Term Insurance: How it Works, Examples, Types & Need

What is Term Insurance?

Term insurance is a type of life insurance that provides coverage for a specified period, known as the “term.” Unlike whole life or permanent insurance, which covers the insured for their entire life as long as premiums are paid, term insurance only provides coverage for a predetermined period, typically ranging from 5 to 30 years. Term insurance is often used to provide financial protection for specific needs that may expire over time, such as paying off a mortgage, funding a child’s education, or replacing lost income for dependents.

Geeky Takeaways:

• Term insurance typically offers lower premiums compared to permanent life insurance policies.
• Term insurance provides flexibility in choosing the coverage period to align with specific financial obligations or needs.
• Policyholders can select terms ranging from as short as 5 years to as long as 30 years, depending on their requirements.

How Term Life Insurance Work?

Term life insurance works by providing coverage for a specified period, known as the “term,” in exchange for regular premium payments.

1. Selecting Coverage Amount and Term: When purchasing a term life insurance policy, you first determine the amount of coverage you need (the death benefit) and the length of time you want the coverage to last (the term). Common term lengths include 10, 20, or 30 years, but other options may be available depending on the insurer.

2. Premium Payments: You pay regular premiums to the insurance company to keep the policy active. Premiums can usually be paid monthly, quarterly, semi-annually, or annually, depending on your preference and the policy terms.

3. Coverage Period: During the term of the policy, if the insured person (the policyholder) passes away, the insurance company pays out a death benefit to the beneficiaries named in the policy. This death benefit is typically a tax-free lump sum payment and can be used by the beneficiaries to cover various expenses, such as funeral costs, outstanding debts, ongoing living expenses, or future financial needs.

4. Renewal and Convertibility Options: Some term life insurance policies offer the option to renew the policy at the end of the term, usually at higher premiums since the insured is older. Additionally, many policies include a convertibility feature, allowing the policyholder to convert the term policy into a permanent life insurance policy without the need for a medical exam.

5. No Cash Value: Unlike permanent life insurance policies (such as whole life or universal life), term life insurance does not build cash value over time. This means that if you outlive the term of the policy, no benefits are paid out, and you do not receive any return on the premiums you’ve paid.

6. Purpose of Coverage: Term life insurance is often used to provide financial protection for specific needs that may expire over time, such as paying off a mortgage, funding a child’s education, or replacing lost income for dependents.

Example of Term Life Insurance

For instance, John is a 35-year-old father of two young children. He wants to ensure that his family is financially protected in case something happens to him. John decides to purchase a 20-year term life insurance policy with a death benefit of $600,000.

Coverage and Premiums:

• Coverage Amount: $500,000
• Term Length: 20 years
• Premium Payment: $2,500 per month

Types of Term Insurance

1. Level Term Insurance: This is the most basic type of term insurance where the death benefit remains the same throughout the term of the policy. Premiums also remain same, meaning they do not increase over time. Level term insurance provides straightforward coverage with predictable premiums, making it easy to budget for.

2. Decreasing Term Insurance: In a decreasing term policy, the death benefit decreases over time while the premiums remain level. This type of policy is often used to cover specific financial obligations that decrease over time, such as a mortgage or other loans. As the outstanding balance decreases, the amount of coverage needed also decreases, aligning with the decreasing financial obligation.

3. Increasing Term Insurance: Increasing term insurance provides coverage where the death benefit increases over time while premiums remain level. This type of policy is designed to help the insured keep up with inflation and rising financial needs. The increasing death benefit ensures that the coverage maintains its value over time, providing adequate protection against future expenses.

4. Renewable Term Insurance: Renewable term insurance allows the insured to renew the policy for an additional term without the need for a medical exam. Typically, the premiums for renewal increase with each renewal term since the insured is older and may present a higher risk to the insurance company.

5. Convertible Term Insurance: Convertible term insurance policies include an option that allows the policyholder to convert the term policy into a permanent life insurance policy without the need for a medical exam. This feature provides flexibility for individuals who may want to switch to permanent coverage in the future to enjoy features such as cash value accumulation and lifetime protection.

