What is Term Life Insurance?
Term Life Insurance is a type of life insurance policy designed to pay out a lump sum to your beneficiaries if you were to die prematurely. That is its purpose. You buy term insurance to financially protect the ones you love if you are no longer around to provide for them.
The insurance coverage lasts for a specific amount of time (also known as the term, typically 10, 20 or 30 years). Simply put, if you own a term policy and you die during the term then your beneficiaries will receive a fat tax free check in the amount of the death benefit of your policy.
Term insurance is also known as pure insurance which means that there are no underlying investments or cash value component to the policy. It is not a savings plan, a retirement plan, a college savings plan or an investment account. It is just insurance on your life with the purpose of protecting your family from financial disaster because you are no longer there to provide an income.
You can stack term life insurance policies to cover certain life events. You can buy additional policies at different stages of your life. I personally own multiple policies with different terms. The reason for this is I need more coverage while my children are young and then my need goes down as they get older.
Not everyone needs life insurance. The question you need to ask yourself is “Is there anyone that would suffer financially if I were to die? If the answer is yes then you need a term life insurance policy to protect them and remove that risk from their lives.
Another important thing to remember is you very well might need life insurance even if you do not have a paying job. Stay at home parents need life insurance because if they were to die prematurely the surviving parent would need to either stay home with the kids for a while or hire someone to watch the children while they are at work.
Term insurance is the most affordable type of life insurance. The younger and healthier you are the less you will pay. Shorter term policies are also less expensive than longer term policies because the risk of death is lower. So for example a one year term costs much less than a 20 year term.
Let’s look at simple example: John, as a healthy 30 year old male would pay around $60 per month for a $1 Million 30 year term policy. As long as John continues to pay that $60 monthly premium his coverage would continue for the next 30 years. The $60 premium payment is locked in and will stay the same throughout the entire term of the policy even if he becomes terminally ill. John is paying the $60 monthly premium to the insurance company in return for the peace of mind that if he were to die during the term of his policy for any reason, his beneficiaries would receive a tax free check for $1 Million from the insurance company.
This $1 Million amount is referred to as the face value or death benefit, which can typically range from $25,000 to millions of dollars depending on your needs. John can decide to cancel his policy at any time by stopping to pay the premium payments on the policy. Since there is no cash value he will not receive any money back if he decides to cancel and obviously he would no longer be covered.
The most common outcome and the best scenario for John is that he outlives this 30 year term and his family never receives any benefit from this policy. It was there all along for peace of mind and to protect against a very unlikely scenario, but in the end John would have paid a total of $21,600 over the 30 years and received nothing in return. It sucks when you think about it this way, but it is a necessary expense and money well spent.
The major decisions when applying for a term policy are how much coverage do you need, how long of a term should you get and what insurance company should you go with. I cover these questions in other videos at the School of Personal Finance website and youtube channel.
Here are some important things you should know about applying for life insurance:
The insurance company will review your medical history and you will typically need to have a medical exam completed. The medical exam usually takes place in your home and consists of a verbal questionnaire along with collecting samples of blood and urine.
You may not get approved or your cost can be prohibitively high. For example, if you recently beat cancer there is a good chance you will not get approved for life insurance. If you are a smoker you might have to pay 2 to 3 times more than a non smoker. If you have high blood pressure and are overweight your cost will be higher. If you have a bunch of speeding tickets your cost will be higher. If you have a family history of heart disease your cost may be higher. All of these factors are taken into consideration by the insurance company when reviewing your application.
The life insurance salesperson typically gets paid a commission based on how much you spend on your policy. The more you spend the more they get paid. Just something to keep in mind.
Some insurance salespeople can shop multiple companies for the best rate while others only sell their companies policies or get an incentive to sell their companies policies.
To wrap things up here are the key takeaways when it comes to term life insurance:
Term Life Insurance is the only type of life insurance I recommend. Whole life and Universal Life are a good fit in extremely rare and specific circumstances. Don’t get sold on these types of policies.
Term Insurance - The cost is low and the need is high. Protect your family. Don’t underestimate how much life insurance you need. Watch my video - How much life insurance do I need?
Get a nice fat policy when you are young and healthy. Don’t wait until after you have put on 20 pounds drinking beers on the couch.
Term insurance has no benefit for the owner except peace of mind. No cash value, no savings component. It is just a monthly bill. Odds are it will never pay out any money. (Hopefully). The same concept as your homeowners, auto and disability insurance.
Do not just do whatever the insurance salesperson tell you to do. Have a gameplan and then just use a trusted insurance broker to perform the transaction.