Breaking down term life insurance

Like other life insurance, term life insurance is designed to help you plan for the unexpected by offering financial protection to your named beneficiaries in the event of your death. It has several potential benefits, as well as drawbacks, to consider before determining if it should play a role in your financial plan.

Term life insurance is coverage intended for a specific amount of time. You choose the length of the term and the coverage amount, so you can tailor it to your needs. It’s one of two basic types of life insurance, with the other being permanent life insurance.

Once you are a legal adult, you can buy term life insurance. However, many policies have a maximum age limit after which you can no longer purchase or renew it.

The policyholder pays premiums to the insurance company in exchange for the promise of a death benefit¹ paid to the named beneficiary (ies) for a set term. The benefit is paid out to your chosen beneficiaries if you, assuming you are the insured person, pass away during the term.

However, if you outlive the term, the death benefit expires, and you will have to decide whether you want to renew it, purchase another policy, or go without coverage. Some term life insurance policies can be converted to permanent life insurance though the premium charged may change.

In contrast, permanent life insurance is designed to stay in place for your lifetime and its death benefit does not expire. It can often offer other financial features, such as a savings-like cash value that grows over time. Permanent life insurance is generally more expensive because of its lasting death benefit and added complexity.

Term life insurance might be a good fit for you, depending on your financial situation and personal goals. It tends to be less complex than permanent life insurance, and it also offers advantages, such as:

• Affordability: Generally, you can get a significant death benefit for a smaller monthly premium with term life insurance. This gives you an affordable way to help protect your family with an insurance payout when they would need it most.
• Customization: Term life insurance allows you to specify the amount of time you need coverage, as well as your level of coverage. For example, if you only need coverage until your youngest child has finished college, you can find a policy that fits that timeframe. That means term life insurance offers you exactly the insurance you need over the time period you need it.

Even with these upsides, term life insurance has some downsides to consider, like the fact that its death benefit can expire and it doesn’t build a cash value.

A premium payment is the amount of money you must pay for an insurance policy. When you buy term life insurance, you’ll pay one of two types of premiums: fixed or renewable.

• Fixed premiums: You will pay the same, fixed amount for the term period indicated on the policy. Once the term is over, you can choose to extend your coverage term, often on an annual basis, and you will likely pay more with each annual renewal.
• Renewable premiums: This policy is renewed annually. It may cost less than a fixed premium term policy initially, but you will likely pay more with each renewal.

You can also choose whether to receive a level or decreasing death benefit. A level benefit stays the same throughout the policy term, while a decreasing death benefit declines by a certain percentage per year.

So, if you purchased a 20-year policy with $300,000 in coverage, a level benefit would give you full coverage for all 20 years. With a decreasing death benefit, coverage would decline 5% to a $285,000 payout in the second year, then to $270,000 in the third year, and so on until there is no benefit by the end of the 20-year term.

The benefit of a decreasing benefit policy is that it may be less expensive than a level benefit policy, while still giving you the coverage you need. You can use a decreasing benefit policy to align with debt obligations your family may have to carry in the event of your death, such as a mortgage. As you pay down your mortgage, your family could rely on lower payouts to pay it off. A declining death benefit could fulfill that need.

You may want to explore term life insurance if you only need life insurance for a specific time.

If you are working to build your assets and you want the lower premiums of term life insurance, term life insurance might be worth considering. Keep in mind: Some policies do allow you to convert term into permanent coverage.

Still, term life insurance isn’t right for everyone. Permanent policies may be a better fit for some investors, like those who are comfortable with higher premiums and have lifelong dependents.

Premiums are based in part on your age and health. For that reason, older people tend to have higher premiums. So, term life insurance may not be their best strategy for providing for their family.

Understanding the pros and cons of term life insurance, as well as how it works, can help you find a policy that fits your financial needs.