You’ve heard you should get life insurance, and just like getting back to the gym, you’ve been putting it off. (And for good reason. Who in their right mind actually wants to do burpees? They should rename those things “throw up-ees.") You may have heard that term life insurance is the best option. That sounds great and all, but that leaves you with a burning question: What exactly is term life insurance?
Don’t worry, I got you. It’s not as complicated as you might think. I’ll spill the tea, the beans, and even the tea beans on everything you need to know about term life insurance so you can protect your family and finally cross “get life insurance” off your to-do list.
To understand term life insurance, you first have to understand how any sort of life insurance works. Life insurance is simply a contract between you and an insurance company. You pay them a monthly premium, and if you die, the insurance company pays a specific amount to whoever you choose.
Compare Term Life Insurance Quotes
Let’s face it. As far as financial planning goes, this is the part we want to discuss the least because life insurance only pays off if you die. No one wants to imagine their own funeral, but we need to talk about life insurance because it’s essential to your family’s security.
Let’s jump in.
- What Is Term Life Insurance?
- How Term Life Insurance Works
- Term Life Insurance vs. Whole Life Insurance
- Comparing Some of the Top Life Insurance Companies
- Types of Term Life Insurance
- What Are the Benefits of Term Life Insurance?
- How Much Does Term Life Insurance Cost?
- What Happens at the End of Term Life Insurance?
- How to Buy Term Life Insurance
What Is Term Life Insurance?
The best type of life insurance is called term life insurance (also called pure life insurance), and it guarantees a death benefit if you (the insured) die during a period of time that you specify—the term. Get it? Term insurance. Very clever. If you die after the term is over, the insurance company doesn’t pay. Pretty simple.
Another important thing to know about term life insurance is that it has no cash value like a whole life insurance policy. And that’s actually what makes term life insurance a much better deal than whole life. You’re only paying for life insurance—not some wonky cash value account that grows slowly (like over your whole life). This way, you can invest those premium savings and build real wealth instead. (More on all that a little later.)
How Term Life Insurance Works
So, how does term life insurance work, exactly?
For starters, the insurance company looks at your age, health, death benefit amount and term length to calculate the cost of your policy. Then you make premium payments for the length of the policy.
The best way to explain term life insurance might be for me to give you an ideal example of a life insurance policy.
Let’s look at our friend Steve, a healthy, nonsmoking 30-year-old who makes $50,000 a year. Steve’s death benefit is $500,000 because you need coverage that’s 10–12 times your yearly income. His term length is 20 years.
If Steve gets his toast out with a fork and dies a shocking death (sorry, that joke was a little dark, not unlike Steve’s toast) before his 20-year term is over, the $500,000 (his term life insurance benefit) will go to his beneficiaries (his wife and two kids). If he’s alive when his term life policy expires, Steve could renew it, but he’ll have to pay higher premiums because he’ll be older and more expensive to insure.
Term Life Insurance vs. Whole Life Insurance
Whole life insurance (aka permanent life insurance) is in place for your whole life. And while I hope it’s a long and prosperous one, that’s a lot of premiums to pay—and high ones at that!
Why are whole life premiums so high, you ask? Because whole life insurance tries to act like a savings or investment fund (along with others in the cash value insurance family, like universal life insurance), but (spoiler alert) it does a really bad job!
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 further down the line. Here’s how it’s supposed to work: You overpay in the early years to build up your cash value. Then as you get older and your premiums go up, you use your cash value to help pay for your insurance.
But here’s the reality: Whole life sucks compared to term life when it comes to growing your money.
Let’s go back to our good friend Steve. He likes to dabble in the stock market, and 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 doesn’t tell Steve is the growth of the cash value in a whole life policy is awful. He’d be way better off going with term life and investing the money he’ll save on the premium into good growth stock mutual funds. That’s because the rates of return for whole life insurance policies are really low compared to the rate of return for mutual funds.
I want you to think of whole life policies as the timeshares of the life insurance industry—they’re just one big scam meant to make other people wealthy—not you.
Comparing Some of the Top Life Insurance Companies
When it comes down to buying term life insurance, there are a lot of options out there. Here are some of the top-rated companies and how they compare.
|Insurance Company||A.M. Best Rating*||Medical Exam**|
|American General Life Insurance Company||A||Yes|
|Banner Life Insurance Company||A+||No**|
|Lincoln National Life Insurance Company||A+||No**|
|Pacific Life Insurance Company||A+||No**|
|Protective Life Insurance Company||A||No**|
|Pruco Life Insurance Company||A+||Yes|
|Savings Bank Mutual Life Insurance Co of MA||A||No|
|United of Omaha Life Insurance Company||A-||Yes|
*A.M. Best is an agency that rates insurance companies on their ability to pay claims over the long haul. An A+ rating means this company has a "Superior" ability to pay out claims.
