Potential clients often call us to ask for help with selecting the right “term” for their life insurance policy.
Term life insurance provides a set amount of coverage for a fixed number of years. The “term” refers to the number of years that your life insurance policy provides guaranteed rates and coverage.
Term life insurance is designed to provide your family or beneficiary with financial protection when they need it the most. In this article, we’ll explain the most common uses of term life insurance and provide you with some insider’s tips to selecting the right term for your policy.
Quick Article Guide:
Term life insurance provides a guaranteed death benefit for a fixed number of years. The death benefit is often referred to as the policy’s “face amount,” while the number of years that the policy is active for refers to the “term.”
The term of a life insurance policy can be as short as 1 year or as long as 35 years. The most common term life insurance policies are 10, 15, 20, 25 and 30 years. If the insured passes away during the term of their policy, their beneficiary or beneficiaries will receive the full death benefit from their policy.
The cost of term life insurance is based on risk factors and the length of your term. The longer the term of your policy, the more expensive the policy is. This is because the life insurance policy is more likely to pay out a death benefit over a 30-year period than a 10-year period. Other risk factors that are considered when determining your rates for a term life insurance policy include your age, health history, and lifestyle at the time you purchase your policy. The less likely you are to outlive your term policy, the more expensive it is.
Some of the clients we speak with are reluctant to buy a life insurance policy that they will likely outlive. Remember, term life insurance is not designed to last for your entire lifetime, it is designed to provide financial protection for a set number of years. Many people purchase term life insurance to plan around important life events like paying off the mortgage, getting their children through college, or reaching retirement age.
Once you’ve surpassed these life events, your need for coverage should become minimal. However, most term life insurance policies provide an option to convert some or all of your policy to permanent insurance if you still need coverage past the end of your term.
This is why term life insurance is so affordable… the insurance company (and presumably you) are hoping you outlive the term of your policy. Term life insurance is extremely popular with financial advisers because it provides the biggest financial benefit for the least amount of money.
When clients call us for life insurance, they generally have a specific concern. Some of the most common concerns we hear are:
• “I’m the breadwinner for the family and they depend upon my income.”
• “I want to make sure my mortgage is paid off if I die.”
• “My divorce decree states I’m required to carry life insurance.”
• “I’m a small business owner, and want to make sure my business could continue and debts are settled if I’m not around.”
• “I’m retiring in a year. I was told I should look into taking my full pension and protect my wife with life insurance rather than taking a reduced pension with a spouse benefit.”
Do any of these scenarios describe your situation?
Below, we’ve outlined the appropriate term for each one of these scenarios and some other scenarios we commonly encounter from our potential clients who are shopping for life insurance.
Here’s a list of some of the most common uses for term life insurance and how to determine the appropriate term length. We’ve also provided some suggestions on how you can save money on your life insurance needs.
1. INCOME REPLACEMENT—Determine how many years you intend to work and purchase a policy that corresponds with your planned retirement age.
If you plan to work 20 or more years and you’re in your 40s, compare the cost of “staggering” or “layering” 2 policies.
Theoretically, you’ll need to replace less income 10 years from now than you do today. As an example, let’s say you earn $50,000 a year. If you passed away tomorrow, your family stands to lose $1,000,000 of income, but in 10 years this number is reduced to $500,000.
In this situation, some of our clients will purchase a 10-year policy for $500,000 AND a 20-year policy for $500,000. This strategy provides $1,000,000 of coverage for the next 10 years and $500,000 of coverage until your planned retirement age. By layering your life insurance, you can reduce the cost of your insurance and provide flexibility for the future. There are no penalties to cancel your policy down the road if your circumstances change. Ask your agent to compute and compare your premium costs over time.
2. MORTGAGE—Term life insurance provides the most affordable mortgage protection available.
Most of our clients buy a term life policy to match the length of their mortgage.
For example, if you just purchased a 30-year mortgage, a 30-year policy will ensure that your family is able to keep your home if you pass away before the mortgage is paid off. If you’re buying a policy in your 30s, we recommend locking in a low rate for the rest of your mortgage while you’re still young and healthy.
Some of our clients in their 40s and 50s purchase a shorter term to protect two-thirds of their planned mortgage length. This allows you to protect your mortgage until you’ve developed a sizable amount of equity for your home, while allowing you to use the money you’ve saved on your policy to pay off the mortgage sooner. You can also “stagger” or “layer” more than one policy in this situation. This strategy is explained above in income replacement.
3. DIVORCE DECREE—This life insurance requirement is usually imposed by the courts until the youngest child turns 18.
If your children are in their teens now, you could likely get by with a 5-year term policy. However, very few insurers offer these shorter terms and the rates tend to be less competitive. For most insurers, 10 years is usually the minimum term available. Because of the increased competition, we often find that a 10-year term policy is less expensive than a 5-year term. Keep in mind that you can cancel your policy at any time with no obligation once the court-mandated requirement ends.