6. Term Riders: Some insurance companies offer term insurance riders that can be added to permanent life insurance policies to provide additional temporary coverage for specific needs, such as covering a mortgage or providing extra protection during the early years when financial obligations are higher.

Term Life Insurance vs. Whole Life Insurance

Basis	Term Life Insurance	Whole Life Insurance
Coverage Duration	Provides coverage for a specific term (e.g., 10, 20, 30 years)	Provides coverage for the entire lifetime of the insured
Premiums	Generally lower premiums	Typically higher premiums, but fixed and guaranteed
Cash Value	Does not accumulate cash value	Builds cash value over time, which can be borrowed against or surrendered
Death Benefit	Pays out a death benefit if the insured dies during the term	Pays out a death benefit whenever the insured passes away
Investment Component	No investment component	Includes a savings/investment component
Flexibility	Limited flexibility, typically fixed term and coverage amount	More flexible options for adjusting coverage and accessing cash value
Policy Loans	Not applicable	Can take policy loans against the cash value
Premium Payments	Premiums are paid for a specific term	Premiums are paid throughout the insured’s lifetime
Cost	Cheaper upfront cost	More expensive due to the lifetime coverage and cash value
Suitability	Ideal for temporary needs (e.g., income replacement during working years)	Suitable for long-term financial planning and wealth accumulation
Tax Implications	Death benefits are generally tax-free	Cash value accumulation may have tax implications

Term Insurance Buying Procedures

I. Online Buying Procedure

• Visit insurance company websites or comparison platforms to explore different term insurance plans.
• Complete an online application form with personal and medical information.
• Some insurers may require a medical examination or ask health-related questions to determine the premium.
• Pay premiums securely online using various payment methods.

II. Offline Buying Procedure:

1. Schedule a meeting with an insurance agent or broker to discuss available term insurance options.
2. Fill out physical forms and provide necessary documents such as identification proof, address proof, and medical history.
3. Submit premiums through traditional methods like cheque or cash at the insurer’s office or through the agent.

How to Select the Best Term Insurance Plan?

Consider these factors when choosing a term insurance plan:

• Coverage Amount: Determine the appropriate death benefit based on your financial obligations and the needs of your dependents.
• Term Length: Choose a term duration that aligns with specific milestones like mortgage payoff, children’s education, or retirement.
• Premium Affordability: Select a premium amount that fits comfortably within your budget while providing adequate coverage.
• Insurer’s Reputation: Research the insurer’s claim settlement record, customer service reputation, and financial stability to ensure reliability.

Who Should Buy Term Insurance Plans?

1. Income Earners: Term insurance is essential for individuals who contribute financially to their families. It ensures that in the event of their untimely demise, their loved ones are financially protected and can maintain their standard of living.

2. Breadwinners: Anyone who is the primary breadwinner of their family should strongly consider purchasing term insurance. This includes parents, spouses, or guardians who are responsible for supporting their dependents financially.

3. Parents: Parents, especially those with young children or children who are financially dependent on them, should prioritize term insurance. It provides a financial safety net to ensure that children’s education expenses and other needs are met, even if the parent passes away prematurely.

4. Debtors: Individuals with significant financial liabilities, such as mortgages, car loans, or personal loans, should consider term insurance. It can help cover these debts in the event of their death, preventing their loved ones from inheriting the financial burden.

5. Business Owners: Business owners, especially those with partners or co-owners, should consider term insurance to protect their business interests. It can help ensure business continuity and provide funds to buy out the deceased partner’s share, preventing financial strain on the surviving partners.

Term Insurance – FAQs

Is term insurance renewable?

Most term insurance policies offer renewal options at the end of the term without the need for a medical exam.

Can I convert term insurance into whole life insurance?

Some term policies provide conversion options to permanent life insurance, allowing policyholders to switch without new underwriting.

What happens if I outlive my term life insurance policy?

Coverage ends, and there is no return of premiums paid during the term.

Is term insurance taxable?

Death benefits are generally paid tax-free to beneficiaries under current tax laws.

Can I change the coverage amount during the term?

Some policies may offer options to adjust coverage amounts during the term based on specific life events or changing financial needs.