Term life insurance is pure insurance that pays a fixed sum of money to your heirs when you die. Like other forms of life insurance, you pay for term life insurance coverage through annual premium payments. These annual payments may be broken up into monthly, quarterly, or semi-annual installments for an additional fee charged by the insurance company.
Unlike whole life insurance or cash value-driven universal life insurance, term policies only provide basic death benefit coverage. You pay a premium and you receive a death benefit. You stop paying the premium, your policy terminates. That's it. Insurance companies sometimes offer riders that modify the basic term policy structure, but most policies are simply a "death benefit only" policy. Term life insurance is generally bought as the insurance component of a long-term savings and investment plan. Since there is no cash value savings component to the policy, you will need to save and invest money "on the side" if you choose to use term insurance as your primary or only form of life insurance coverage.
Why Does Term Life Insurance Matter?
The tl;dr version:
- Term life insurance provides basic financial protection against death, and protects the value of your future earning potential against loss due to death.
- Term life may provide some living benefits if you become disabled or chronically ill, allowing you to spend your death benefit before you die.
- Some term insurance policies can be cashed in or sold on the secondary market before you die. This "hidden cash value" of term insurance helps you recover years of premium payments so that they are not lost if you do not die within the term of the policy.
- Term insurance can be converted to either whole life or universal life insurance, creating a more permanent life insurance plan.
- Term life insurance can preserve your future insurability and make estate planning much simpler through creative term conversion strategies. Term insurance is a "gateway" insurance product, leaving you multiple options for future (sometimes complex) financial planning.
What Is Term Life Insurance?
Term life insurance, like all other forms of insurance, is a contract that transfers financial risk away from you and onto an insurance company. The risk being insured against (and thus the risk being transferred) with term life insurance is only the financial risk associated with your death and only the financial risk your beneficiaries bear when you die.
The way this is accomplished is through a very clever sort of financing mechanism. You pay the insurance company money in the form of premium payments. These premium payments are then invested to help pay for the future death benefit and to generate profits for the insurer.
The premium payment is, in essence, a loan to the insurance company. The life insurance company then "lends" you the insurance death benefit for a set period of time. Or, from your perspective, you are "borrowing" a portion of the insurance company's accumulated capital and will use it if you die within the term of the contract.
If you do not die within the term of the contract, however, your beneficiaries receive nothing.
The insurance amount (which, in the case of term insurance, is just the death benefit) represents an amount of money equal to your future income - income your beneficiaries will receive (when you die) in advance of you actually earning it. In essence, what you are insuring is not current income but rather your earning capacity or future earning potential.
For example, if you buy $1 million of insurance, you are buying $1 million of your future income before you've actually made it.
Or, to state it another way, you want or need $1 million dollars saved up before you die but… you don't have it (yet). However, the insurance company does have this money and they're willing to give it to you… or rather, they're willing to "lend" it to you for a specific period of time, for a price - the premium.
And, this money, called a "death benefit," is subject to terms and conditions (the most obvious being you have to die before the insurer will pay the money to your beneficiaries).
What Is The Purpose Of Term Life Insurance?
There are oodles of opinions on the Internet about what life insurance "should" do for you, from protecting your spouse in the event of your premature death to providing money for your kids' college education in the event of same.
But, let's look at the fundamental reason why term life insurance exists:
Term insurance, like all other forms of insurance, exist (ultimately) to create certainty out of the greatest uncertainty you face - your own death, disability, or chronic illness. No one knows exactly when they will die, become sick, or if they will become disabled and unable to work. And, that fact has a "trickle down" effect which makes it difficult (and in some cases impossible) to make long-term financial plans - plans you need to make in order to be (and feel) financially secure. In some cases, this uncertainty affects even short-term plans.
But… if you buy an insurance death benefit equal to all the income you can potentially make over your entire lifetime, you're fully insured against uncertainty. You have purchased as much future income as you reasonably expect to earn. Thus, no matter what happens to you, your future earning capacity or earning potential is guaranteed to materialize. This amount, called your Human Life Value (HLV), represents your full or total earning capacity or potential. Anything less than this amount leaves you underinsured.
And, since literally everything you do in life hinges entirely on your ability to earn an income, and since you need that income until you breathe your last breath, losing that income is a huge risk at any age.
And, it's a huge risk for your beneficiaries who might want or, in some cases might need, that money.
While most insurance advisors talk about the poor widow and children you leave behind, even most well-off children and spouses are resistant to the idea of losing a source of income when they don't have to.