Save money by buying a term policy that allows you to decrease the amount of coverage you carry.
Some life insurance companies will allow you to decrease the amount of life insurance you carry once a year. If you are purchasing life insurance to settle a divorce decree, you can save money by decreasing the face amount of your life insurance policy as your obligation for coverage diminishes. Most of our clients are able to save up to 50% utilizing this strategy. Make sure you tell your agent the reason you are purchasing the life insurance so we can recommend a policy that offers annual face amount reductions.
4. KEY PERSON—This policy protects a business by placing life insurance on a key employee.
If an employee or owner of your business passes away, key person life insurance provides support to the business and provides for the cost of finding their replacement.
The money from these policies can be used for any reason including dealing with possible business disruption or lost profits.
Most businesses purchase 10-year term policies to protect against the loss of a key employee. If the employee leaves, the policy can be cancelled without penalty, or the employee could take over the policy and assign a new beneficiary.
5. BUSINESS LOAN—If you’re in the process of applying for a SBA loan or business loan, affordability and promptness are key.
Ask your agent if they have an affordable short “no exam” term policy you could qualify for.
These policies are often approved in less than a week compared to traditional term life insurance policies that typically take 4-8 weeks to get approved. If purchasing a traditional term life insurance policy with an exam is less expensive, but you’re in a time crunch, you can purchase a “no-exam” policy first. Once your loan is approved and funded, you can reapply for a less expensive term life policy that requires an exam.
When the less expensive policy is approved and “in force,” you can cancel your original “no-exam” policy. Most insurers will provide a pro-rated refund, so you’ll only have to pay the more expensive premiums for a few months while you’re waiting for an approval.
6. BUY/SELL STOCK REDEMPTION PLAN—life insurance is purchased by a business for co-owners so that in the event of one partner’s death, cash is paid to the beneficiary in exchange for their ownership share.
Most businesses purchase 10-year term policies for their buy/sell agreements, but we usually recommend purchasing a policy with a longer term.
Most business people only want to go through this process once, and as a business owner, 10 years can fly by. Although a shorter term policy could be considerably less expensive, it can be difficult to re-qualify for a large term policy later in life.
Before applying for coverage, consider how long you expect to work before you retire or sell the business. If you intend to work for more than 10 years before selling your business or retiring, buy a longer term. In the long run, it will save you money and you can always cancel or reallocate the coverage if your needs change.
7. PENSION MAXIMIZATION—Pension maximization strategies are utilized to maximize your retirement income while adequately protecting your spouse.
Most of our clients purchase the longest term available, but we can also offer coverage that is guaranteed until the age of 90 or later.
If you’re in average or better health, you can probably qualify for an affordable lifetime policy for less than the cost of accepting a reduced pension plan with a spousal benefit. The policy “staggering” strategy described in #1 can be very effective for pension maximization planning as well.
If your work is offering you a pension and you’re nearing retirement, we can help you determine your best options by creating a cost/benefit analysis. Some of our clients are able to save more than $500 a month by purchasing life insurance instead of accepting a joint pension plan. Another advantage of this strategy is that you can cancel the policy if you outlive your spouse, or change the beneficiary. Some insurers also provide a one-time option to reduce the policy’s death benefit and corresponding premiums for affordability or if needs change.
The first step is to apply for the maximum amount of life insurance you will consider, 3-6 months before your pension election deadline. Once you have been approved for the life insurance, you can compare all of your options before making a decision. You’ll also have at least 30 days to reduce the amount of coverage you accept, or change the length of the term, or break the coverage up into more than one policy to save money by “staggering” or “layering” your coverage. If you decide your reduced pension is a better option, no problem. There are no fees if you decide not to accept the coverage.
8. STUDENT LOANS—Most students don’t want to be stuck with a needle, or they don’t have the time to complete an exam. We recommend comparing the cost of a “no exam” term policy to one with the medical requirement.
If you’re young and healthy, our agents will find you a competitively priced “no-exam” policy without the inconvenience of an exam.
Even if your student loans will likely be paid off within 10 years, you may want to consider buying a longer 20 or 30-year term policy. Buying life insurance at a young age will likely save you a considerable amount of money in the long run and you can always keep the coverage in place once your student loans are paid off.
When purchasing life insurance for your student loan, the person co-signing the loan is generally the beneficiary (rather than the bank) and you can change the beneficiary (or cancel the policy) once the loan is paid off. Also, ask your agent to compare the cost of a Return of Premium (“ROP”) policy to a traditional term policy. If you are young and healthy, ROP coverage could be very affordable. ROP policies provide a refund of all the money you’ve paid into your policy once you outlive the term.
If you have any questions about term life policy length or if you would like a free, no-obligation term life insurance quote to help you compare your options, we can help. Feel free to request an instant quote below to compare rates from more than 60 top-rated life insurance companies or call us toll-free at 855-902-6494 to speak with an experienced agent.
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