What Is Term Life Insurance?

Approximately 41 million consumers expressed a need for life insurance but do not have any coverage. A common reason is the perceived high costs.

Term insurance is a more affordable insurance option for most people. Typical coverage ranges from $250,000 to $1 million for a predetermined time period. These policies may come with various customization options to meet your needs, such as end-of-term renewal options and conversions to a permanent policy. 

Below, we’ll review how term insurance works and what you should consider when shopping for life insurance. 

How does term life insurance work?

Term life insurance provides coverage for a limited time period. It’s a contract with the life insurance company to pay your beneficiary a certain amount of money if you die during the coverage period. Some policies will allow you to use your benefits before you die to cover medical expenses.

You can have multiple term life insurance policies in your name. You can also name multiple beneficiaries on each policy. If you outlive your policy, your beneficiary will not receive benefits.

Term life insurance has two main components.  

• Death benefit: This is the cash your beneficiary or beneficiaries receive when you die.  The common amounts include increments like $100,000, $250,000, and $500,000. The death benefit is usually tax free for those who receive it.  

• Length of policy: There is a fixed period when term insurance is valid. You can typically purchase term life policies in 5-year increments such as 5, 15, or 30 years. Depending on the terms of the policy, you may renew it or convert it to permanent coverage.

You might have to get a medical exam for coverage. It depends on your insurance carrier, age, and death benefit.

“Many carriers will go up to $2 million in a death benefit without needing an exam for people under 50 and up to $1 million from 50 to 60,” said John Boutte, a licensed insurance agent in San Antonio, Texas. “Over 60, you typically will need an exam for larger amounts.”

If you have a severe illness, like diabetes or high blood pressure, you may get coverage. But you will likely have to pay more.

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Types of term life insurance

There are multiple types of term life insurance. These include:

• Convertible term life insurance

• Decreasing term life insurance 

• Family-income benefit 

• Increasing term life insurance 

The most common type of term insurance is level term. This is typically what people are referring to when they talk about term insurance. Your level term policy will only last for a specific period of time, such as 5, 15, or 30 years. Your monthly premium and death benefit remains fixed for the length of the policy. Level term policies are known for being affordable.

There is also decreasing term insurance. This helps cover specific financial obligations, such as a mortgage. The death benefit declines over time. But the monthly premium amount remains the same. Decreasing term insurance tends to be cheaper because of the reduced coverage. 

What does term life insurance cover?

If the insured person dies during the coverage period, the beneficiaries will receive the death benefit. There are no restrictions on how life insurance beneficiaries can use the funds. Here are some common uses:

• Funeral expenses: Depending on the type of services you select, funeral expenses can be a financial burden on families. According to a 2021 study from the National Funeral Directors Association (NFDA), the median cost of a funeral was $7,848. Those expenses go up to $9,420 if you include a vault or casket.

• Everyday expenses: Life insurance can help a family replace the deceased’s income.  This means there will be enough money for rent or the mortgage as well as food, education, transportation, car payments, and clothes.

• Healthcare expenses: Even with the protections of the Affordable Care Act, health insurance is still a major expense. For 2021, the average premiums ranged from $2,664 to $7,152 per person. You also have to pay the deductible and copayments. The payout from the term life insurance policy can help cover a portion or all of these costs of the beneficiary’s healthcare costs. It can even cover outstanding healthcare expenses that the policyholder had.

• Debt: A decreasing term policy can pay off a mortgage obligation. You can also use a level term policy to meet the payments on credit cards, student loans, and car debt.  

• College: You can use proceeds of term insurance to pay for tuition and room and board.  

How much do term life insurance premiums cost?

An insurance company calculates your premiums based on these factors: 

• Age

• Gender

• Smoking status

• Lifestyle

• Occupation 

• Health status

This process is called underwriting. This helps individuals or institutions analyze the amount of risk they are taking on. Your monthly insurance premiums are based on your risk factors.

Generally, your term life insurance rates are lower the younger you are. They are also usually lower for women because they have longer life expectancies.

The following table shows estimated monthly premiums for a 20-year term policy: 

Source: Policygenius

What reasons or circumstances should a person buy term life insurance?

The following are reasons where this type of insurance is a good option:

• When you are younger and healthy: Your premiums will be lower, and they will remain fixed for the duration of the policy.

• If you already have health problems: While the premiums will be higher, the coverage will still be important. You want to make sure your family has the resources if you die.

• When you have kids: If you die, the consequences can potentially be severe for your family. A rule of thumb is to have coverage for your youngest child until they reach at least age 18.

• When you get married: Without coverage, there is likely to be financial hardship for your spouse. There will be funeral bills, and ongoing obligations, if you have children. You do not want your spouse to make tough decisions, such as whether to sell the house to pay bills.

How is the length of time within a term life insurance policy determined?

They are usually in 5-year intervals like 5, 10, and 20 years. But the longer the coverage, the higher the premiums.