What this means is, the purpose of term life insurance is to protect and guarantee the future value of your income (your earning potential) for your beneficiaries. These beneficiaries could be your spouse or children, but they could also just as easily be your business partners, your parents, your brothers or sisters, a charity or other non-profit, or a scientific or research organization you believe in.
Basically, term life insurance is for anyone (or any organization) you care about which would be financially harmed by, or would suffer an economic loss because of, your death.
The Myth Of Temporary Life Insurance
Contrary to what most financial experts claim, most term insurance sold today is not "temporary insurance."
This myth - which is really more of a gross oversimplification than anything else - is one even I bought into for many years. It's not that true temporary term insurance doesn't exist. It does. But, most term life insurance sold today is actually a combination of two different term products. It has both a level term period and an annually-renewable period.
Financial advisors and insurance agents typically do not show the full illustration for these term policies, instead showing policyholders only the level premium schedule.
Once the level term policy ends and turns into a one-year annually-renewable policy, premiums rise substantially. This is the point at which advisors usually cut off the illustration, showing no further premium payments due and no further insurance coverage.
Advisors then advertised these policies as "10-year," "20-year," and "30-year" term policies, with the implication being the policy terminated after the level premium period.
The reality is, most of these term life insurance policies, and most policies sold today, automatically renew and provide life insurance coverage up to age 80, 90, or 95 with some only providing coverage to age 75.
In all cases, these policies start out as a level term policy and eventually become a one-year guaranteed annually-renewable term insurance policy.
The annually-renewable portion of the policy means the insurance company guarantees your policy is renewable each year without evidence of insurability and without any application requirements, up to a certain age (again, usually between age 80 to 95) - very handy if you become ill and wouldn't ordinarily qualify for life insurance anymore.
When the one-year term is up, the insurer simply sends you a bill and automatically renews your coverage every year until you cancel.
Types Of Term Life Insurance
Term life insurance is often pitched as a simple and straightforward life insurance product, but the truth is it comes in many different flavors - just like Baskin Robbins, but without the extra calories.
Here are just a few of the more common policy configurations:
• Annual Renewable Term
• Increasing Term (increasing death benefit)
• Level Term (level death benefit)
• Decreasing Term (decreasing death benefit)
See? Simple.
Now, within each of those policy configurations are a couple of options and combinations of options to alter the basic functionality of the product, including:
• Non-Convertible Term
• Convertible Term
But that's foreplay. Let's go deep… into the details.
With the exception of annual renewable term insurance, most term policies have a level premium period - a specific length of time when premiums are level and do not change.
This level premium period can either be guaranteed not to change or can be non-guaranteed and sometimes it's not entirely obvious when an insurer has guaranteed your premiums to be level.
They do tell you in the policy contract, of course, but it's not always obvious on the policy illustration you get from your insurance agent or in the marketing brochures from the insurance company.
Anyway, non-guaranteed means the insurer can change the premium amount during the term policy while guaranteed level means your premiums will not change until the level premium period is over.
Guaranteed level premium periods are typically 10 years, 20 years, or 30 years. In rare cases, an insurance company will sell you a 40-year level premium, level term policy.
During the guaranteed level premium period, your premiums remain - wait for it - level. They do not change.
For example, if you buy a 20-year level premium, level term policy, and the premium quoted by the insurance company is $1,000 per year, then… your premium will stay at that level for 30 years before increasing.
And here's where the complexity starts.
The exact type of term policy that's best for you depends a lot on your current and expected future financial circumstances - circumstances which aren't easy to predict.
Most financial decisions you make, and all decisions you make about life insurance, have life-long consequences since… these are typically contracts which will be in force for 20 or 30 years, and sometimes much longer.
A mistake now can cost you anywhere between $100,000 and over $1 million dollars.
As an example of this, I have a client who delayed buying life insurance for many years. They made some poor life choices and never fixed them but… they needed life insurance.
Long story short, a financial mistake they made roughly 30 years ago is costing them $324,856 today.
Chump change, right?
The good news is most mistakes can be fixed (this client can reverse their fortune with a little elbow grease and grit), but… a lot of how things turn out for you ultimately depend on the life insurance advisor you have working on your case.
Once you have an agent lined up, it's time to comb through your policy options.
Once again, they are:
One-Year Annually-Renewable Term or Yearly Renewable Term Life Insurance (ART/YRT)
The life insurance policy that started it all. Every life insurance policy in existence today is, ultimately, based on the one-year annually-renewable policy. This policy type offers a level death benefit and guaranteed increasing premium.
This term contract gives you one year's worth of death benefit protection for a set premium which does not change for the entire year.
That premium is just enough to cover one year's worth of insurance charges. At the end of the year, you must renew this policy if you want to keep the same insurance coverage. You can also just surrender (terminate) the policy and your insurance coverage ends.
