When you’re insurance shopping, a lot of new terms get thrown around. Historically you were expected to rely on your broker to translate this industry gibberish, but then we invented this thing called the internet. Which is how you ended up here, on this page, about to learn the answer to your biggest life insurance question: is term life insurance worth it?
What exactly is term life insurance?
Well it’s life insurance, obviously, which means its primary purpose is to let you provide financial protection for those you leave behind. For most people, "those you leave behind" means your spouse and kids, but it can also mean a family business, a dog shelter, your home town, a piano factory, your neighbors, your best friend’s kids, and so on.
Life insurance is a good idea if you're young and have a lot of financial obligations – i.e. kids, a mortgage, and other debt. Term life insurance is particularly worth it because it's the most affordable type of life insurance available.
It’s called "term" because the policy lasts a set amount of time and then expires, after which you will no longer be covered by it. You’ll have to buy a new policy or renew the old one before it expires if you want to remain covered after the initial term.
There are two components of any life insurance policy that you should also know—or rather, you already know what these are, so this is just about sharing the professional lingo with you:
The death benefit is a lump sum of cash paid out by the life insurance company when you die. If you’ve ever heard someone say, "I took out a one million dollar life insurance policy," that one million dollars is the death benefit.
The beneficiary is the person or organization that will receive the death benefit. As we mentioned above, the beneficiary does not need to be a family member or even a human being—it can be a trust fund, or a non-profit organization, or a business partner.
The other thing to know about the beneficiary is you don’t have to name only one. You can list several on your policy, and either distribute the death benefit among them as you see fit or order them like pageant contestants, with one "winner" and then a first runner up, second runner up, etc., so that if the first beneficiary is unable to receive the death benefit, there’s someone else on the list.
At minimum, you should always choose a backup beneficiary. If the primary beneficiary isn’t able to accept the death benefit for some reason and you haven’t named any alternative beneficiaries, then the state will step in to help determine who should receive it. And nobody wants that.
A rider is an add-on feature that extends the usefulness of the coverage in some way. Sometimes riders are included as part of the price, and sometimes they cost extra. Some riders are better than others. Check out our guide to the most common life insurance riders.
What alternatives are there to term life insurance?
Term life insurance is considered the simple, straightforward flavor of life insurance. There are no complicated rules or investment components - which is good, because life insurance isn't a good investment.
The alternative to term is permanent life insurance, which can cover you for your entire lifespan so long as you keep paying the premiums. But there are two things to keep in mind with permanent life insurance:
It’s more complicated, partly because there’s usually an investment component mixed in with the death benefit, and partly because it can come in a variety of forms; there’s whole life, variable life, universal life, and variable universal life (yes, seriously). Permanent insurance is the Silly Putty of the life insurance industry, because it can be stretched and distorted into all sorts of shapes. This doesn’t necessarily make it bad, but it makes it complicated, and therefore easy to misunderstand, which in turn means it can be easy to buy the wrong policy or to spend more than you need to for adequate coverage.
It’s much more expensive than term. All of that complication and longevity comes at a price, so you’ll spend far more on a permanent policy to get the same amount of death benefit as you would on a term policy.
The other alternative is to self-insure, which means you’ve accumulated enough wealth to personally provide financial support to your dependents (or spouse, siblings, etc.) after your death. In an ideal world self-insurance is the best because there’s no insurance to buy at all, but for most people it’s not a realistic alternative before your mid-50s at least—after you’ve built up some savings, sent the kids off to school, paid off your mortgage, hit your peak salary, etc.
What’s good about term life insurance?
First, what’s good about any type of life insurance is that it provides a lump sum of cash that can be used for pretty much anything: burial expenses, college tuition for your children, living expenses for your spouse, mortgage payments, other outstanding debt, a donation to a favorite charity, and so on. That lump sum will be tax free if you buy the life insurance policy on your own and pay the premiums with after-tax dollars. (If your employer pays for it, the death benefit will still be taxed.)
Here’s what’s good about term life in particular:
It’s an easy-to-understand insurance product. This might not sound like that big of a deal, but once you take a look at all the varieties of permanent life insurance (see chart), you’ll appreciate how straightforward term life is. [caption id="attachment_5915" width="300"] All the varieties of permanent life insurance. Click for the full-sized image.[/caption]
It’s much cheaper than any type of permanent life insurance. Realistically, the older you get the more any insurance is going to cost. But if you buy term life when you’re young and healthy the monthly premium can cost as little as $30-40.
You can further reduce the cost by only buying enough coverage for your specific needs, instead of for the rest of your life.
Because the premiums are so much lower than permanent, if you decide to abandon the policy at some point before the term ends, you won’t lose as much money as you would with a permanent policy.
What’s bad about term life insurance?
The strengths of term life are also its weaknesses, at least for some people.
It ends at a predetermined point in the future. Let’s imagine you buy a 20-year term policy when you’re 30. When you turn 50 and it ends you will no longer be covered. You can of course buy a new one (and sometimes you can roll over your old one to get more years of coverage) but it will be more expensive because of your age and health.
Although you can just stop paying for the policy and let it lapse at any time, you can’t cash in the policy early to get some money back, nor will you get any of your premiums back when the term ends. This is how it’s both cheaper and less complicated than permanent insurance.
If you want to guarantee that you’re covered until you die no matter when you die, permanent is way to go. If you want to be covered until your golden years, and then cash in the policy to get some of the value of it back, you might want to consider permanent. We think the drawbacks to permanent are too significant to offset these benefits 99% of the time, but every situation is different.
Is term life insurance worth it?
If you have anyone who is financially dependent upon you, and you don’t have enough money set aside to provide for their financial needs should you die tomorrow, then life insurance is absolutely worth it. It should be your top insurance priority*. And since term is cheaper and simpler than permanent, it’s easier to fit it into both your present-day budget and your long-term financial strategy.
* If you don’t have any dependents or co-signed debt to worry about, consider long-term disability.
Photo: paulisson miura