When choosing a life insurance policy, deciding whether you want term or permanent life insurance is the first step. Keynote of term life insurance is that coverage lasts for a specified period.
Things get more complicated when you start researching because these two broad categories break up into various subcategories. In addition, there are seven types of term insurance, and in this article, we will represent them to help you find what works the best for you.
In today’s article, we will cover:
- The basics of term life insurance.
- How does term life insurance work?
- How and who should get a term life insurance policy?
- What are the different types of term life insurance and their differences?
- The comparison between term life and whole life insurance.
- How to become financially self-reliant?
Let’s get started!
The Basics of Term Life Insurance
We mentioned above that the first decision you must make when buying life insurance is whether you want term or whole life insurance. We will give you a brief comparison to help you make that decision.
Term Life Insurance vs. Permanent Life Insurance
All life insurances have the same structure: an agreement between the insurer and insured to secure (insure) life coverage for a stated death benefit of the insured. In exchange, the policyholder pays a predetermined set of premiums.
So, life insurance is a tool to provide financial stability and support to the insured’s family and loved ones.
This is common for both primary types of life insurance – term and whole life. The crucial difference between these two is the period for how long the coverage lasts.
Term life insurance provides coverage for a specified time, usually between one and 30 years. In contrast, permanent insurance lasts throughout the insured person’s entire life. The second crucial difference between these types of life insurance is building cash value. The permanent policy is designed to build cash value while the term policy isn’t.
What Is Term Life Insurance?
After the term life insurance policy expires, the death benefit protection is ended. Since it’s designed to last a set number of years, this is usually a choice for people that need temporary coverage while raising a family, or paying off their mortgage, for example.
Another frequent reason people go with term life insurance policies is their affordability. No term policies have value other than the guaranteed death benefit, meaning no savings component is found in a whole life product. This is the core of term life insurance policies, and we will see below how term insurance types can vary.
How Does a Term Life Insurance Work?
Usually, people match the length of their term policy with the financial obligation they want to cover. It involves specific debts, buying a house, mortgage, or taking care of their family. Annual costs of policy stay the same for the level term period.
When the fixed period ends, it’s possible to renew it, but the rates get higher each year.
Some life insurance companies offer another option: conversion from a term life policy to a permanent life policy. It is a great option mainly because people often realize they want permanent insurance coverage, but for some reasons (perhaps poor health conditions), they don’t want to buy a new policy.
Unfortunately, this option isn’t always available, so check with your life insurance company if they offer it.
If the insured person outlives the length of the policy and doesn’t renew it, the term policy expires. But, if the insured person dies while the coverage is in force, their beneficiaries will get the death benefit.
How to Get It?
Any term life insurance policy is available for purchase in numerous ways: through insurance agents or brokers, online, or traditionally from an insurance company. Of course, there are pros and cons to each form. The best is to see what works best for you.
For example, applicants without health issues can enjoy buying a policy online because they don’t have to take a traditional medical exam. Instead, algorithms calculate life expectancy.
On the other hand, people who are unsure which type of life insurance will be suitable for them might find it helpful to talk to an agent or a broker.
Who Should Get It?
We can’t make a lengthy list of situations when people can benefit from term life insurance because we all have different needs and plans. However, there are few examples when people usually choose a term life insurance plan.
- Sole Financial Providers. Life is unpredictable, and in case of losing a source of income can disturb a family’s life. In times of this uncertain financial situation, term life insurance can have a central role in recovering. The death benefit can be used as income replacement, allowing the remaining parent to stay home and take care of their children. That money can be used for current and future education expenses, childcare, or everyday costs.
- People with outstanding debts. Significant debts often motivate people to choose term life insurance to repay them upon their death. The insured person chooses their beneficiary who will use the death benefit to repay those debts. Instead of paying them out of pocket or forfeiting the property, they can cover their student loans or a mortgage with a policy. Once again, proceeds can also be used to replace an income to cover current and future expenses.
- Business owners. It’s similar to the previous example, but we are talking about the company’s debts, expenses, and outstanding taxes instead of personal debt. Many business owners use term life insurance to precede their financial obligations.
Different Types of Term Life Insurance
All types of term life insurance follow the basic coverage model for a specified period. There are several different types of that general category:
- Level premium term life insurance
- Increasing term life insurance
- Decreasing term life insurance
- Renewable term life insurance
- Convertible term life insurance
- Return of premium insurance
- No medical exam life insurance
- Group term life insurance.
