Term Life Insurance
What is Term Life Insurance?
In general, life insurance falls into three categories: term, permanent (whole life) or universal life. Universal life insurance also includes an investment component. Each insurance type has advantages and disadvantages. However, in most cases term life insurance is the most economical.
Term life insurance covers you for a specific number of years (10 years, 20 years and to age 100 etc.). You choose the coverage amount and your premium normally remains “level” throughout the insured period.
Should you die within the term laid out in your policy, your insurer pays out the coverage amount (death benefit) to your beneficiary. Beneficiaries receive a lump sum, tax-free payment. If the policy expires before your death, the policy does not pay out. However, level term policies aren’t your only choice.
Some term life policies allow you to convert to permanent life insurance. The timeline varies with the carrier, but generally this is between one and five years beforehand. Others allow you to renew at the end of the term.
Term life insurance offers many benefits when compared to other life insurance products. These include:
- Lowest initial outlay of life insurance premiums
- Suitable for short-term protection
- Easily matched to your debt timeframe
- May be eligible to receive coverage without a medical examination
- Some products available for pre-existing conditions
- Potential to convert to a permanent policy without medical evidence, sometimes up to age 65 or 70
- Available for most Canadians, sometimes up to age 70, depending on the policy term
- Flexible choice with a wide range of terms and coverage options
- Many policy riders available for customization and additional protections
- May be able to use policy as collateral for loans in some cases
- Tax-free, lump sum benefit to beneficiaries
- Exempt from estate taxes and bypasses probate, if left to a named beneficiary
- No public record of the death benefit if left to a beneficiary
- May provide funds for business continuation through a buy-sell agreement
- May provide capital for dependents to continue a business
- Can fund charitable bequests
Like all insurance products, term life also has potential disadvantages. These may include:
- Premium payments increase after the initial guarantee period
- Not suitable for long-term needs as policies can become cost-prohibitive
- Coverage amount available may fall as the policyholder ages due to underwriting criteria such as health, and life expectancy
- Potential to lose preferred rate as the policyholder ages
- May not be able to obtain a policy for long periods as the policyholder ages
- Renewability options expire at some point if a new policy isn’t purchased
- Death benefit paid to the deceased’s estate may be subject to probate fees, executor, accounting and legal fees, as well as estate administration taxes
- No cash value and policy does not build equity
- No tax-free, automatic savings feature as found in permanent life insurance
- Coverage only available for the term, with no payout outside of this timeline
- May not be available to individuals in extremely poor health
Term Life Insurance Policy Types
We already mentioned that most term life insurance policies are “level term” with a fixed coverage amount and premium throughout. However, other policy types exist which may suit individuals in particular cases.
Decreasing Term Life Insurance
This policy type is tied to the declining balance of an amortized loan, such as a mortgage or another personal debt not easily covered by personal assets or income. Premiums normally remain the same but the value of the policy is decreased year by year.
Generally, level term life insurance is a better option as it provides a larger payout and beneficiaries can use the money for whatever they choose. However, it is often used in small business partnerships to protect against indebtedness incurred from operational expenses and startup costs.
Return of Premium Term Life Insurance
This policy type refunds your premiums if you outlive the policy. Essentially, it a hybrid of term and permanent life insurance. It guarantees your chosen amount of death benefit to your beneficiary or estate within a specific number of years.
Premiums are approximately 50 percent more than regular term life insurance, but much less than permanent life insurance. However, return of premium term life insurance does not include the investment component found in permanent insurance. As a result, buying term life and investing the cost difference may be a better option.
Renewable Term Life Insurance
Unlike most term life policies, this policy type automatically renews at the end of the policy term, usually for the same duration. For instance, if you bought a 10-year policy, it would automatically renew for another, new 10-year term.
However, renewable term life insurance premiums will increase at renewal, because they are calculated according to the insured’s age at the time of the extension. Nonetheless, you’re guaranteed insurability without reapplying or taking another medical exam to reaffirm eligibility.
For most people considering term life insurance, a renewable policy is highly recommended. No one knows what the future may hold, but if you should become ill, you can still renew your policy as the end of its term without submitting medical evidence. This isn’t the case with most other term life policies and can make it impossible to obtain coverage if you become seriously ill.
If you are still healthy at the end of the term, you may be able to renew at a lower rate by undergoing a medical exam or by finding a better rate through another insurer.
Convertible Term Life Insurance
This policy type provides an option to exchange your term life insurance policy for a permanent life insurance policy at the end of the term. This includes whole life or universal insurance.
The primary benefit is you do not need to have a medical exam to qualify for permanent coverage. Even if you’re diagnosed with a debilitating illness, you can still maintain your coverage.
If you choose term life insurance initially, a convertible, renewable policy provides you with flexibility. Even though term life is inexpensive for the short-term, premiums will increase substantially over time. It makes financial sense to convert to a permanent policy for long-term insurance needs.
Life Insurance Premiums
Life insurance companies set their own premiums and use their own criteria. This can lead to premium differences between insurers.
However, all insurance companies assess your level of risk. They gather data and pool those with similar risks into groupings. Consequently, low risk groups pay lower premiums and high-risk groups pay more.
Insurance companies may look at many factors including policy term, age, gender, occupation, health, habits such as smoking, and in some provinces your credit score. Women tend to pay lower premiums since statistics show they live longer. Smokers will pay more than non-smokers.
When comparing term life insurance policies, it is important to look beyond premium price. The policies must include identical terms to provide a true comparison. In almost all cases, the policies from various insurers will differ slightly. Consequently, professional advice can help you assess whether the policy differences are worth the premium.