When you renew, your premium is guaranteed to increase since your risk of buying the farm increases every year on your birthday. Meanwhile, your death benefit remains the same as the previous year.
How Level Premium Funding Works
Before I go any further, a slight detour.
It's important. I promise.
Most term insurance sold on the market today is not annually-renewable term.
It is level premium term insurance and… despite what you may have read elsewhere online, this kind of term insurance works the way it does largely because it combines elements of insurance with elements of investing.
This method is called "level premium funding" and it helps keep the premiums level at each death benefit amount or for a set period of time. Here's how that looks, conceptually:
Level premium funding allows a life insurance company to level the premiums out for a policy.
If you're a detail-oriented person, or a spreadsheet junkie, then I recommend you check out the book, Actuarial Aspects of Individual Life Insurance and Annuity Contracts, by Albert E. Easton and Timothy F. Harris, where these (and other) insurance concepts are fleshed out in more excruciating detail.
The way this works is… the insurance company collects more than what it actually needs to pay for the death benefit. By doing so, they establish a cash reserve.
This reserve is, in actuality, a liability that the insurance company needs to pay the future death benefit. There are lots of different ways insurers can establish reserves but… they all basically work the same way.
Whenever a life insurance policy has a level premium, you can be sure the insurer is collecting more premium than it really needs and then investing that money on your behalf. The level premium is proof positive that a cash value exists for the policy. This reserve is invested in the insurance company's General Investment Account (GIA).
In the later years of the policy, this excess premium, plus investment interest, is used to hold down the rising cost of insurance thus keeping the premium level for the duration of the death benefit term (yay!).
But, in many cases, insurers are able to generate excess profits through the combination of the level premium (i.e. "overpayment" of premium) and investment of that premium. Any excess profits earned by the insurer are kept by the insurance company and not refunded to you (boo), unless…
… unless your policy specifically provides for a refund of premiums paid plus interest earned on those premiums (commonly called "term with return of premium").
Increasing Term Life Insurance
Increasing term life insurance provides increasing coverage over a specific number of years.
Increasing term policies have a death benefit which increases over time while the premium (kinda-sorta, but not really) remains level, either on a guaranteed or non-guaranteed basis.
Premiums are usually level for a specific period of time and then increase as the death benefit amount increases or until the level premium period ends.
For example, the insurer may offer you the option of $100,000 of death benefit for 5 years, which increases to $250,000 for the next 10 years, and then after that, the death benefit increases to $500,000 for another 10 or 15 years.
Each increase in death benefit comes with an increase in premiums.
So, when you buy an increasing $100,000, 30-year term policy, you may initially be charged a flat rate of $20 per month. In that sense, the premiums are level since they don't change for the initial death benefit period.
But… when the death benefit increases to $250,000, your premium might rise to a flat premium of $75 per month. And, when your death benefit increases again to $500,000… your premium rises again, maybe to $150 per month.
In the case of increasing death benefit policies, as the death benefit increases, a new level premium amount is established and the process starts all over again.
So, for example, if the actual cost of insurance is $20, the insurer might collect $50, investing the $30 it doesn't need right now. As the insurance death benefit increases, the premium (and excess collected) also increases. After the level premium period ends, your policy switches to an annual-renewable policy and premiums increase every year.
Level Term Life Insurance
Level term life insurance provides level death benefit (insurance) protection for a specific number of years. It is, by far, the most common type of term life insurance sold today.
Level term policies also have level premium periods.
But, these periods are usually much longer than with increasing term policies since the death benefit also remains level or flat for the entire duration of the contract.
When you initially purchase the policy, you choose the number of years you want your term insurance premiums to remain level.
For example, the insurer may offer you the option of a 10-year, 20-year- or 30-year level premium policy. Just like the increasing term option, the insurance company then collects an amount of money from you which exceeds the actual cost to provide death benefit protection.
The excess premium is invested in the insurance company's general investment account. This excess premium, plus investment interest, is used to hold down the rising cost of insurance as you get older, the same as in the rising death benefit term option.
So, when you buy that 20-year term policy for $500,000, instead of paying $50 or $100 per month in actual insurance charges, you might pay $150 or $200 a month, but that extra amount doesn't increase until the end of the level premium period - until the end of those 20 years.
Once the level premium period ends, your policy switches to an annual-renewable policy and premiums increase every year.
Decreasing Term Life Insurance
Decreasing term life insurance provides decreasing term insurance coverage over a specific number of years. It's often used as mortgage protection insurance.