Let’s dive in!
Level Premium Term Life Insurance
A level premium policy is the most basic kind of term insurance. This policy’s premium never increases, and the death benefit amount stays the same throughout the term. So, this policy pays the same benefit amount if death occurs at any point during the time.
They usually last from five to 30 years, in five-year increments. Some insurance companies offer annual renewals (single-year policies), which are considered renewable term life insurance.
However, they are technically level policies because premium payments are the same throughout the term. Still, a policyholder may see annual rate increases because each term only lasts one year.
If a person who is 30 years old and in good health buys this policy, they might pay $23 per month in exchange for a $500,000 and 20-year policy. However, as the person ages, the actual cost of insurance becomes prohibitively expensive.
In contrast, an overweight man who is 65 years old with minor health problems could pay over $700 per month. The coverage is $500,000, which expires when he is 85. As you can see, even though term policies can be much cheaper for younger people, they can be quite unaffordable. This example is excellent to see how it actually can be different.
Usually, term life insurance policies have a maximum age limit for the applicant. These limitations vary by the insurance company, but here is a rough example for reference:
- 50-60 years old: 30-year term policy
- 60-70 years old: 20-year term policy
- 70-75 years old: 15-year term policy
- 75-80 years old: 10-year term policy
Increasing Term Life Insurance
This type is called increasing due to death benefit that increases each year. Usually, it is between 2-10 percent, but the percentage is fixed when you sign the contract. Along with increasing death benefits, the premium payments are also going up.
For example, if you get a $250,000 policy with a 10% fixed percentage, in the second year, that policy will be $275,000. In the third year, it will be $302,500 (+10%), and so on, and so on. It is undoubtedly a poor option for someone that wants long-term coverage. As you saw, the reason is due to benefits and premiums growing substantially over a short time.
After a more extended period (20-30 years, for example), the policy usually becomes cost-prohibitive. It is especially dangerous for people that experience financial insecurities. There is a possibility that premiums increase at a higher rate once the benefit crosses a certain threshold.
Decreasing Term Life Insurance
In contrast to increasing policy, the death benefit in decreasing term insurance decreases every year of the term. Sometimes it’s also called mortgage protection insurance. It’s not strange because people usually choose to pay down the balance on large debts (such as a mortgage) during the term.
Simultaneously the debt obligation and the amount of coverage the person needs shrinks. Still, the premiums don’t decrease with the benefit. Instead, decreasing policies provide a much lower annual premium from the beginning. They also remain level throughout the term.
The considerable advantage of decreasing term insurance is that it can be beneficial to cover any financial obligation, from business, or student, to personal loans. However, it doesn’t offer a level death benefit.
Suppose you have already decided to buy a life insurance policy. In that case, it is rational to choose the option that can help you resolve financial problems but also helps your family (or you) in the future. Therefore, it seems like it’s missing a crucial element of the life insurance policy – the life insurance itself.
Decreasing term policy is generally easy to understand and often has lower-cost premiums at first. But on the other hand, it has significant drawbacks:
- No cash value,
- Upper age limit (usually age of 50 for all term lengths),
- Poor policy’s death benefit,
- Harder to find an insurance company that offers it
Renewable Term Life Insurance
The basic idea of renewable life insurance is to allow policyholders to extend or renew their policies for an additional term after expiration. A crucial benefit is that the renewable policy doesn’t require a new medical exam. Some renewable policies are designed to renew coverage yearly when the person is up to a specified age (usually 65).
Premiums in these policies typically increase each year as well. On the other hand, other policies automatically renew the insured’s original term length after the first one ends.
A life insurance company considers the applicant’s age, health, and risk of dying. Due to that criterion, it is preferred to buy it in your 20s and 30s. In that period, the risks are lower, and so do premium costs. Often people who recently lost a job, or don’t have access to benefits at their job, decide to buy an annual renewable term.
Some of the advantages of the renew coverage are:
- Cost-effective. Because the policyholders only renew the old policy, the cost is lower than the process of buying a new policy.
- No medical exam. This is especially beneficial when people go through health issues they didn’t experience before getting a policy.
- Transitory solution. When people need to cover small and unexpected expenses, this policy can be an easy fix. However, remember that it is cost-efficient only up to a certain age.
There are the drawbacks too:
- Higher cost after some time. Even though it at first seems like the most affordable option, as the policyholder gets older and those premiums increase, it indeed can be expensive.
