How Does Term Life Insurance Work?

Term life insurance is the most affordable and straightforward type of life insurance. It provides temporary coverage for a set period of time, typically 10, 20, or 30 years.

Term life is a good option for people looking for coverage for specific goals, like paying for a mortgage or for higher education. In this article, we’ll dive into how term life insurance works, the various types available, what affects costs, and how to buy it.

What is term life insurance, and how does it work?

All life insurance provides financial security for your loved ones if you pass away. Term life insurance is temporary coverage that pays your beneficiaries a pre-determined death benefit if you die while the policy is in effect.1 It can replace your income, pay off debts, pay for college, and pay for other financial goals. Common terms are 10, 20, and 30 years.

Because it’s temporary, term life is usually the most affordable type of life insurance. Premiums stay the same throughout the policy term, so your monthly or annual payment won’t change.

Unlike whole life insurance, term life doesn’t have any cash value, meaning you can’t access any of the money from the policy if you’re still alive.

Term life insurance is a great option for young families, new homeowners, and anyone who needs temporary financial protection for their families. Once the policy term ends, you may have the opportunity to renew it. Or you may choose to let it lapse or convert it into a permanent life policy.

If you choose to renew, your premiums will likely increase since you’ll be older and at a higher risk of health complications.2

Pros and cons of term life insurance

Because it’s temporary and the most basic type of life insurance, term life insurance isn’t right for everyone. It’s important to weigh term life’s advantages and disadvantages before choosing a life insurance policy.

Types of term life insurance

You can choose from various types of term life insurance. The right policy for you depends on your lifestyle, your budget, and what’s important to you in a life insurance policy. Here are some common types of term life insurance policy and the key differences among them.

Each of these types of term life insurance has advantages and disadvantages. It’s important to understand how each works before selecting a life insurance policy.

• Level term: Level term life insurance has a fixed monthly payment and death benefit for the entire duration of the policy. It’s a standard type of life insurance, good for people who want to buy it and forget about it. But keep in mind that if you outlive the term of the policy, your loved ones won’t receive a death benefit and the money you paid for premiums will be gone.

• Decreasing term: Policyholders pay a fixed premium for decreasing term life insurance, but the death benefit amount decreases each year. These policies generally have inexpensive premiums, making them good options for people looking to save money. They can work well if you’re paying down a debt and just want insurance to cover the unpaid balance if you pass away.

• Renewable term: With renewable term policies, you’ll have the option to renew at the end of the initial policy term. You may be able to renew the policy for the same amount of time as the original term. And you can typically renew without taking a medical exam. But premiums rise when you renew, so these policies are typically a good option for people only looking for temporary coverage.

• Convertible term: Convertible policies allow you to turn an in-force term policy into a permanent policy without having to undergo the typical underwriting process. It doesn’t require a medical exam or consider medical conditions when converting, so it’s a good option for people with a history of family medical issues.

• Return of premium: With most term life insurance policies, you won’t get any money (either as a death benefit or refund) if you outlive the policy term. But return-of-premium policies allow you to get some of your premiums back at the end of your policy term if you don’t pass away. This coverage is typically a rider that you can add to a term life policy. Return-of-premium term life can be a good option for people who want to have not only protection but also money for future investments.

Cost of term life insurance

Various factors affect the cost of term life insurance, including your age, health, gender, lifestyle, occupation, coverage amount, term length, and family medical history.

The following table provides average monthly term life insurance rates based on age, gender, term length, and death benefit amount.

How to buy term life insurance

Buying term life insurance is fairly easy, but you’ll want to make sure you’re prepared before signing anything.

1. Assess your needs. Start by looking at your needs and considering why and if you need life insurance. If you have loved ones who depend on you financially, or you have debt that could pass on to your family if you die, you may need life insurance. If you decide you do, calculate how much coverage you need and decide on a term length.

2. Compare policies and quotes. Once you know what you’re looking for, start comparing life insurance companies and get quotes from each.

3. Choose an insurer. Find an insurer that fits your needs for an affordable rate. Don’t just choose the cheapest option. Read company reviews online to ensure the company is reliable and financially stable.

4. Complete the application. Once you’re comfortable with your choice, you’ll need to complete an application detailing your medical and financial history along with other personal information.

5. Take a medical exam. Some life insurance companies may require you to complete a medical exam before getting a policy. If this is the case, schedule an exam as soon as you can to confirm your status with your insurer.

6. Review and finalize your policy. Take a final look at your policy and consider if you need to add on any insurance riders. Make sure you understand your policy before signing anything.

7. Start paying your premiums. Once you’ve signed, you’ll just need to start paying your premiums to ensure your coverage remains active. It’s important to pay your premium on time every month to ensure your policy stays in force.

How to calculate how much life insurance you need

The main purpose of life insurance is to protect your loved ones financially if you pass away. Common goals for life insurance include replacing your lost income, paying off debts, paying for your children’s college tuition, and securing your survivors’ financial future.

You can calculate how much life insurance you need in several ways. A general rule of thumb is to buy coverage that equals 10–15 times your annual income. Another way to decide is to consider specific expenses, such as funeral costs and future purchases.

One of the most reliable methods, however, is the DIME formula. DIME stands for “debt, income, mortgage, and education.” Essentially, you add all these factors together to estimate how much coverage you should buy. Here’s how it works:

How to save on term life insurance

Term life insurance can be a long-term commitment, so it makes sense to find the best price available to you. Here are some ways to save money on your term life insurance policy:

• Buy a policy when you’re young. Buying life insurance when you’re young can get you lower premiums, as the older you get, the more risk insurance companies assume.

• Follow a healthy lifestyle. Avoid bad habits like smoking, and stay active to keep your health in top shape. The healthier you are, the lower your premiums will be. Some insurers even offer discounts to non-smokers.

• Compare quotes. Always compare insurance quotes from multiple life insurance companies before buying a policy. Some insurers may offer cheaper rates than others for the same coverage.

• Bundle policies. Try to bundle your life insurance with your home insurance or auto insurance. Many insurers offer a discount if you buy multiple policies with them.

• Pick the right term length. Make sure to choose the right term length. Don’t choose an unnecessarily long term, as it will increase your premiums.

How term life insurance works FAQs