UPDATED: Aug 14, 2014
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Term life insurance is one of the most affordable ways to ensure you have adequate protection for anyone or anything that relies on you and your income should the unthinkable happen. Most finance professionals agree that adequate life insurance is a foundation for a successful finance portfolio.
The most affordable and common type of life insurance is called guaranteed level term, and that will be the focus in this article. Guaranteed level term is a temporary life insurance policy that works in a similar fashion to other polices such as home or auto insurance. The insured (policy holder) pays the insurance company a fixed premium on a monthly, quarterly, semi-annual or yearly basis, in exchange for life insurance coverage at a predetermined amount.
Level term is called temporary because at the end of the policy there is no value such as with permanent life insurance that also builds a savings or investment account. Term life insurance is perhaps the easiest to understand because it is a simple exchange between two parties, the insured and the insurance company.
Guaranteed level term life insurance is commonly sold in different lengths, often ranging from 5 to 30 years. The insurance company will determine a premium payment based on an applicants age, sex, medical history, medical exam information, personal hobbies, and even their occupation. The underwriter will compare all of this data along with actuary tables that indicate the likelihood a person will die within a given time frame and determine the amount of premium required to insure that person against death. In general, the younger and healthier you are the lower your premium will be.
Once a premium is determined and agreed to by both parties, the price will stay constant for the entire policy. So if a 25 year old male signs up for a $1 million dollar 20 year guaranteed level term life insurance policy with a premium payment of $20 per month, that cost will remain at that level until the policy expires at age 45 or he stops making the premium payments, whichever comes first.
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Who Needs Life Insurance?
As previously mentioned, life insurance is a necessity for anyone that has dependents relying on them and/or their income. Here are examples of people who would benefit from the protection of a term life insurance policy:
Married Couple – A duel income couple that relies on both incomes to sustain their quality of life is a good example of people who would benefit from life insurance. If both people make significantly different levels of income, the policy for each individual can be adjusted to help offset the loss of the other.
A married couple that only one spouse works would be even more dependent on life insurance should the income producer pass away. With no income whatsoever, the surviving spouse could deplete any savings or assets the couple had rather quickly.
Couple with Children – This situation is even more important to have adequate life insurance. Children require a lot of financial resources as they grow, especially for parents wanting to send their kids to college. If both parents work then the life insurance can offset the loss. If both parents do not work, then the death benefit can cover either the loss of the wage earner or the increased cost of hiring help with the children, should the stay at home spouse die.
Single with Children – Here is an example of a scenario where proper life insurance coverage is vital. It is important to think about what would happen to kids if the parent were to die, and then imagine how that could be eased if there was a large enough financial safety net to continue providing for the children.
Business Partners – A lot of small business that are run by two or more people could be forced to shut down if one of the business partners were to pass away. Frequently the other partner cannot carry the load or must buy out a widow in order to continue operating, and this could be too big of a financial burden to come out of the individual’s pocket.
While these are only a few situations where life insurance can be crucial, it is important to analyze your own situation and think about what would happen to others if you were no longer around.
How Much Life Insurance Do You Need?
This question can be difficult to assess on your own and may require the assistance of an insurance or financial professional. But a good rule of thumb is you need enough life insurance to cover what your dependents would lose from you not being around.
If income is the most important thing for your surviving dependents, then you want to get enough life insurance so that the principal death benefit can be invested in a way that would produce a similar amount that your lost income would. The money could then be invested or used to purchase an annuity, for example.
A good rule of thumb is somewhere between 8-12 times your current (or expected) yearly income, but be sure to discuss with a professional if you are unsure.
Sometimes people just want to pay something off like their house or pay for the kid’s college with the death benefit. More financially established families may have enough assets to provide for day-to-day living already, and getting rid of some of those big payments could be all they need. If this were the case, simply adding up the total required to cover these costs and finding a policy with that level of benefit would be sufficient.
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Beneficiary and Settlement Information
The death benefits on a term life insurance policy can be paid out to just about any individual or entity, including businesses and non-profit organizations. The method in which the beneficiaries receive the funds is an important thing to determine.
A common method for death benefit distribution is what is called a ‘lump sum’ payment. This means upon proof of death, the insurance company will write a check or make a payment for the entire benefit amount and give it to the beneficiary (or beneficiaries). The beneficiary then has the ability to do with it what they please. This method is very common, and recommended when the receiving party is trusted to do what the policy owner would wish.
Another option is to have the insurance company hold the funds and distribute them over time in a structured payment process. This is similar to an annuity (or sometimes converted to one) and allows the beneficiary to receive smaller payments for an extended period of time. This option is good when the receiving party is either unable or incapable of managing a lump sum distribution.
Things That Affect The Cost of Term Life Insurance
When insurance providers are determining the cost for a term life insurance policy, there are many factors that they look at. Here are some of the most common:
Age – The age of the person is very important when determining the premium for life insurance since they can check actuary tables to determine the likelihood an individual is to die during the term policy.
Sex – Women, on average, live longer than men, so gender plays a big role in determining mortality rates and thus life insurance premiums.
Occupation – Underwriters will look at a person’s job when determining the premium because certain careers are more dangerous and thus have higher mortality rates.
Hobbies – A person’s recreational habits are also examined when pricing an insurance policy since dangerous hobbies can result in more injuries or deaths. An individual that participates in skydiving or scuba diving will pay more for a life insurance policy than if they did not do those activities.
Length of Term – The length of the insurance policy will play a big role in determining the rate. Since a level term policy is guaranteed to never increase in premium during the policy term, the longer the term the higher the premium since the individual is statistically more likely to die.
Amount of Coverage – This one is pretty simple: the more coverage you have the more the premium. If the insured were to die, this would be the amount the insurance company would be required to pay out to the beneficiaries.
An insurance company may look at all of these factors as well as numerous others when determining a premium payment for a policy. It is important to remember that the healthier you are and the lower risk your lifestyle is, the lower your premiums will generally be.
What Insurance Company Should You Use?
With life insurance being such a competitive industry, there are numerous companies willing to fight for your business and offer you their services. It is important to find someone that will help assess your individual needs and not just throw a generic policy in your direction.
When selecting a company to work with, be sure to find an established firm with good business practices and responsible agents. If you are very knowledgeable about life insurance and confident in your ability to select the right coverage type and amount, you can go with a direct insurer and bypass an agent altogether.
We have reviewed many insurance companies as well as brokers and put together a list of companies that are a great place to start when looking for insurance.