- There is no investment component. We will go in-depth about investment components later when comparing terms and whole life, but the following is enough for now. Since it doesn’t offer cash value build-up and premiums go up, the beneficiaries and the policyholders have access to the same death benefit. It’s also evident that you can’t use it for retirement planning.
- Non-convertible. A yearly renewable term policy cannot be converted to other permanent policies.
Convertible Term Life Insurance
Convertible life insurance allows the policyholder to convert their policies to one of the permanent policies if they outlive the term. This is the safest option because people can easily change their financial priorities and still don’t have harmful consequences. Additionally, conversion doesn’t require re-qualifying for a new policy.
Convertible policies are also level-term policies, meaning the death benefit and premium remain the same during the term. People with a high probability of developing health issues usually consider this option. It can benefit them because it expands the possibilities for mitigating life’s risks and uncertainties.
Another common reason people choose a convertible policy is their doubts about whether to buy a term or a whole life policy. For them, the conversion option can be helpful with the adaptability they need to deal with changing circumstances. One more frequent reason why people buy a convertible policy is that they right now don’t have enough money for other options.
However, this type of insurance doesn’t guarantee you the ability to obtain a permanent policy for the same price as it was (if you want the full death benefit). Usually, permanent insurance is more expensive or equal to term insurance. Another drawback is specific requirements people need to meet to become allowed for conversion. Often people over the age of 65 cannot convert their policies.
Return of Premium Insurance
The return of premium (ROP) policy is a relatively new product designed to unite the advantages of traditional term insurance and a return of premium features. From standard terms, it took over affordability and guaranteed level premium periods (10, 20, or 30 years).
The insurance company returns 100% of the premiums paid to the policyholder when the level premium period ends. In contrast, with most types of the term (including auto insurance and homeowners), if the insured person hasn’t had a claim under the policy by the time it expires, they get no refund of the premium.
ROP excludes substandard fees and extra charges. No wonder they charge extra for this added benefit. ROP policies are more expensive compared to other types of term insurance.
No Medical Exam Life Insurance
No medical exam term life incorporates affordability and guaranteed level premium periods of traditional term life with simplified underwriting. These term policies are usually approved quickly, from 24 to 48 hours. There are no medical exams and lengthy underwriting.
People who want to apply must choose life insurance coverage amounts from $50,000 to $400,000 and coverage periods of 10, 15, or 20 years. Since there is no physical exam, applications can be filled out by telephone or online.
Group term life insurance is one kind of term insurance that covers all members of a particular group. Employers commonly offer this insurance as part of their employee benefits package. Of course, it can also be provided by other groups – labor unions or professional organizations.
This life insurance aims to cover an entire group of people with just a single contract. If the insured employee dies within that term, their family will get a death benefit. If they outlive, they can either apply for a new policy or extend (renew) their existing one.
Group term life insurance often costs less than an individual policy because the employer pays a premium. $50,000 is the maximum amount employer can provide without a tax implication.
It sounds amazing, but unfortunately, there are many problems. An individual doesn’t have an option for customizing their policy. It’s not rare that the death benefit equals one (or even two) times the individual’s yearly salary.
Riders For Policy’s Customization
Riders are optional supplies that offer added protection and benefits. Even though a term policy isn’t for the entire life, a lot can happen in 20 or 30 years. Maybe your health will unexpectedly change, or you might lose the ability to work. That’s why riders exist – to provide additional protection and help during uncertainty.
- Guaranteed renewability rider or clause. This can be beneficial for people with terminal illnesses near the end of their term, which may not have other alternatives for insurance.
- Waiver of premium rider. This rider will cover premiums, keeping the policy in effect if the policyholder becomes disabled and can’t work.
- Term conversion rider allows the insured person to convert their term life policy to a permanent policy with the same health rating for a specified period. It’s helpful if the health state worsens, so the person doesn’t have to undergo a medical exam.
Term Life Insurance vs. Whole Life Insurance
As you saw, there are many drawbacks of term policies. Therefore, we want to compare it to the whole life insurance policy and explain why we think it’s a much better option.
Whole life insurance is the true representative of the permanent life insurance policy.
Permanent insurance offers lifelong coverage and the opportunity to build cash value, which is why it’s sometimes called cash value life insurance. Other than whole life, universal life insurance (also called adjustable life insurance) and variable life insurance policies offer permanent coverage.
Premiums and death benefits in universal life policies increase or decrease over the insured’s lifetime. The similarity between a whole and a universal life policy is that both have a cash benefit.
