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Financial Planning Basics: Term Life Insurance

Life insurance can be confusing. Here are the basics on a few different types of term policies.

Financial Planning Basics: Term Life Insurance

By Scot Whiskeyman

Despite the fact that life insurance awareness month officially starts in September, it is still an important topic, all year long.

With such a great deal of misunderstanding about how term life insurance works, we thought we’d go high level and talk term insurance basics this week to keep you informed.

Why Term Life Insurance?

It’s no mystery that the biggest asset a young earner has is there potential for income. However, it’s also no secret that many young earners are saddled with copious amounts of student loan debt, which puts a squeeze on their monthly budget. This is where term insurance comes into play. Whether an individual has dependents or not, buying term insurance while healthy means it will be as cheap as it will ever get.

Why Term Life Insurance? Because it’s:

  • Affordable
  • Provides lump sum of cash that can replace your income, cover the mortgage and other debts, or help pay for college for kids

Now let’s talk about the different types of term life insurance and what to know about each of them. We’ll give you our take on each type of insurance after each breakdown.

Group Term Life Insurance:

What to know:

  • Pricing is age-banded – it increases in price as you get older
  • The coverage typically lasts as long as you are with your employer
  • The employer can cancel the coverage on a non-discriminatory basis, meaning they can’t cancel just yours, but they can cancel the insurance coverage altogether
  • Your coverage is typically not portable, though it is sometimes convertible to a permanent type of policy after you leave your job

Our take:

I hear it all the time: I have life insurance through work! I’m good, right? Maybe. Having some life insurance coverage is better than having none at all – but I often advise clients to get what they can, but not to depend on it. Why? In the event that they retire, get disabled, or change jobs, their term insurance policy is probably staying behind.

Sample of MetLife's group term insurance rates. Notice that the cost of coverage (quarterly) increases in 5 year increments
Sample of MetLife’s group term insurance rates. Notice that the cost of coverage (quarterly) increases in 5 year increments.

Annual Renewable Term Life Insurance:

What to know:

  • Pricing increases every policy anniversary. Thus it is extremely cheap when you are young, but tends to go up when you get older.
  • Good through a certain age – often age 95
  • Cannot be canceled by anyone but you
  • Can often be converted to permanent policy after you buy it

Our take:

The biggest lure of annual renewable term policies are its price. When it comes to owning an individual term insurance policy, annual renewable term policies are often the most inexpensive way to go in the beginning. However, with a price that increases every year, they may not be the best type of policy to own over a long period of time.

Rates per $1,000 of an Annual Renewable Term policy issued on a 22 year old. The insurance company in this example is Lion Life. The rates increase every year as the policyholder ages.
Rates per $1,000 of an Annual Renewable Term policy issued on a 22 year old. The insurance company in this example is Lion Life.

Level Premium Term Life Insurance:

What to know:

  • Pricing is level for the number of years stated in the policy. 10, 15, 20 and 30 year policies are common
  • Good through a certain age – often age 95 – but the price increases dramatically after the level premium period
  • Cannot be canceled by anyone but you
  • Can often be converted to a permanent policy after you buy it

Our take:

Level premium term insurance is cheap today and level for as long as you own the policy. It’s for this reason we’re a big fan of level premium term insurance and favor it over annual renewable term insurance.

This 20-year term policy has a level cost for 20 years. Notice how the premium jumps up dramatically in the 21st year. Issued by Penn Mutual. This 20-year term policy has a level cost for 20 years. Notice how the premium jumps up dramatically in the 21st year. This illustration is for Penn Mutual’s 20-Year Level Term product.

What Else Should I Consider?

You’re likely healthier today than you ever will be again, so consider buying a term policy with conversion privileges. This allows you to change the policy, either in part or entirely (your choice) to a policy that will last forever.

  • Consider the strength of the insurance carrier. Check out our post on strength ratings of insurance companies to get a better idea of what’s good and what’s not.
  • Consider the insurance company’s history. Have they been around for 15 years or 150 years? History says a lot about a company’s commitment to its policyholders.
  • Consider the company’s product mix. If you think you’d like to lock in your health rating to convert to a permanent policy later, there’s no point in buying a policy from a company that doesn’t have a permanent product to begin with.

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