These policies are somewhat rare, but combine level premiums and a decreasing insurance death benefit amount. Yes, you read that right. You pay the same premium year in and year out, but receive less and less death benefit over time (lame).
The most common examples of this type of life insurance are mortgage protection life insurance and credit life insurance (not to be confused with private mortgage insurance).
Like other types of level premium policies, the level premium period only lasts for a specific number of years. During this time, the death benefit gradually decreases by a fixed dollar amount or by a specific percentage each year.
Some policies may offer the option of "step-down" face amounts, where death benefits remain level for a number of years before decreasing and remaining level for several more years.
More often than not, however, the death benefit decreases by a stated percentage each year until it reaches $0, at which point the policy terminates and coverage ends.
But wait… there's more!
Term Life Insurance Options
Term life insurance can also be modified with riders (which add additional features and benefits to the basic policy contract), like:
- Return-Of-Premium Rider
- Extended Coverage Rider
- Accelerated Death Benefit Rider
- Disability Waiver of Premium Rider
- Accidental Death Benefit Rider
- Disability Income Rider
- Guaranteed Purchase Option Rider
Each of these individual options can be combined to create a truly customized term policy and… each combination can have dramatic long-term implications for your finances.
That's because every dollar you spend on insurance premiums is a dollar you cannot spend (or invest) elsewhere, so choosing the right product and features is really super-important so as to not screw yourself over later on in life.
At the same time, not spending enough on life insurance means a really fantastic catastrophic financial loss (either death, illness, or disability) can put you or your family down for good.
Again, totally simple and straightforward and… of course… no pressure.
The only thing riding on this is you and your family's well-being.
Moving right along…
The two basic term policy options are:
Non-Convertible Term
This is one of the more basic term insurance options. It does not allow you to convert your policy to a whole life or universal life policy. When your policy terminates, or when you decide to stop paying premiums, your coverage ends. You have no more insurance.
Convertible Term
This option allows you to convert some or all of your term insurance policy into whole life or universal life insurance later on in life. It's particularly useful if you plan on buying either of these types of life insurance at some point but either don't have the money or don't want to pay the premiums for them right now.
Every life insurance company differs in how they administer the conversion option.
Some companies, for example, will allow you to convert only part of your term death benefit. Others will allow a full conversion but only if you convert the policy within a certain time frame. Still others allow full conversion at any time as long as the policy is still in force (i.e. as long as you're still paying premiums).
Some companies offer partial premium credits towards the conversion into whole life or universal life, while others offer a full credit. Still others offer no credit at all.
Term Life Insurance Riders
Term riders are modifications to the basic term policy which add functionality or features to your policy. Fun, right?
Common riders include:
Return-Of-Premium Rider
This rider allows you to get back some or all of your premiums at the end of your level premium period. Some insurers also allow you to receive a refund, with interest added.
To get this refund, most insurers require you to make all premium payments on time. Any late-paid, or missed, premiums result in a partial or total loss of the refund option. Insurers also tend to charge a higher premium for this benefit. So, only choose this option if you're certain you can pay all required premiums on time.
Some insurers offer a return of premium "baked" into the policy configuration instead of as a rider.
Extended Coverage Rider
This rider option adds additional insurance coverage for a family member. It's kind of like getting 2 (or more) policies in 1. Most of the time, the coverage is extended to your spouse and children. The supplemental insurance death benefit has its own premium and terms and cannot be separated from the base term policy.
Terminal Illness Rider
More and more term policies are coming equipped with accelerated death benefits. This means you get to spend your death benefit before you die.
Of course, there's a catch (isn't there always?). For the terminal illness rider to kick in, you have to be expected to kick the bucket within 12 or 24 months. It's a way for you to enjoy your death benefit while you're still alive and go make peace with the world before your time is up.
Chronic Illness Rider
Similar to the terminal illness rider, this rider benefit lets you spend down some or all of your death benefit before you die. However, to exercise this rider, you have to suffer a heart attack, stroke, or have some other permanently disabling event.
Some policies will also allow you to use the death benefit to pay for long-term care costs, but you must be expected to need care for the rest of your life to qualify for the death benefit acceleration.
Some riders allow you to suffer non-permanent disabling events but this tend to be expensive for insurance companies to underwrite. So, most specify that your chronic illness be permanent.
And, as always, there's normally a flat-extra premium (extra charge) for the privilege.
This is usually a good option to include on a term policy if you plan on keeping it for a long period of time (well into your 70s).
Disability Waiver of Premium Rider
If you become disabled, the insurance company will waive the premium payments until you are back on your feet (up to the maximum payment allowance). Normally, this rider option is good for either a 3-year disability or a 6-year disability, with some companies offering a 2-year benefit or grade benefits depending on your age.
