It’s human nature to wish for a long, healthy, happy life for yourself and your loved ones.
Sadly, that’s not in the cards for everyone. That’s why life insurance — specifically, level term life insurance, the most affordable type of coverage — factors into so many families’ long-term financial planning.
Contrary to one of the most persistent myths about life insurance, most people should at least consider level term life insurance coverage during the early and middle years of their adult lives. But it’s not appropriate for everyone.
To determine whether level term life insurance is right for you, learn more about how it works, who needs it, and when it’s just not worth the cost.
Pro tip: Life insurance can be confusing for many people. That causes the process of purchasing a policy to be stressful. But Ladder makes purchasing life insurance simple. With a few simple questions, you can apply for a new policy in just minutes.
Key Features of Term Life Insurance – Comparison With Permanent Life Insurance (Whole Life Insurance)
Term life insurance is one of two categories of life insurance. The other is permanent life insurance, whose sub-types include whole life insurance, universal life insurance, and variable universal life insurance.
The key features of term life insurance contrast with those of all permanent life insurance types in some important respects. Let’s take a look at each in greater detail.
The Policy Term
The distinguishing feature of term life insurance is its temporary term. Whereas a permanent life insurance policy remains in force until the policyholder dies, cancels and cashes out the policy, or lapses on payments, term life insurance expires at a predetermined future date.
Though policyholders often have the option to extend coverage for an additional term or convert to a permanent policy, they aren’t obligated to.
Initial policy terms run for a set number of years — typically 10- to 30-year terms. Longer or shorter initial terms are rare but do exist.
If offered, an option to renew (rather than convert to permanent) usually presents as a series of one-year extension terms with significantly higher premiums than the initial term.
The Policy Premium
Like all types of insurance, term life insurance policies require policyholders to pay premiums on time and in full (subject to a grace period) to maintain coverage.
Term life insurance premiums generally remain fixed during the term and increase with the policyholder’s age at the time of application — which is why it’s essential to apply for term life coverage earlier in life.
Life insurance companies also use other variables to set term life premiums during underwriting. The most notable include:
- Coverage amount (death benefit)
- Term length
- The policyholder’s family medical history
- The policyholder’s health and health history as determined by the results of a medical exam, self-reported answers to health-related questions, and any available health records
- The policyholder’s lifestyle and habits, including tobacco use and any risky jobs or hobbies
Policy premiums increase proportionally with the size of the death benefit and the length of the initial policy term.
Risky behaviors and health concerns also increase premiums, which is why nonsmokers usually pay much lower rates than smokers. Insurers reserve the right to deny coverage altogether to applicants with serious health issues that could significantly shorten life expectancy.
In contrast to term life premiums, permanent life premiums tend to be much higher than term premiums. The difference is typically on the order of five to 10 times, though (like term life premiums during the initial term) permanent life premiums generally remain constant absent action by the policyholder, such as increasing coverage.
For some policyholders, the guarantee of coverage for one’s entire life and the option of tapping the policy’s cash value justify the higher cost, but it’s important to understand upfront.
The Death Benefit
Every term life insurance policy has a death benefit — its amount of coverage. It’s the amount paid to the policy’s beneficiary or beneficiaries if the policyholder dies while the policy remains in force.
With rare exceptions, such as application fraud or death by suicide during the first two years of the policy, insurers make good on their promise to pay death benefits in full. For this reason, term life death benefits are often referred to as guaranteed death benefits.
Like permanent life insurance death benefits, term life insurance death benefits are not subject to federal or state income tax. However, unlike permanent life insurance policies, term life insurance policies don’t accrue cash value. Absent a terminal diagnosis, there’s no way for the policyholder or beneficiary to tap the death benefit before the policyholder’s death.
If the policyholder outlives the policy term and chooses not to renew, the policy becomes worthless and the death benefit evaporates. Payout only occurs if the policyholder dies during the term.
If the policy offers a return of premium rider or the death benefit isn’t paid at the policyholder’s death, the policyholder or beneficiary could recoup some or all monthly premiums paid over the lifetime of the policy. Otherwise, the insurer keeps any premiums paid.
Permanent life insurance policies pay death benefits as well, but that’s not the end of the story. Unlike a term life insurance policy, which has no cash value and expires worthless when the policyholder outlives the term, a permanent policy also builds cash value over time.
Though cash value builds slowly and remains essentially worthless for the first few years of the policy, a permanent policy’s cash value can approach that of the death benefit toward the end of the policyholder’s life. During the policyholder’s life, they can tap it much as they might tap the equity in their home — as collateral against a low-interest loan, for example.
Who Needs Term Life Insurance?
The simple answer to this question is that most people need some kind of life insurance.
