy?

Term life insurance is popular among families with young children because it provides protection in case your income is lost. It helps to replace what you would have earned and provides financial stability to your loved ones even if you’re not around.

These types of policies are also best for those who want an affordable monthly premium and have a pretty good grasp on investments elsewhere (meaning, no need for a whole life insurance policy).

The Bottom Line: Shop Around For Term Life Insurance

Term life insurance is a great idea if you want to make sure your loved ones are taken care of if you die prematurely. When choosing the best policy, review our guide to shopping for life insurance. That way, you can find something that suits your needs best at a price you can afford.

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    Sarah Li Cain

    Sarah Li Cain is a freelance personal finance, credit and real estate writer who works with Fintech startups and Fortune 500 financial services companies to educate consumers through her writing. She’s also a candidate for the Accredited Financial Counselor designation and the host of Beyond The Dollar, where she and her guests have deep and honest conversations on how money affects our well-being.