Term Insurance
As
the name implies, term insurance provides protection for a specific
period of time and generally pays a benefit only if you die during the
"term." Term periods typically range from one year to 30 years, with 20
years being the most common term.
Advantages
One
of the biggest advantages of term insurance is its lower initial cost
in comparison to permanent insurance. Why is it cheaper when initially
purchased? Because with term insurance, you're generally just paying
for the death benefit, the lump sum payment your beneficiaries will
receive if you die during the term of the policy. With most permanent
policies, your premiums help fund the death benefit and can accumulate
cash value.
Term insurance is often a good choice for people in
their family-formation years, especially if they're on a tight budget,
because it allows them to buy high levels of coverage when the need for
protection is often greatest. Term insurance is also a good option for
covering needs that will disappear in time. For instance, if paying for
college is a major financial concern but you're pretty sure that you
won't need life insurance coverage after the kids graduate, then it
might make sense to buy a term policy that will get you through the
college years.
When the Term Ends
But
what happens if you buy a term policy only to realize at the end of the
term that you still have a need for life insurance? Well, it's sort of
a good news, bad news story. The good news is that many policies will
give you the option to renew your policy when you reach the end of the
term. The bad news is that you'll probably face much higher costs since
age is one of key factors used to determine life insurance premiums. To
renew the policy, you also may have to present evidence of insurability
(that's insurance jargon meaning, "take another medical exam and answer
a new round of questions about your lifestyle, health status and family
health history"). If you're still a fine specimen with healthy living
habits, you might requalify at a reasonable rate. But if your health
has deteriorated, you may find that it's too expensive to renew your
policy or you may not even requalify.
So if you're considering
a term policy, make sure you carefully consider how long you'll need
the coverage. If you're pretty sure that your needs are temporary, then
term insurance is probably the right choice for you. But if you think
there's a possibility that you might need the coverage for a long time,
then remember that if you want to renew your term policy after it
expires or buy a new term policy at that time, your age, health status
or other factors may make coverage very expensive.
To better
understand term insurance, consider this analogy. When you purchase
term insurance, it's sort of like renting a house. When you rent, you
get the full and immediate use of the house and all that goes with it,
but only for as long as you continue paying rent. As soon as your lease
expires, you must leave. Even if you rented the house for 30 years, you
have no "equity" or value that belongs to you.
Return-of-Premium Option
One
exception to this rule is what's called a return-of-premium term
policy. With these policies, if you keep the policy in force for the
entire term, say 20 years, the insurance company will refund the
premium payments you made over that 20-year period. Of course, there is
a price to be paid for this added benefit. The premiums for
return-of-premium policies are considerably higher than premiums for
standard term policies. The price difference can be 20%, 30% or more.
Another factor to consider is that term insurance rates have dropped
considerably over the past decade, mostly because people are living
longer. If you own a standard term policy, there's really no harm done
in dropping that policy in favor of a newer and cheaper term policy.
But if you own a return-of-premium policy, dropping the policy before
the full term has expired means that you will have paid a high price
for your term insurance coverage and the premiums you paid won't be
fully refunded. At best, you'll get a partial refund of the money you
put into your policy to that point.
Key Policy Provisions
When
considering a term purchase, one thing to keep in mind is that not all
term policies are the same. Some may include certain provisions as
standard features, while others may require you to pay extra to add
these features as "riders" to your policy. So if you're comparing term
policies, remember that price is not the only factor to consider. Ask
your agent about provisions such as:
- Accelerated death
benefits - allows a terminally ill person to collect a significant
portion of his or her policy's death benefit while that person is still
alive
- Disability waiver of premium - waives premiums
when a policy owner suffers a long-term disability, typically one
lasting six months or longer
- Accidental death benefits - doubles or triples the benefit in the case of death by accidental means
Convertibility
Another
provision that is very important is something called convertibility.
Some insurance contracts only allow "conversion" in the first few years
of the policy, while others allow it at any point during the term. This
valuable feature allows you to convert your term policy to a permanent
policy (e.g., whole life insurance) without submitting evidence of
insurability. Being able to convert to a permanent policy is a great
option to have in the event that circumstances in your life change such
as failing health or maybe just the realization that coverage is needed
for a longer period of time than you originally anticipated. That's why
when purchasing a term policy, it's never a bad idea to find out what
kind of permanent policies are offered by the company you are
considering. Some companies may only have strong term insurance
offerings, while others may have very competitive products in both
categories.