More specifically, anyone who believes their premature death would cause a financial burden for their loved ones needs it. That’s more likely to be the case for would-be policyholders who:
- Have Children or Plan to Have Children. Food, clothing, day care, school supplies, extracurricular activities, postsecondary tuition (and perhaps elementary and secondary tuition as well) — the list of parents’ financial obligations goes on and on. That leads to one inescapable conclusion: Children are really expensive. Adequate life insurance ensures your kids’ surviving parent or guardian(s) don’t have to raid their savings or go into debt to do right by your kids after you’re gone.
- Carry Substantial Joint or Nonforgivable Debts. It wouldn’t be fair of you to leave your spouse holding the bag on a joint mortgage or saddle them with debts that can’t be forgiven in death, such as private student loans (an especially important consideration for residents of community property states). If you carry or plan to carry substantial debts with your spouse and lack — for the foreseeable future — sufficient liquid assets to settle them in probate, term life insurance is most likely worth the cost.
- Earn Significant Income for the Household. Even if you’re not the primary or sole breadwinner, your family will miss your income after your death. The very rough rule of thumb for the amount of life insurance you need is 10 times your annual income when you apply. In other words, a death benefit significant enough to replace 10 years of income at your current pay rate.
- Want to Provide a Financial Cushion for Survivors. Life insurance can dull the shock of financial unknowns, such as end-of-life medical care not covered by insurance, child care expenses incurred by a surviving spouse returning to work, and funeral costs.
When Term Life Insurance Might Not Be Worth the Cost
Most adults should at least consider purchasing a level term policy, especially if they’re young and healthy enough to obtain ample coverage at a relatively low cost. But it bears repeating that there are times when term life insurance isn’t worth the cost.
You Don’t Have Dependents & Don’t Plan To
No doubt about it, kids are expensive. If you’re as confident as can be that you won’t ever have or adopt children, the massive long-term cost of raising them — before or after your death — need not concern you.
The caveat to this general principle is that you probably will need life insurance if you do end up with kids later in life. That’s most likely to happen due to an unexpected pregnancy or a decision to adopt. But rarer circumstances can arise as well, such as inheriting guardianship of a sibling or friend’s children after tragedy strikes.
But note that the cost of term life insurance increases with each year of age, and years can pass between deciding to expand your family and actually welcoming kids. So get life insurance as soon as you know your circumstances have changed.
You Don’t Have Significant Debts & Don’t Plan To
Whether you’re a renter by choice or circumstance, your determination to avoid joint ownership of a home could significantly reduce your need for life insurance. The same is true for other major debts, such as education loans, unsecured personal loans, and loans you’ve cosigned for a spouse or relative.
It becomes a trickier consideration for would-be policyholders in community property states, where both spouses are generally liable for debts incurred during a marriage.
If you live in a community property state and rack up tens of thousands of dollars in credit card debt throughout your marriage, that burden could transfer to your spouse after your death. That increases your chances of needing life insurance, even if you’re otherwise debt-free.
You or Your Spouse Have Ample Liquid Assets or Equity in Nonliquid Assets
If your debt burden is relatively low, your net worth relatively high, and you see no significant expenses (such as college tuition for school-age kids) on the horizon, your survivors won’t need to rely on your policy’s death benefit.
That’s more likely for would-be policyholders with spouses working full-time and no kids or dependents. In such a case, the policyholder’s death wouldn’t meaningfully affect the surviving spouse’s lifestyle or financial position.
You’re on the Older Side
The cost of life insurance invariably increases with age, shrinking the death benefit-to-premium ratio over time. Due to the complexity of calculating life insurance premiums, there’s no general age threshold at which term life insurance is no longer worth the cost. The answer varies according to the applicant’s health and desired policy term, among other variables.
However, to keep premiums manageable, applicants over age 50 should consider shorter terms — perhaps 10 to 15 years. Over age 65, premiums can be prohibitively expensive, even for applicants in good health.
Seniors whose savings aren’t adequate to cover their funeral and burial costs should consider final expenses insurance, a low-benefit term policy designed specifically for that eventuality.
You’re a Child or Dependent With Little or No Income
Sorry, kids. Your turn to buy life insurance will come eventually. For now, you’re simply not productive enough to bother insuring.
(Seriously, parents: Don’t fall for those heartstring-tugging children’s life insurance ads. Immensely and senselessly tragic though it may be, the death of a child is not a financial imposition.)
Were life insurance only sold as a hedge against the relatively low likelihood of one’s premature death, life insurance companies would have a much tougher time selling it.
Of course, that’s not the case. You needn’t spend all day watching life insurance commercials to realize that life insurance’s biggest selling point isn’t financial protection. It’s peace of mind.
When you buy term life insurance, you’re not just buying a financial windfall that may never come. Your life insurance costs come with the assurance that if anything happens to you, your family won’t suffer serious financial harm.
In other words, you’re buying better sleep for as long as your policy term lasts. If that sounds like a sound investment, then term life insurance is probably worth it for you.