What Is Term Life Insurance and How Does It Work?

How Does Term Life Insurance Work?

Term life insurance covers you for a set time period, which can range from one year up to 30; some policies cover you up to a certain age, such as 65. If you die during the term and your premium payments are current, your beneficiaries receive a payout called a death benefit.

Premiums for term life insurance usually stay the same during the policy term, although there are some exceptions. Insurance companies set life insurance premiums based on multiple factors, such as your age, gender, health and risk factors such as whether you smoke. The amount of coverage you buy also affects the cost of term life insurance.

Types of Term Life Insurance

There are several different kinds of term life insurance to choose from.

• Level or fixed term life insurance means your premiums and death benefit stay the same for the policy term, making this a predictable option.
• Renewable term life insurance can be renewed when the term ends without another medical exam. Although the insurer can't refuse to renew your policy, your premiums are likely to rise as you get older.
• Convertible term life insurance can be converted to permanent life insurance without undergoing a medical exam or otherwise proving you're insurable.
• Decreasing term life insurance features death benefits that decrease over the policy term; sometimes, the premiums decrease too. This type of coverage can be purchased to pay off a debt, such as a mortgage, that decreases over time.
• Return of premium (ROP) term life insurance refunds your premiums if you're still alive at the end of the policy term. That's a nice perk compared to regular term life insurance, which offers no refund, but you'll pay significantly more for an ROP policy.

Learn more: What Are the Different Types of Life Insurance?

Term vs. Permanent Life Insurance

Unlike term life insurance, permanent life insurance lasts your lifetime (or up to age 99, depending on the policy) if your premiums are paid. Along with a death benefit, permanent life insurance builds cash value you can tap into or use to pay premiums. Some types of permanent life insurance also let you adjust coverage and premiums or choose how to invest your cash value account. However, these additional benefits mean permanent life insurance can cost 10 times as much as term life insurance, or more.

Learn more: Which Is Better: Term or Whole Life Insurance?

Pros and Cons of Term Life Insurance

Evaluate the pros and cons to decide if term life insurance makes sense for you.

How Much Does Term Life Insurance Cost?

The cost of term life insurance depends on factors including your age, health and gender; the policy term; and the amount of coverage you buy. For example, men generally pay more than women for life insurance.

Assuming you're a healthy nonsmoker, a 20-year, $500,000 term life insurance policy costs an average of $23.10 per month for a 30-year-old woman and $29.56 per month for a 30-year-old man, according to Policygenius data. In comparison, the same policyholders would pay an average of $408 and $472 per month, respectively, for $500,000 of permanent life insurance, Policygenius data shows.

The older you are, the more term life insurance will cost you, regardless of your health. Since premiums generally stay level during the policy term, buying term life insurance when you're young and healthy can help you lock in lower rates.

Learn more: Factors That Affect Life Insurance Costs

Is Term Life Insurance Worth It?

Term life insurance can be worth buying in the following situations:

• You're married. If your spouse or partner relies on your income, life insurance helps them cover living expenses such as mortgage payments and maintain their standard of living. Your surviving spouse can also use life insurance to pay for services you provided for free, such as child care or housekeeping.
• You have dependents. Term life insurance can provide funds to raise your children or financially support aging parents. Life insurance payouts can also help finance your dependents' long-term expenses, such as college tuition, wedding costs or ongoing care for a child with special needs.
• You have outstanding debt. Depending on the type of debt and state laws, surviving family members may be held financially responsible for your debt after you die. Life insurance can provide the money to cover these costs.
• You own a business. Life insurance can pay for your business partners to buy out your share of the business, or allow your family to buy out the partners and take control of the company.
• You have a high net worth. If you expect to owe estate taxes at your death, life insurance can cover the cost so your loved ones don't have to.
• You want to pass on wealth. Even if you're single with no dependents, life insurance can be a way to leave money to a favorite cause, a friend or a family member.

Tip: If you're concerned about burial costs but don't otherwise need life insurance, consider final expense insurance. It requires no medical exam and typically pays out $5,000 to $20,000, which can be used to cover end-of-life expenses.

Learn more: Do I Need Life Insurance?

How Much Term Life Insurance Do I Need?

It's often advised to buy life insurance equal to 10, 20 or 30 times your annual income, but for a more accurate estimate of how much life insurance you need, consider the following:

• Your family's monthly living expenses and debt obligations (such as a mortgage or auto loan)
• Your dependents' future financial needs (such as paying for a child's college tuition or wedding)
• Final expenses, such as funeral costs or estate taxes
• Income your family would need to replace, including non-wage income such as employer-provided health insurance or 401(k) matching contributions
• Services your family would need to replace, such as paying for child care if you are a stay-at-home parent
• Assets your family will receive upon your death (such as your retirement accounts, pension or Social Security survivors benefits)

Review your budget to find a balance between how much life insurance you need and the amount you can afford.

Tip: Laddering life insurance, or buying multiple policies of different terms, can be a cost-effective way to tailor your coverage to different life stages.

Where to Buy Term Life Insurance

You can buy life insurance by calling insurance companies, visiting their websites or using life insurance comparison sites to shop for coverage from multiple insurers. If you have complex insurance needs, you may want to work with an independent life insurance agent or broker who sells life insurance from several different companies.

Whichever option you choose, getting quotes from different insurance providers will help you find the right policy at the best price. Be sure to compare quotes for the same type and amount of life insurance.

Your employer may offer group term life insurance as an employee benefit. Group life insurance policies usually end with your employment and provide only limited coverage. However, in some cases you can buy additional coverage or pay to maintain coverage after leaving your job.

Learn more: How to Buy Life Insurance

What Happens When Term Life Insurance Expires?

When your term life insurance policy expires, you'll stop paying premiums and no longer have coverage. You generally won't get any money back from the premiums you paid unless you purchased a policy with a return of premium rider.

What if you still want life insurance after the term ends? Some term life insurance policies can be converted to permanent life insurance. Policies with a guaranteed renewable clause can be renewed annually without the need for a medical exam. Before your policy expires, check the details to see if it's renewable or convertible.

If renewing or converting your policy aren't options for you, you can buy a new life insurance policy. This generally requires a medical exam, and since you're older and more likely to have health issues, premiums will likely be higher than for your original policy. If you're concerned you may be denied coverage due to your health or just don't want to take a medical exam, consider a no-exam life insurance policy.

Learn more: How Does Age Affect My Life Insurance Rate?

Protect Your Loved Ones With Life Insurance

Term life insurance can help ensure your family's financial security after you're gone. Saving money on life insurance can help you make the most of your finances while you're here. Insurance companies may check your credit-based insurance scores when you apply for life insurance. Although credit-based insurance scores differ from consumer credit scores such as the FICO^® Score^Θ, they're based on similar underlying information.

Before applying for life insurance, check your FICO^® Score from Experian for free to see if your score needs improvement. Actions such as paying bills on time and reducing debt could boost your credit-based insurance scores, which may mean paying less for life insurance.