Term Life Insurance: How it Works and Who it’s Right For

If you're shopping for life insurance, you've probably noticed you have several different options. You could choose a permanent life insurance policy, which would be in effect indefinitely as long as you keep the policy active and still pay premiums. Or you could opt for term life insurance.

Term life insurance is a different type of life insurance policy that isn't intended to provide benefits for life, but rather for a limited period when others may be counting on your income.

So how does term life insurance work and is it right for you? This guide will help you decide.

What is term life insurance?

To understand term life insurance, you need to know how life insurance works. Basically, a life insurance policy pays out a death benefit to a chosen beneficiary if the policyholder dies for a covered reason while the policy is in effect.

Whole life policies are intended to remain in effect indefinitely. But term life insurance policies are intended to stay in effect only for a specific amount of time, such as 20 years. One of the most common life insurance questions is why you might need coverage only for a limited time.

The reality is, however, that most people only need term coverage. That's because their loved ones typically count on their income for a limited period. Once you are older and no longer bringing in an income or raising your family, your death may not cause such a devastating financial loss or necessitate hiring people to handle the services you are performing. So, coverage wouldn't be needed any longer to help your loved ones maintain the same quality of life.

How does term life insurance work?

Term life insurance may provide coverage for anywhere from a few years to 30 years or more. If you buy a 20-year term policy and pass away within 20 years of that time, your policy could pay out, assuming you aren’t subject to certain coverage exclusions. If you die in year 21, then your policy will not pay out.

Most term life policies contain some coverage exclusions. For example, the insurer may not pay out if you die doing something very dangerous, like flying on a non-commercial airline, or if you die by suicide within a short period of time after purchasing the policy.

But as long as your cause of death isn't excluded and the term of your policy hasn't ended, your insurer should pay a death benefit to a chosen beneficiary. You'll decide on the amount of the death benefit when you buy insurance coverage. And you'll also specify who should receive the money (your life insurance beneficiary). You can choose one or more people to be your beneficiaries.

How much does term life insurance cost?

Term life insurance policies are typically pretty affordable. In fact, it can be a lot cheaper to buy a term policy than a whole life policy. That's typically the case because a term policy doesn't cover you forever, while a whole life policy does. Since your term coverage will end, a term life policy may not end up paying a death benefit but a whole life policy will generally pay one at some point (as long as you aren’t subject to exclusions and don't let your coverage lapse).

Whole life insurance also has an investment component. These policies acquire a cash value, which you can cash in or borrow against. Premiums are higher because you're not just getting insurance coverage but also an investment asset. That doesn't happen with term life insurance.

The most common type of term life policy is "level term" which means that your premiums stay the same for the whole time your coverage is in effect — they never go up during the duration of your policy. However, there are other options including:

• Annual renewable policies: These policies are good for just one year. You're allowed to renew your coverage for the period of time specified in your original plan, but the premiums get more expensive each year.
• Decreasing term policies: These policies have a level premium, but your death benefit goes down over time so you end up paying the same amount each month for less coverage. Decreasing term policies can start out cheaper than level term policies, but your death benefit gets smaller each year while your premiums stay the same.

The actual premiums you will owe for your insurance coverage will depend on whether you choose a level term policy or one of these other options. The premium cost will typically be determined by:

• How old you are when you buy your policy
• How long you want your term of coverage to be
• How much coverage you want
• What your health status is when you buy your policy
• Whether you are a smoker or have other risk factors such as engaging in high-risk hobbies

The pros and cons of term life insurance

Term life insurance has some advantages including:

• Lower premiums than other kinds of life insurance, which could make it more affordable to get coverage. Term life policies can typically be purchased for well under $100 per month if you're relatively young and healthy and don't require a huge death benefit. By contrast, whole life insurance policies could potentially cost as much as 10 times what a term life policy does for the same amount of insurance coverage.
• Flexibility in how long you want your term to be in effect so you only pay for protection when your beneficiaries need it. Most people do not need life insurance protection for their entire lives. With a term life policy, you can decide to get coverage for just 10 years, 20 years, or another specific time period appropriate to your needs. Your coverage will be priced based on the length of time that your policy will be in effect so you won't be paying for coverage that you don't need.
• Affordable protection for loved ones: If you have people counting on you, term life policies can help give you the peace of mind of knowing that you've provided a generous death benefit for them. You don't need to spend a fortune to get this type of protection for the people in your life.

And it also has some disadvantages including:

• The policy may never pay a death benefit. If you do not pass away during your term of coverage, you'll pay premiums for years but your surviving family members won't get money from your policy if you die after your term is over.
• You may not be able to get additional coverage at an affordable price once your term policy expires. If you decide that you need to continue your term life insurance coverage at the end of your initial coverage period, you may face challenges getting covered. Unless you have guaranteed renewable coverage, it's possible that you won't be able to buy a new life insurance policy if you've gotten too old or have developed medical conditions. You may not qualify for coverage or it may have become too expensive to afford the premiums
• There's no investment component: Some people like the convenience of paying monthly life insurance premiums that not only protect loved ones but that also help them to build up cash value in their policy. While you can usually earn a better return on investment by purchasing assets separately from life insurance, you may prefer insurance coverage that incorporates investing. If so, you won't find this with a term life policy.

Alternatives to term life insurance coverage

Alternatives to term life insurance include permanent cash value policies, which provide guaranteed coverage for life and also have an investment component. Different types of permanent coverage also serve as investments. They include:

• Whole life: Whole life policies come with set premiums that don't change. They also provide a guaranteed cash value accumulation so you'll know how much your policy will eventually be worth. Your policy stays in effect for your entire life unless you cancel it.
• Universal life: Universal life, or adjustable life insurance, provides more flexibility in the amount of your premiums, as well as your death benefit. It's also called adjustable life insurance. You can raise or lower your death benefit to alter how much your premiums cost, and can use some of the cash value to cover your premium payments.
• Variable life: Variable life insurance comes with adjustable premiums. You also have the option to choose a guaranteed death benefit or for your death benefit to be affected by your cash value. Your cash value is invested in the market, and the performance of your investments determines the value of your policy.

Before you move forward, it's important to research your insurance options and compare life insurance quotes carefully to decide which makes sense for you.

FAQs about term life insurance

The final word on term life insurance

Term life insurance could be one of the most important types of insurance you buy. If you have people who need your income or who you are caring for or providing with services, you should have life insurance. Term life insurance is an affordable way to get covered and ensure a death benefit is paid out.

It's not the only type of life insurance available, though. If you want coverage only for a limited time or are looking for the lowest-price protection, a term life policy might be a good option for you. If you need a death benefit payout no matter when you pass away or if you'd prefer to have an insurance product that also allows you to invest for your future, other options such as whole life insurance may be a better bet.

If you’re in the market for a new policy, check out our picks for the best life insurance companies to compare coverage from top insurers.