You should take your financial obligations into consideration when choosing a term life insurance policy. You should do the same for your healthcare. According to the Centers for Disease Control and Prevention (CDC), about 4 in 10 Americans suffer from at least one chronic disease. If you end up with a severe health condition and your policy has a short duration, you could have difficulties finding an affordable replacement.  

What happens at the end of a term life insurance policy?

The policy usually expires at the end of your term. After your term ends, you will not have any more coverage. But some policies may allow for renewal of the insurance, or conversion to a permanent policy such as whole life. A permanent policy has a cash-value component, which can grow tax deferred. You can borrow against it, and you can use it for sophisticated estate-planning strategies.

If you can’t renew your policy or convert to a permanent policy, you can look to buy another policy.

Do you get your money back at the end of a term life insurance?

Generally, you do not get money back when the term insurance expires. But there are exceptions:

• Free-look period: This is a short time period, such as 30 days, where you can cancel your policy and get the premium refunded. There are no penalties.

• Return of premium life insurance: You get premiums refunded when the policy expires. But the premiums are high.  

• Living benefits riders: You can take part of your death benefit early to pay for medical expenses for a critical or terminal illness. But your beneficiaries will get a lower death benefit.

What kind of deaths are not covered in a term insurance plan?

If you die from suicide, the insurance company has at least a 2-year exclusion period to contest the payout. For example, the purpose of the death may have been for triggering the insurance. If so, the insurance company can deny the claim.

An insurance policy will not pay the beneficiary the death benefit if they murdered the insured. This is called the “slayer rule.” However, your contingent or secondary beneficiary will receive the proceeds of the policy.

Term insurance does not cover deaths while in pregnancy or childbirth. There is also no coverage if a person died while under the influence.

A policy may exclude payment if the insured engaged in high-risk activities like hang gliding, scuba diving, or rock climbing. Your policy contract discloses all the exclusions. But you should still ask the company or insurance agent about them.

What are the pros and cons of term life insurance?

There are many benefits that attract individuals to term life insurance, such as the affordable coverage. Terri Crespo, a life insurance agent in Windsor, Connecticut, says that, “The biggest pro is that term insurance offers the most death-benefit protection at the lowest cost, and that could be very important for those living on a tight budget.”

Your term life insurance may also include living-benefit riders. Some insurance companies offer these at no cost.

At the end of your policy, you may have the option to convert to a permanent policy. This applies to most term policies. “A lot of the time, the younger clientele can't afford a permanent policy, so we will set them up with a term. Once their income goes up, we will start converting amounts of that term into a permanent policy,” said Boutte.

The following are disadvantages with term insurance:

• Must requalify at the end of the term: This may mean the costs are high if you have health problems. You might not even be able to qualify for a new policy.

• Premiums increase: Even if you are healthy, the premiums will likely be higher when you get a new policy. 

• There is no cash value: Your premiums only count toward insurance coverage. There is no investment component.  

How long do you have to have term life insurance before it will pay?

When you are approved and pay the first premium, you are covered. There is no waiting period.

For example, if you purchase a policy in March 2022 and die in April 2022, the insurance company will pay the full death benefit to your beneficiaries. 

Should I convert my term life to whole life insurance?

It’s important to seek advice from a financial planner or insurance agent who understands your specific situation. Here are some considerations:

• Health: You do not have to get a medical exam if you make a conversion from term life to whole life insurance. This can be a benefit if you have health problems that could make it difficult to get affordable coverage.

• Estate planning: If your estate exceeds the annual IRS threshold, you may owe the federal estate tax if you die. Your heirs can pay for the tax bill if you have a whole life insurance policy in a trust.

• Savings: You can benefit from tax-deferred growth of the cash value with a whole life insurance policy.

• Dependent: If you have a lifelong dependent, such as a child with special needs, a whole life policy may provide better protection.

What are the differences between whole life and term life insurance?

Below is a table that summarizes the main differences between whole life and term life insurance:

Is term life better than whole life insurance?

The type of insurance you purchase depends on your needs. If you want an affordable way to protect your spouse and children, then term is usually a good option. For example, a term policy for 20 years can cover the costs of children until they start working.

But a term policy has drawbacks. There is no cash value, and it can be expensive to buy another policy after your term expires. This is why you might want to look at a permanent policy. It can be effective for protecting lifelong dependents or handling complex financial or estate planning matters.

Should I buy both whole life and term life policies?

This depends on your goals. For example, you may have a child who will need care for the rest of their life. A whole life policy could cover the ongoing expenses. But you may have a term policy for the costs of your other dependents.

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Written by:

Tom Taulli, EA

Tom Taulli, EA, founded and operates his own tax preparation and planning firm, Pathway Tax. He is a licensed enrolled agent and can represent taxpayers before the IRS. He can also prepare and advise on tax matters for all 50 states.

Edited by:

Charlene Rhinehart, CPA

Charlene Rhinehart, CPA, is a personal finance editor at GoodRx. She has been a certified public accountant for over a decade.

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