“Life insurance is way too complicated! I’ll worry about it when I’m older.” We’ve all had similar thoughts. Let’s face it, everyone zones out of those life insurance infomercials because they’re ridiculously boring. But stick with us and we'll show you why term life insurance is the best life insurance option.
What Is Term Life Insurance?
Term life insurance just means it lasts for a set number of years, or term. If you die before the term is over, the insurance company will pay the death benefit (another way to say payout). If you die after the term is over, the insurance company doesn’t pay. We recommend buying a term policy that lasts 15–20 years.
You need life insurance if you have a family or loved ones who depend on your income—because no one lives forever. Life insurance helps you provide for them even after you’re gone. It’s not a nice thing to think about, we agree. But taking the time to figure it all out now is a million times smarter than leaving your loved ones stranded if you suddenly died.
How Does Term Life Insurance Work?
Term life insurance works just like your car or home insurance with a monthly payment, aka a premium. Let’s look at a term life policy example for Steve, a healthy, non-smoking 30-year-old who makes $40,000 a year.
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Steve’s death benefit is $400,000 because we recommend getting coverage that’s 10–12 times your yearly income. If he dies before his 20-year term is over, the $400,000 will go to his beneficiaries (his wife and two kids). Even though a beneficiary is most likely to be a loved one, it could also be legal guardians, your estate, a charity, or a legal trust.
How Is Term Life Insurance Different from Whole Life Insurance?
Whole life insurance is known as a permanent life insurance because it’s in place for the whole of your life (and we hope that’s into your 80s and beyond!). But that’s a lot of premiums to pay—and high ones at that! We’re talking 5-10 times more than a term life premium.
Why are whole life premiums so high? Because whole life insurance tries to act like an investment fund (along with others in the cash value insurance family).
Part of the sales pitch for cash value types of insurance is that they’ll help you build up an investment that could be tapped into further down the line. So you are overpaying in the early years and building the cash value to offset the increasing cost of insurance in your later years. In reality though, whole life doesn’t compare to term life when it comes to the “making money” part.
Let’s go back to our good friend Steve. He likes to dabble in the stock market, but his insurance agent says if he goes with whole life insurance, his premium will cover his life insurance policy and include investing. What the agent may not tell Steve is this:
The amount Steve makes if he goes with whole life is awful compared to if he went with term life and put some money every month into another type of investment pool (like a good mutual fund). That’s because the rates of return for whole life insurance policies are low compared to the rate of return in something like a mutual fund.
What Are Riders?
Unfortunately, “riders” have nothing to do with horses or motorcycles in the exciting world of insurance. Riders are extras that “ride” on your regular term policy to serve as an answer to “what if” questions like:
- What if we need to cover unexpected funeral expenses for a member of the family?
- What if I become disabled and can’t pay my premium?
One rider that might be worth having is one that covers funeral expenses for your child. But when it comes to riders like AD&D (accidental death and dismemberment) or critical illness, getting some good disability insurance will cover those things.
And the truth is, other worries can also be covered by building an emergency fund of savings through Dave Ramsey's 7 Baby Steps. Get that going, and you’ll basically create your own “rider” or cushion just by saving and taking control of your money. You don’t need to throw money away to pay for a rider you don’t need. And believe us, you’ll fork out a lot because they’ll rack up your premium to double what it should be.
What Happens When Term Life is Coming to An End?
If you are nearing the end of the term of your policy, you could always renew the policy for another term. If you have a “level term” type of plan (more on the types soon) then your premium rate will go up when you renew (as you’ll be older and more expensive to insure). There’s also a chance your premiums could go down if you choose a lower death benefit.
But you should ultimately shoot for being self-insured with an emergency fund by the time your policy expires. It’s easier than you think! If you put 15% of your household income toward investing, you won’t need the death benefit by the time your term life plan ends because you’ll have made a pretty penny in investments.
What Are the Types of Term Life Insurance?
