Key Takeaways
- Term life insurance provides the most coverage with the most affordable premiums.
- Coverage is limited to the specific number of years a term life policy is in effect and renewing coverage may be more expensive or difficult to acquire depending on your age.
- Term life insurance is less complex than permanent life, but does not build cash value over time.
What Is Term Life Insurance?
Term life insurance provides coverage for a fixed rate of payments over a specific number of years or other period of time. This time frame is the term. If you die within this term, the insurance company pays a death benefit to whomever you name as your beneficiaries.
It does not provide lifetime coverage, but it is a leading choice to cover a young family’s financial obligations if one or both income earners die. Term life insurance can be used to cover mortgage and other debt, college and other education costs or lost earnings.
Term life is one of the two main types of life insurance — the other being permanent life insurance, which does cover you for your lifetime. But term life insurance is typically much less expensive than permanent life insurance.
Typically, the younger you are when you buy a term life policy, the lower the premium payments will be throughout the term of the policy.
Term insurance is the most basic and affordable life insurance available to consumers. It should be a foundation of your protection strategy during periods of time when you have spouses, dependents or business partners depending on you during a defined period.
Stephen Kates, CFP®, Licensed Life Insurance ProducerPrincipal Financial Analyst for Annuity.orgStephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.
Types of Term Life Insurance
There are several types of term life insurance, but most policies tend to be level term policies, according to the Insurance Information Institute.
- Level Term
- The name level term applies to the death benefit paid out during the term of the insurance policy. With a level policy, the death benefit remains the same — or level — regardless of when you die during the policy’s term.
- Decreasing Term
- Again, the name applies to the death benefit. With a decreasing term policy, the amount of the death benefit decreases over the course of the term. The longer you live, the less of a benefit.
- Convertible Term Policies
- Convertible policies allow you to convert your term life policy into a permanent life policy — either whole life or universal life insurance. This allows you to shift from term to lifetime coverage without having to provide medical or other evidence that you are insurable.
- Renewable Term
- These are policies meant to be renewed. The premiums remain level, but increase with each renewal. Yearly or five-year renewable policies have become less popular as most term life policies are now 20-year term policies.
- Return of Premium
- With term life insurance, once the term expires, you get no refund of the money you paid into the policy. This feature allows you a return on the money you spent over the years. Return of premium policies tend to be more expensive than traditional term life insurance policies.
Types of Term Life Insurance Policies
Source: Insurance Information Institute
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How Does Term Life Insurance Work?
Term life insurance is the most basic type of life insurance — and typically meets the needs of most people looking for life insurance.
You pay a fixed premium over a specified period of time — usually between 10 and 30 years. If you die during that term, the insurance company pays a death benefit to whomever you name as a beneficiary or beneficiaries.
The amount of the death benefit is specified in the policy.
If you outlive the term of the policy, your coverage stops, and you typically don’t get any of your premiums back. You paid for a specific period of coverage, so the idea is that you received fair value. The exception is if you had a return of premium policy.
On the other hand, if you quit paying your premiums before the term is up, your coverage stops and you cannot reclaim the premiums you’ve paid into the policy.
Pros and Cons of Term Life Insurance
Term life insurance is the most common type of life insurance and fits the needs of most people. But it’s not the best choice for everyone.
You should compare the pros and cons of term life insurance before making a decision on what kind of life insurance is best for your needs and goals.
Advantages of Term Life Insurance
Cost and flexibility are among the top advantages term life insurance has to offer. But there are other qualities you should also consider.
- Cost
- Term life insurance is the least expensive type of life insurance. The younger you are when you purchase a term life policy, the lower your premiums.
- Convertibility
- If you buy a term life policy and decide later that permanent life insurance is a better option, you can typically convert your term life policy to permanent life insurance.
- Cancel Anytime
- If you no longer want or need life insurance coverage, you can cancel a term life policy at any time — without having to pay a penalty.
- Easy To Understand
- Term life policies are fairly simple compared to permanent life insurance. Permanent life policies include complex features dependent on savings, interest and market fluctuations. Term life is straightforward — detailing a death benefit, a specific term and premiums.
- Flexible Policy and Payments
- Term life insurance allows you to more easily decide the frequency at which you make premium payments — monthly, quarterly, semi-annually or annually. You also have a wide range of terms for the policy — typically from one to 30 years.
- More Coverage
- Because of the way term life insurance is structured, you can get far more coverage for less cost than similar coverage through a permanent life policy. The death benefit from term life coverage can be above $10 million.
- Tax-Free Death Benefit
- If you die, your beneficiaries receive the policy’s death benefit in a single lump sum. But they do not have to pay income, estate or other taxes on that money — allowing them to use the full amount as they see fit.
Top Advantages of Term Life Insurance
Disadvantages of Term Life Insurance
Term life insurance is designed to pay off debt, replace income and pay expenses for your survivors. But it does have some drawbacks to consider.
- Temporary Coverage
- Your coverage is limited to the term of your policy. If you have a special-needs dependent or long-term debt likely to outlive you, you may want to consider permanent life insurance.
- No Cash Value
- Term life insurance typically only provides a death benefit. You don’t build up cash value in a term life policy like you would in a permanent life insurance policy. If you’re still alive when your term ends, you don’t receive any of the money you put into premiums. (A return of premium rider will repay if you outlive the policy, however.)
- Upper Age Limit
- As you age, it becomes increasingly difficult to purchase a term life policy. The age limit for buying term life insurance varies by company, but by the time you hit your 60s, you may be limited to a shorter, 10- to 20-year, term policy.
- Uncertainty
- When your policy’s term ends, your coverage stops. If you still need life insurance coverage at this point, coverage may be much more expensive — or you may no longer be insurable.
Top Disadvantages of Term Life Insurance
How are Term Life and Permanent Life Insurance Different?
There are several differences between term and permanent life insurance — the biggest one is that term life covers you for only a specific number of years while permanent life insurance covers you for your entire life.
Each of these types of life insurance serves a different purpose. Term life provides a financial safety net for your beneficiaries if you die. Permanent life insurance — whole life and universal life insurance — provides the same safety net but also includes a savings component allowing you to tap into your life insurance policy while you’re still alive.
These purposes allow lower cost and less complex policies for term life policies, while permanent life insurance can be used as a savings and investment tool.
Which One Is Right for You?
To determine which type of life insurance is right for you, it’s important to consider the reason you’re buying life insurance.
Term life insurance may be the better choice if you only need life insurance for a specific period of time and need a large amount of life insurance on a limited budget.
Permanent life insurance may be the better choice if you need a death benefit for your beneficiaries no matter how long you live and if you want to accumulate cash savings you can borrow from your policy while you’re still alive.
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