The easiest kind of life insurance to understand is term life insurance. To put it simply, the insured person pays a small premium per $1,000 of coverage once a year, every six months, every three months, or every month. If he or she dies during the policy's term, the life insurance company will pay the face value of the policy to the beneficiary.
What's different about term life insurance?
To get a better idea of what makes term life insurance different, think about the following:
First, term life insurance is "pure insurance" because you only buy a "death benefit" when you buy a term policy. Unlike other kinds of "permanent insurance," like whole life, universal life, and variable universal life, this policy doesn't build up any extra cash value. Term insurance only gives you a set amount of money when you die.
Second, the coverage is for a set amount of time (called the "term"), such as one year, five years, ten years, fifteen years, etc. Once the policy is in effect, it stays in effect only until the end of the term, as long as you keep paying the premiums.
Third, at the end of the term, most term insurance policies can be renewed. With "Level Term Life Insurance," the death benefit stays the same over the life of the policy, but the premium goes up over time because the insured person is getting older. As time goes on, the cost of a level term insurance policy may rise beyond what you are willing to pay for a simple death benefit. Another option is "Decreasing Term Life Insurance," which has the same premium but a decreasing death benefit over time.
Fourth, most term policies can be changed into permanent policies after a certain amount of time. If you think it's important to keep the insurance coverage, you might want to plan on converting. You can figure out that the cost of term insurance premiums will go up over time and change your policy before the premiums become too high. It's true that the premium will usually be higher in the short term than if you just kept your term policy. But in the long run, this difference will get smaller because the cost of term insurance goes up quickly as you age. A permanent policy also builds up cash value, which raises the total amount your beneficiary will get when you die.
Common Ways to Use Term Life Insurance
Term life insurance is best when you want to keep your loved ones from having to pay a lot of money all at once because you died. Here are a few common ways that people use term life insurance.
Costs to the person who died: When a spouse or family member dies, there will be costs right away. To cover these costs, many people buy a fairly small term life insurance policy.
Mortgage insurance: Banks and other financial institutions often require people with mortgages to have enough life insurance to pay off their loan if they die. With these policies, the bank is the one who gets the money. If the person with the mortgage dies before the loan is paid off, the insurance policy will pay off the loan. This is also a great benefit for a spouse whose ability to make money will likely go down when their partner dies.
Business Partner Insurance: People in business also use term insurance to pay off loans with their bank or to buy the shares of a partner who has died if they had agreed to do so. Most partnerships have this kind of agreement, and the business pays for the policy premiums.
Key Person Insurance - When a business loses a key person due to death, it can be hard on the business. The company buys "key person" insurance for any person it thinks is important. The policy is set up so that the company itself gets the money. So, when a "key" person dies, the company gets a cash infusion to help with the problems that come with finding a replacement.
Getting a quote for term life insurance
When getting a quote for term life insurance, here are some things to look for:
- Make sure you fully understand how the different policies you are thinking about can be changed. Most policies let you change all or part of your term insurance into permanent insurance within a certain amount of time and without a medical exam.
- The rate that is the cheapest today won't be the cheapest tomorrow. For example, a Yearly Renewable Term policy is likely to have the lowest premium today. Every year, this policy is renewed, and your premium goes up at the same time. This is fine if you plan to switch to a longer-term solution (such as permanent insurance) in a year or two, or if you only need insurance for a short time. But if you think you will need this insurance for a long time, it would be better to sign up for something like a Ten Year Term Policy. This is a ten-year lock on your premium and death benefit. Your rates won't go up until you renew them.
- There are times when you might want to think about options like Decreasing Term Life Insurance, where the death benefit goes down as time goes on. If the policy is being used to cover a mortgage or business loan, this makes sense.
- Look at what each policy covers and how much it will cost. Think about the long run and get insurance that will save you money in the long run.
Term life insurance is not the best choice for everyone, but it should be a part of every person's plan for their financial future.