Variable life insurance is a type of policy that has an investment component. It has a cash-value account that is invested in several sub-accounts that act similar to a mutual fund. Variable life offers the most flexibility, but it’s a riskier and more complicated option.
The significant advantage is the opportunity to tap into the policy’s cash value during your lifetime. With permanent life insurance, premiums are fixed, and these policies generally offer a guaranteed death benefit.
The main characteristic and reason we prefer a whole life policy is a possibility of borrowing money against your policy. Besides permanent coverage, whole life also has a savings component that accumulates cash.
The cash value supports a living benefit to the policyholder. So, it’s not strange why this policy is used as a source of equity.
Even though term life insurance policies are genuinely cheaper than whole life, a variety of factors influence those prices. If you choose a more considerable death benefit or more extended length coverage, it will significantly increase the premiums.
The health complication may raise payment rates above the norm because almost all policies require a medical exam. The ultimate drawback of term life policy is the lack of cash value component and the impossibility of using it as an investment tool to build wealth or save on taxes.
On the other hand, monthly premiums with whole life are split in two ways. One payment segment goes to the insurance component, while the other goes into a savings component which helps build your cash value.
Cash value grows on a tax-deferred basis, and after some time, you can borrow or make a withdrawal from that amount. You can use that money to pay expenses such as your children’s college tuition or home repair.
So, not even that whole life provides life insurance coverage, but it is also a flexible financial tool. Loans you will take against your policy are tax-free.
- Coverage length. Permanent life insurance is planned to offer financial protection during the entire lifetime, which is shown that the majority of people need. On the contrary, term life insurance provides permanent coverage, usually from one to 30 years.
- Premium expenses. Term life premiums are lower. But only in the beginning. After that, they usually increase after every renewal. With permanent coverage, premiums remain the same for as long as the insured person lives.
- Cash value. The cash value from a whole-life policy grows as long as the policyholder pays into the policy. Every policyholder can decide to withdraw or borrow against it. In contrast, a term life insurance policy doesn’t accumulate cash value.
Whole Life Insurance
Typically, permanent life insurance is more complicated than term life. However, the whole life policy works more straightforwardly than other kinds. The essential elements of a policy consist of the yearly premium payments, the death benefits payable to the beneficiary, and the cash surrender value the policyholder would receive if the policy is surrendered before death. All whole life guarantees are subject to the timely payment of all required premiums and the claims-paying ability of the issuing insurance company.
People often choose term life as a more affordable option when it comes to payments. Even though the annual premiums are higher with whole life, you get much more benefits from it.
With whole life, you have different family options, guaranteed rate, permanent coverage, early payouts if you become terminally ill, and additional payments for covered accident-related claims.
Additionally, your whole life isn’t correlated to your employment or employer company. That means you can easily change jobs and don’t worry about your policy. There is also an option for your whole life to produce dividends, adding value beyond the death benefit. It’s possible if you buy your policy from a mutual insurance company.
The significant aspect of whole life is the complete control you, as a policyholder, have. You can access and use the policy whenever and however you want. If you’re not sure yet whether you like whole life insurance, let us introduce the Infinite Banking Concept – a process that will blow your mind.
Learn How to Be Financially Self-Reliant
Infinite Banking Concept, also called over-funded life insurance, looks explicitly into the surrender value of the whole life insurance. That value acts as cash collateral for a loan.
The basic idea of over-funded life insurance is built around funding your whole life and then leveraging the cash value via policy loans for any financial goal – self-finance debt, personal and business investments, and even passive income for retirement.
By borrowing and re-paying your loans, you will have a traditional banking system without banks. That’s why this financial strategy is also known as the process of becoming your own banker. Thanks to Infinite Banking Concept, you will be done once and for all with high-interest rates, application fees, and interest charges that traditional banks require.
This process isn’t something new. It has existed for decades, and there are many examples of people that become wealthy thanks to it. For instance, the current U.S. President, Joe Biden, also used whole life.
We hope this article helped you get familiar with different kinds of term life insurance policies. They all have their pros & cons. The choice depends only on you, your current financial situation, and your plans for the future.
Our strong beliefs are that it is possible to have everything you wish! Regarding life insurance, we hold that the perfect policy has to help you for a lifetime and your family after you are gone. The whole life policy fulfills that criterion.
If you have similar goals as we do, watch our free masterclass! In just one hour, you’ll get all information on making, using, and multiplying your money. You will learn how to take control of your finances and achieve all of your aims.