Okay, so here’s where most people want to check out because, well . . . insurance. But take a deep breath and think premium and payout. To get the best of both, you’ll want to know the breakdown of all these different types of term life insurance:
Level premium term life insurance makes sure the costs stay level based on the length of term you’re after (we recommend a term of 15-20 years). It’s the simplest form of life insurance because once you have it in place, the premium and the death benefit amount won’t change. That’s a nice feeling, isn’t it? This is the main reason Dave recommends level premium term life policies. You know exactly how much it’s going to cost every time your premium is due and can work it into your budget. Could insurance really be this easy? Yes!
Annual Renewable Term
This one is a bit like level premium, except that the policy “renews” and the premium amount increases every year until the term ends to cover the increasing cost of the insurance. Exactly how much it increases by is determined the insurance company when they measure your “risk” every year at renewal time (yikes!) This is a bit risky, and while it can seem cheap at first - for about the first 5 years of your plan - after that the premiums will come out higher than if you’d opted for a level premium term life policy.
Return of Premium
This looks good on paper since it’s supposed to give you back the cost of the policy if you survive through the end of the term (and we’re hoping you do!). What about all those premiums you paid? You’ll get them back. But those premiums are much higher in the first place. We’re talking 30–40% higher than a level premium. In the end, it’s not worth it if you’re paying more in the first place.
Guaranteed or Simplified
A guaranteed or “simplified” term life plan is one you can get without a medical exam. You may just have to fill out a medical questionnaire rather than get poked and prodded. But—you guessed it—there’s a catch with this one too.
Premiums can be really expensive—sometimes more than double the cost of a regular term life policy. That’s because without the medical tests, all the insurance company has to go on is your age and the fact you’re looking for insurance that doesn’t require a medical exam. This means you’re going to be classed (by the insurance gurus) as a “higher than average risk.” So you’ll also be charged a higher than average premium.
This one is less of a type of term life plan, and more what you can do with it. Which is converting it to a permanent life insurance policy down the line. We say, don’t do it! It’s not worth the hike in premiums you’ll be paying. Some people might convert if they’re coming towards the end of their policy and have a terminal illness, but that’s a rare example. You can’t escape the fact that when it comes to conversion time your premium will jump up in a big way.
Voluntary or group term insurance
Your employer might offer group term life insurance as a benefit to staff. They might even pay the whole premium in some cases. Either way, it’s cheap. We’ll always recommend you take the free option, but compare it closely to what you can get on your own before you chip in for it. Also check the death benefit, because an employer payout could be a lot less than one you took out on your own. And don’t forget: If you change jobs, that insurance doesn’t go with you.
Which Type of Term Life Insurance Should I Choose?
Of all the types to pick from, we think a level premium term life policy is your best option. Get coverage that’s 10–12 times your income and a term that’s 15–20 years in length. You’ll have a premium and death benefit payout that won’t change. This is life insurance with no frills or extras you don’t need.
How Much Term Life Insurance Do I Need?
Get that calculator out (and take another deep breath), because you’re about to think about how much money your family would need if you died. Funeral costs, child care, education for your kids (including college), and your mortgage are the most common expenses to cover. If you’re married, will your spouse work after your death? If so, you may not need to provide as much with another income in the mix.
We know we sound like a broken record, but you should always get 10–12 times your income. So if you’re earning $50,000 a year, look for coverage that gets you at least $500,000. That way if your family wants to invest some or all of your death benefit into a good mutual fund, they could earn a decent amount on it and maintain your income even after you’re gone.
The Bottom Line
By now you know how we feel about life insurance. It has one job: to replace your income if you die. It’s there to provide for your loved ones, not to make them rich. You can do that all yourself by following the Baby Steps and investing wisely. And that’s why we’ll always recommend term life insurance over the others.
Our friends at Zander Insurance know the ins and outs of the insurance business. They’ve been helping folks find the best life insurance policy for more than 50 years. Get a quote in less than 5 minutes!