What It Is, Different Types, Pros and Cons

Most term life insurance policies expire without paying a death benefit, lowering the insurer’s overall risk compared to a permanent life policy. The reduced risk is one factor that allows insurers to charge lower premiums.

Interest rates, the financials of the insurance company, and state regulations can also affect premiums. In general, companies often offer better rates at the “breakpoint” coverage levels of $100,000, $250,000, $500,000, and $1,000,000.

Example of Term Life Insurance

Thirty-year-old George wants to protect his family in the unlikely event of his early death. He buys a 10-year, $500,000 term life insurance policy with a premium of $50 per month.

If George dies within the 10-year term, the policy will pay George’s beneficiary $500,000. If he dies after the policy has expired, his beneficiary will receive no benefit. If he remains alive and renews the policy after 10 years, the premiums will be higher than his initial policy because they will be based on his current age of 40 rather than 30.

If George is diagnosed with a terminal illness during the first policy term, he probably will not be eligible to renew the policy when it expires. Some policies offer guaranteed re-insurability (without proof of insurability), but such features come at a higher cost.

Types of Term Life Insurance

There are several types of term life insurance. The best option will depend on your individual circumstances. Generally, most companies offer terms ranging from 10 to 30 years, although a few offer 35- and 40-year terms.

Level Term or Level-Premium Policy

Level-premium insurance has a fixed monthly payment for the life of the policy. Most term life insurance has a level premium, and it’s the type we’ve been referring to in most of this article. As we mentioned before, this type of policy generally provides coverage for a period ranging from 10 to 30 years. The death benefit is also fixed.

Because actuaries must account for the increasing costs of insurance over the life of the policy’s effectiveness, the level premium is comparatively higher than yearly renewable term life insurance.

Yearly Renewable Term (YRT) Policy

Yearly renewable term (YRT) policies are one-year policies that can be renewed each year without providing evidence of insurability.

The premiums rise from year to year as the insured person ages. Thus, they can become prohibitively expensive as the policyholder ages. However, they may be a good option for someone who needs temporary insurance.

Decreasing Term Policy

These policies have a death benefit that declines each year according to a predetermined schedule. The policyholder pays a fixed level premium for the duration of the policy.

Decreasing term policies are often used in conjunction with a mortgage, with the policyholder matching the insurance payout to the declining principal of the home loan.

Benefits of Term Life Insurance

Term life insurance is attractive to young people with children. Parents can obtain substantial coverage for a low cost, and if the insured dies while the policy is in effect, the family can rely on the death benefit to replace lost income.

These policies are also well-suited for people with growing families. They can maintain the coverage needed until, for example, their children reach adulthood and become self-sufficient.

The term life benefit may be equally useful to an older surviving spouse. However, premiums for people who wait until they are older to apply for insurance will pay higher premiums than if they’d gotten a level-term policy when they were younger. 

Each insurance company sets a maximum age for its term life insurance coverage, which usually ranges from about 80 to 90 years old. 

Term Life Insurance vs. Permanent Life Insurance

The main differences between a term life insurance policy and a permanent insurance policy (such as whole life or universal life insurance) are the duration of the policy, the accumulation of cash value, and the cost. The right choice for you will depend on your needs. Here are some things to consider.

Cost of Premiums

Term life policies are ideal for people who want substantial coverage at a low cost.

People who own whole life insurance pay more in premiums for less coverage but have the security of knowing they are protected for life.

People who buy term life pay premiums for an extended period, but they get nothing in return unless they have the misfortune to die before the term expires. Plus, term life insurance premiums increase with age.

Availability of Coverage

Unless a term policy is a guaranteed renewable, the company could refuse to renew coverage at the end of a policy’s term if the policyholder develops a severe illness. Permanent insurance provides coverage for life as long as the premiums are paid, regardless of changes in the insured’s health.

Investment Value

Some customers prefer permanent life insurance because the policies typically contain an investment or savings vehicle. A portion of each premium payment is allocated to the cash value, which usually grows while the policy remains in force. Some plans pay dividends, which can be paid out in cash or left on deposit within the policy.

Over time, the cash value may grow large enough to pay the policy’s premiums. There are also several unique tax benefits, such as tax-deferred cash value growth and tax-free access to the cash portion.

However, financial advisors warn that the growth rate of a policy with cash value is often paltry compared to other financial instruments, such as mutual funds and exchange-traded funds (ETFs). Also, substantial administrative fees often cut into the rate of return. This is the source of the phrase, “buy term and invest the difference.” However, the performance of permanent insurance can be steady and it is tax-advantaged, providing additional benefits when the stock market is volatile.

Other Factors

There is no one-size-fits-all answer to the term versus permanent insurance debate. Other factors to consider include: 

• Is the rate of return earned on investments sufficiently attractive?
• Does the permanent policy have a loan provision and other features so you can access the cash value during your lifetime?
• Does the policyholder have or intend to have a business that requires insurance coverage?
• Will life insurance play a role in tax-sheltering a sizable estate?

Term Life Insurance vs. Convertible Term Life Insurance

Convertible term life insurance is a term life policy that includes a conversion rider. The rider guarantees the right to convert an in-force term policy—or one about to expire—to a permanent plan without going through underwriting or proving insurability. The conversion rider should allow you to convert to any permanent policy the insurance company offers without restrictions.

The primary features of the rider are maintaining the original health rating of the term policy upon conversion (even if you later have health issues or become uninsurable) and deciding when and how much of the coverage to convert. The basis for the premium of the new permanent policy is your age at conversion.

Of course, overall premiums will increase significantly since whole life insurance is more expensive than term life insurance. The advantage is the guaranteed approval without a medical exam. Medical conditions that develop during the term life period cannot cause premiums to be increased. However, the company may require limited or full underwriting if you want to add additional riders to the new policy, such as a long-term care rider.

The Bottom Line

Term life insurance is a good option for people who cannot afford or will not pay the much higher monthly premiums associated with whole life insurance.

Term life is somewhat similar to car insurance. It’s statistically unlikely that you’ll need it, and the premiums are money down the drain if you don’t. But if the worst happens, your family will receive the benefits.