**All you have to do is answer a few health questions instead of setting up medical exams and blood tests. Depending on responses, you may still need a medical exam to obtain a policy.
Types of Term Life Insurance
Okay, so here’s where most people want to check out because, well . . . insurance. And I don’t blame you. I get it. But hang with me. As you look into term life insurance, you’ll definitely want to understand the different types.
Level term life insurance is a plan that offers a flat premium rate for the entire term (I recommend a term of 15–20 years). It’s also known as level premium because it keeps your premiums level based on the length of your term. It’s the simplest form of life insurance because once you have it, the premium and death benefit amount don’t change.
That’s a nice feeling, isn’t it? This is the main reason I recommend term life insurance level premium policies. You know exactly how much it’s going to cost every time your premium is due, and you can work it into your budget. Could insurance really be this easy? Actually, yes! Oh, and by the way, if you’re wondering, my friend Dave Ramsey also recommends level premium term life.
Term 80 (Annual Renewable)
I don’t know about you, but I just think term 80 sounds cooler. It’s a shame though because term 80 is probably not actually cooler when it comes to saving money. This type of policy is renewable every year until you turn 80, and the premium amount increases annually as you age. Exactly how much the premium increases is determined by the insurance company when they measure your risk every year at renewal time.
While the low premiums for increasing term life insurance can seem pretty sweet during the early years of the plan, the premiums will increase over time and turn out to be higher than if you’d opted for a simple level premium policy.
This one’s a little more complicated because, well, it makes no sense. A decreasing term policy is one where the payout decreases over time as your mortgage (or other type of loan) goes down—the payout and your loan amount drop together. The thought is that you don’t need as much of a death benefit if you’re paying down the loan—usually your mortgage—linked to the policy.
Premiums usually don’t change, so you end up paying the same every month but with the added feature of a decreasing payout. Sound like a good deal to you? Yeah, nope.
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 I’m definitely rooting for you).
You get your premium payments back, but premiums for this type of term life insurance are much higher in the first place. We’re talking 30–40% higher than a level premium. You could’ve invested that money and made more than the premiums cost in the first place.
Yeah, that’s a hard pass.
Guaranteed or Simplified
A guaranteed or simplified term life insurance policy is one you can get without having to mess with a medical exam. That’s right, no poking, prodding or uncomfortable encounters in a funky blue hospital gown. It may just take filling out a medical questionnaire. And some no medical exam policies have become very affordable, so keep your pants on and start typing. That’s a brand-new sentence for me.
Hang in there because we’re almost done. A convertible term life insurance policy is one that lets you convert term life to whole life down the line. But don’t do it! Your premium will jump way up when it comes time to convert. Some people might convert if they’re coming toward the end of their policy and have a terminal illness, but that’s a rare example.
Your employer might offer group term life insurance as a benefit to their employees. They might even pay the whole premium in some cases. Either way, it’s cheap. I’m always for taking the free option. But if you have to pay for your group plan, compare it closely to what you can get on your own before you chip in.
Payouts for group term life insurance are usually a lot less than a term life policy you take out on your own, so be sure to check the death benefit. And remember that if you change jobs, the insurance doesn’t go with you.
What Are the Benefits of Term Life Insurance?
Getting a term life insurance policy may be one of the smartest insurance decisions you can make. Here are some of the top benefits:
Pros and Cons of Term Life Insurance
Is way more affordable than other insurance options like whole life or universal life insurance.
Lack of investment options (but really, this belongs over in the pros section because insurance needs to stay in its lane and not try to be an investment).
Gives you the option to invest however you prefer (instead of locking your hard-earned dollars into a crappy, low-return investment).
You can’t cash it out (but you don’t really want to).
Allows you to move toward becoming self-insured (more on that below).
Protection for Your Family
Listen: If you and your spouse have young kids, term life insurance is the best way to protect them if something were to happen to you, full stop. And you’ll sleep so much better knowing those little ones will be taken care of, along with your spouse.
When it comes to term life insurance, you get what you pay for—and in this case, that’s a good thing! All you want is insurance, not insurance with a side of crackpot investments. We’re just wanting the entrée here. Don’t let anyone upsell you on the apps and ‘zerts. So if you want to save some money—and you know I’m into that—term life insurance is your best bet. It’s some of the cheapest insurance out there and gives you the best bang for your buck, by far.
