Term life insurance is a kind of life insurance policy that provides coverage for a specific period or a term, usually ranging from 1 to 30 years. By any means, if the insured dies during the term period of the policy, their beneficiaries can receive a payout, known as death benefits. However, if the policyholder dies after the term is expired then there will be no payout. Since term life insurance provides coverage for a certain time period it is less expensive compared to permanent life insurance such as whole life insurance and universal life (UL) insurance.
How a term life insurance policy works
A term life insurance policy works by providing coverage for a certain period or term. During this period the insured will pay a certain amount of money to the insurance company monthly or annually for their coverage.
If the policyholder dies within the term of the policy, their beneficiaries receive a certain amount of money as a death benefit. The amount of death benefit is predetermined during the time when the policy is purchased. If the policyholder lives longer than that period, there is no payout. However, in some cases short-term policy allows an insured person to convert the policy into a permanent life insurance policy which gives coverage for the insured whole life.
Term life insurance can be purchased for various lengths of time such as 10,15,20, or 30 years. The insurance company calculates the premium of an individual based on several factors including policyholder age, health, and life expectancy. This means younger and healthier individuals will pay lower premiums compared to older and less healthy individuals.
Example of Term Life Insurance
Term life insurance is a form of life insurance policy that offers coverage for a certain number of years, generally 10, 20, or 30. A term life insurance policy looks like this:
Bijay, 35, is a married guy with two children. He wants to ensure that his family is financially secure if he passes away. He chooses to buy a 20-year term life insurance policy with a $500,000 death benefit.
Bijay pays a $500 yearly premium for his coverage. If he dies during the next 20 years, his beneficiaries will get a $500,000 tax-free lump payment.
If Bijay outlives the term of his insurance, his coverage terminates, and he receives no money from the policy.
This is an example term life insurance policy since it offers coverage for a set period (20 years) and does not accrue cash value.
Types of Term Insurance
In the market, there are various types of term life insurance policies. Here are a few examples of the most common types of term insurance:
Level-term insurance:
It is the most fundamental sort of term life insurance, with the death benefit and premium amount remaining constant throughout the policy period.
Decreasing term insurance: The death benefit of this type of coverage lowers over time while the premium remains constant. Decreasing term insurance is sometimes used to cover the diminishing value of a mortgage or other debts.
Increasing term insurance: It is the inverse of decreasing term insurance in that the death benefit grows over time while the premium stays constant. Insurance of this type can be used to cover the rising costs of an expanding family.
Renewable term insurance: It allows the insured to renew the policy for another term without having to take a medical test. The premium amount, however, may increase upon renewal.
Convertible term insurance: This policy enables the insured to change their term policy into a permanent life insurance policy without having to undergo a medical exam.
Return of Premium term insurance: This policy reimburses all or a portion of the premiums paid if the policyholder lives beyond the policy’s term. This coverage may be more expensive than standard term insurance.
Term Life Insurance vs. Whole Life Insurance
- Coverage term: Term life insurance offers coverage for a certain length of time, such as 10, 20, or 30 years, whereas whole life insurance covers the insured for the rest of his or her life.
- premiums: Although term life insurance only offers coverage for a certain period, it often has cheaper rates than whole life insurance. Whole life insurance rates are often higher because it covers the insured for the rest of his or her life and includes a savings component.
- Cash value: Cash value is a component of whole life insurance plans that accumulate over time and may be withdrawn or borrowed against. There is no cash value component to term life insurance contracts.
- Investment: it doesn’t allow you to invest in the policy’s cash value component, however, whole life insurance policies do.
- Death benefit: Both types of plans pay a death benefit to the beneficiary, but the death benefit for a whole life insurance policy is often larger than the death benefit for a term life insurance policy.
Frequently asked questions
What is term life insurance?
A term life insurance policy is the most basic and straightforward type of life insurance. You pay a premium for a set length of time—typically 10 to 30 years—and if you die within that time, your family receives a lump-sum payout.
What happens if I outlive my term life insurance policy?
If your policy ends you won’t get any payouts and you need to buy a new policy or need to go without insurance. However, if your policy allows you to extend your coverage you can extend but may need to pay a higher amount than before.
Do you get your money back at the end of a term life insurance policy?
No, you do not get your money back at the end of a insurance policy.
Can you cash in a term life insurance policy?
No, it does not have a cash value component. A whole life insurance policy is a good option if you want coverage that pays a death benefit while also building cash value over time.