Here are just a few factors an insurance professional will look at when comparing policies:
- Does a renewable term policy have a comparable renewable premium to the competition, or does it only rival it initially?
- Until what age does a convertible policy allow you to convert? Some may include a clause with a younger age limit.
- Until what age does a convertible policy allow you to convert to permanent insurance without evidence of insurability? Some policies do not guarantee this throughout the term or charge higher premiums to do so.
- Does the renewable policy include a grace period after the expiration of the term? Some policies do not, which can leave you uninsured if you don’t pay your premium on time.
- Does the permanent life insurance converted from term life waive the qualifying periods for all clauses such as incontestability found in the original policy?
- Can the waiver of premium rider on the term life policy convert to permanent insurance without evidence of insurability, including for pre-existing conditions?
It may be worth paying higher premiums for this feature, in some cases.
Just because a company offers a good term life insurance policy, it doesn’t necessarily mean their permanent policies are equally attractive and competitive. It is important to look beyond the term policy if you’re considering a renewable, convertible policy for a true comparison.
Beneficiaries are the people you name on your policy to receive your death benefit. You can also name a contingent beneficiary should the primary beneficiary pre-decease you. You also have the option to leave your death benefit to your estate or a trust fund. However, this can have significant tax implications.
Naming a person or persons as beneficiary bypasses probate. Funds go directly to them as a lump sum, tax-free. However, if your death benefit passes to your estate or a trust, it can incur taxes and fees such as trustee or executor costs, federal and provincial taxes, probate fees, and more.
How Much Life Insurance Do I Need?
Choosing the right coverage amount is important and many factors can affect your decision. The most notable include income replacement and your debts.
If you are the sole provider in your household, you will want to ensure that the policy payout replaces your income, plus an additional amount to guard against inflation and salary increases over the years.
For instance, if you earn $50,000 per year and you want to buy a policy to age 100, you would need a $500,000 policy. Of course, this isn’t a fixed rule and you may want to reduce this amount if your spouse works, or increase it due to other circumstances.
Your insurance needs will also change as you progress through life too, so it is important to review your coverages annually with life insurance professional.
Your life insurance should also cover your outstanding debts such as personal loans, car loans, student loans, credit cards, and your mortgage. For instance, if you have a $450,000 mortgage and a $70,000 car loan, you will need a $520,000 policy just to cover these debts, on top of replacing your income.
Once again, your calculation should include an extra amount to account for increases and inflation. Don’t let these numbers scare you – term life insurance policies often exceed a million dollars. In fact, a million-dollar policy is often the minimum coverage needed for a typical middle-class family. Despite the large numbers, premiums are often very affordable.
Importance of Professional Advice
As mentioned earlier, it can be difficult to accurately compare term life insurance policies unless you delve into the fine print. With so many options available, it can also be difficult to find one that fully meets your needs at the best possible price.
However, working with a professional life insurance broker can simplify the process to ensure you get what you need. Here are just a few of the benefits they offer.
A professional life insurance broker provides an unbiased analysis of your existing policies and your future needs. They can also assist your beneficiaries in the event of a claim during a very difficult time. They work for you and your loved ones, not the life insurance companies.
They Do the Legwork
A professional insurance broker understands insurance products and they have the skills needed to identify and compare the most appropriate for your personal circumstances.
They will access many insurance companies and delve into the fine print. This simplifies and speeds the process. Plus, they have a fiduciary duty to protect your interests. As a result, they are your best bet for the best possible coverage at the best possible rates.
Explain Everything in Simple Language
If you’ve ever tried to decipher an insurance policy, you already know how difficult it can be. The insurance industry uses specific clauses, exceptions, and exemptions that can directly impact your life.
For this reason, it is very important that you fully understand the coverage. A life insurance broker can explain every aspect of your policy, recommend a policy amount, and balance your premiums against coverage. They are also available to you as your insurance needs change during your life.
No Hidden Agenda
Life insurance companies want to sell their own products. Consequently, you can’t rely on them for life insurance advice. You may end up paying more than you should or find you’re stuck with a policy that doesn’t suit your needs, just because that is what they sell.
Conversely, a life insurance broker has no hidden agenda. If a policy doesn’t make sense for you, they will tell you so and recommend something better.
An insurance broker doesn’t just look at initial costs, but what it could you over the long-term. This is particularly important if you want to buy a renewable, convertible life policy.
Many life policies involve much higher costs at these milestones. Looking at short-term costs ignores this higher cost burden later in life. After all, life insurance should give you peace of mind, not leave you wondering if you’ll be able to afford it down the road.
Term life insurance may offer many riders with additional coverages. This may include coverage for critical illness, disability, your business, and more.
Every life insurance company and every life insurance policy can differ, as can their offerings for additional coverages. The experience and knowledge of a professional insurance broker is invaluable to tap into these resources.
Find Out More
LifeAnnuities.com understands every individual has distinct financial requirements due to their life circumstances. A single person without a partner or dependents certainly wouldn’t need the same financial products as a family man that wants to guarantee an inheritance for his loved ones.
Let us connect you with one of our life insurance advisors. They can ensure you buy the best possible for your needs and can easily transition to permanent life insurance, if you wish. Our independent advisors provide unbiased advice and represent many companies. They also have a fiduciary duty to protect your interests.
LifeAnnuities.com also offers Wealth Planning expertise to help you build, protect, and transition your finances for the future. Contact us for a free consultation.
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