Yeah, like the one on your bag of kale that you totally meant to use. Term life has a set time it expires, so you’re only paying for it for a specific amount of time. And you won’t be wasting money later in life on monthly premiums when you really don’t need the protection anymore.
How Much Does Term Life Insurance Cost?
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Your age and your health are two of the biggest factors that affect the cost of term life insurance. Insurance companies also consider other factors when tallying your premium, including:
- Length of term
- Death benefit amount
- Personal and family medical history
- Tobacco use
What Happens at the End of Term Life Insurance?
If your term life insurance policy is about to expire, you could renew it for another term depending on your age and life circumstances. Unless your name is Benjamin Button and you’re somehow aging in reverse, your premium rate will go up when you renew because you’ll be older and more expensive to insure (even if you have a level term plan). There is a chance you could get your premiums to go down if you choose a lower death benefit, but don’t do that if you still need the bigger payout to take care of your family.
Ultimately, though, you should shoot for being self-insured by paying off your debt, saving up an emergency fund, and building a good-sized retirement nest egg by the time your policy expires. It’s easier than you think! I’m doing it. And if I can do it, then you know what? So can you. 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.
How to Buy Term Life Insurance
There are a couple things to keep in mind as you think about getting a rock-solid term life policy in place. I’ll unpack how to get life insurance—specifically term life so you can know what to expect—and pass along some tips that will prevent you from making some common mistakes when setting up your policy.
It’s also a good idea to check with your employer to see if they offer a group term life insurance policy. Employer policies usually don’t cover all your needs, but they can get you partway there.
Here are the essentials for getting term life insurance:
Submit your application.
After you’ve gotten your quotes and picked the company you want to use, the first step is to apply. I know, you never saw that coming. Depending on your situation, the insurance carrier will look into how much of a risk it would be for them to insure you (this is called an underwriting process). If you smoke like a chimney and wash skyscraper windows, you’re a bit more of a risk than a librarian who eats kale salads for lunch every day. Sometimes a medical exam is also required, but like I mentioned earlier, some companies offer policies that don’t require a medical exam.
PSA: Smoking is bad. Please don’t smoke.
Pick the life insurance term length.
How long should your term length be, you ask? I recommend buying a term policy that lasts 15–20 years. That’s because if you have young children now (bless you and all the long nights and dirty diapers), they’ll be out of school and on their own by the time the policy ends. So, the only coverage you really need is during those 15–20 years in between—when they’re fully dependent on your income. And if you don’t have kids or they’re grown up (ah, the sweet sound of silence), that 15–20 years gives you plenty of time to become self-insured (more on that below) and provide for your spouse if something happens to you.
Choose your term life insurance payout amount.
Okay, here comes the math. (Don’t worry, no invisible numbers here—they’re all extremely visible.) Your death benefit needs to be 10 to 12 times your annual income. So just take your annual income and multiply it by 10–12 to figure out how much money your family would need if you died. Or check out this handy term life insurance calculator that will do the math for you!
The goal is for your family to invest the death benefit in good growth stock mutual funds averaging 10–12% growth each year. That way your family can use that growth to replace your income without having to touch the original investment.
So, here’s the equation: If you make $80,000 a year, multiplied by 10, you’d want a death benefit of at least $800,000.
Name your beneficiaries.
It’s time to name your beneficiaries—the ones who will receive the money if you die. And don’t forget to name a contingent beneficiary as well. This person would receive the payout if something ever happened to you and the primary beneficiary. I like to think of it as a back-up plan for your back-up plan.
The Bottom Line
Here’s the meat and potatoes: You want to get level premium term life insurance with coverage that’s 10–12 times your income and a term that’s 15–20 years in length.
Remember, life insurance has one job: to replace your income if you die. It’s there to provide for your loved ones, not to make them rich.
If you read this article and are thinking Wow, I need term life insurance, go to our estimator and start the process or talk to the experts at Zander Insurance. They’re a RamseyTrusted partner and are where I get my insurance.
Frequently Asked Questions
Do you get money back at the end of a term life insurance policy?
No—unless you get a return of premiums policy where you pay extra for the privilege of getting your money back 20 years later. (But if you’d just invested those extra bucks instead, you would have way more of that moolah at the end of 20 years!)
Can you cash in a term life insurance policy?
Nope. Typically, only whole life or universal life insurance policies can be tapped for any sort of cash value, but you’re paying through the nose for a measly return.
Can a senior citizen get term life insurance?
Term life insurance is available up until you’re 80 years old, although the available term lengths will shorten. But here’s the thing, insurance is meant to replace your income if you die and have a lot of people depending on you to bring home the bacon. Hopefully, your kids are out of the house by the time you’re 65 and you’ve invested wisely so there’s no need for life insurance.