Most insurers also require you to be disabled for at least 6 months before they will waive the premium payments.
If you're concerned about disability, look for a company that offers "own occupation" definition of disability.
Most companies only offer "any occupation" definition of disability. The difference is… huge. With an "any occupation" definition of disability, the company will only waive premiums on your policy if you are unable to do any work at all. Meaning, if you can still pump gas at a gas station, you can still work or… if you can still sweep floors, flip burgers, or work for minimum wage, you won't qualify for disability coverage.
"Own occupation" means you cannot work in your primary occupation or line of work doing the exact same job you were doing before you became disabled. If you do some kind of skilled labor job, or own a business, or you're a high-level executive, this is usually the definition of disability you want to have from your insurance company.
It's more favorable to you and thus easier to get approved for the disability benefit if you ever need it.
Disability Income Rider
This rider is different from the premium waiver. Under this rider benefit, the insurer will actually make a cash payment directly to you if you become disabled, just like a regular disability income insurance policy. The same rules and caveats apply with regard to "any occupation" vs "own occupation" definition of disability.
Accidental Death Benefit Rider
This rider adds additional insurance to the basic term policy which only pays out if you die as a result of an accident.
Guaranteed Purchase Option Rider
Handy if you know you'll be purchasing more life insurance in the future.
This rider lets you buy more life insurance at specified ages without going through medical underwriting to prove your insurability. That means, if you get sick later on in life, you can still get life insurance.
There's usually a hefty fee for this option as you're basically putting the life insurance company on the hook for potentially high-risk coverage (high risk for them).
So… Are Any Of These Options Useful?
The short answer is: Yes.
The slightly longer, more nuanced, answer is: It depends on your long-term financial plan.
Your term policy configuration and supplemental riders or options come in handy if you need them. And, if you don't need them, then it's money wasted. Sounds obvious, right? Well, that's because it is.
Stay with me. I promise I'm going somewhere with this.
Term Premiums Vs Net Cost Of Insurance
As mentioned earlier, there is a misconception that term life insurance is "cheap insurance."
There is no such thing.
All life insurance is, basically, expensive.
Life insurance companies have various ways of shifting these costs around, but they cannot eliminate it.
The reason for this is obvious. Your risk of death at any age is the same regardless of whether you buy a term life, whole life, or universal life policy.
What changes is how the insurer chooses to arrange those costs in the policy.
A one-year, annually-renewable term policy, for example, is pretty straightforward. You bear the cost of insurance each and every year.
For example:
The cost of annually-renewable term insurance rising each year as the cost of insurance is realized.
This policy is for a 35 year-old male, non-smoker (end of the first year is actually age 36 and the line break after age 70 is because this illustration was split into 2 pages), $1,000,000 of life insurance, and annual premiums start out low and rise over time.
At age 90, the policy terminates and the policyholder cannot buy life insurance anymore.
He (or she) is too old.
Total premiums over the life of this policy are $5,447,559.
That means the policyholder has paid $5,447,559 for $1,000,000 worth of insurance coverage. This is what it costs to provide the specified coverage amount.
And, it is why people often believe life insurance is a terrible deal.
If you held a term policy to the maximum insurable age, it would be a terrible deal… which is why most people drop their term coverage after the level premium period is over. It's not because they don't need or want insurance coverage anymore. It's because the policy becomes too expensive and impractical.
If you think about it, it makes perfect sense. How many people would turn down free insurance? Now, how many people routinely turn down expensive insurance?
It's a question of economics, not absolute need.
That doesn't mean people don't have a psychological need for insurance… for financial security. They do. But, that need is largely driven by economics (affordability). If the insurance costs more than what your financial security is worth, then the insurance becomes impractical.
On the other side of this transaction is the insurance company. It is out to make a profit by transforming your unknown future into a known premium payment… by selling you life insurance.
It charges enough money to cover death benefit claims, operational costs of running an insurance company, plus profit for the insurer. This (annually-renewable term) is the "gold standard" for determining those internal costs for all types of life insurance.
This is because the annual renewable term policy is the most basic type of life insurance policy. There are (generally speaking) no pricing games, no gimmicks. You pay for the pure cost of insurance each and every year.
Its premium is also guaranteed to increase each and every year, owing to the fact that annually-renewable life insurance is priced based on your probability of death for 1 year.
And, it is an inescapable fact of reality that every year you are growing older. It is also an inescapable fact of reality that the closer you get to age 100, the higher your probability is of keeling over.
At some point, it's academic.
Now, life insurance actuaries (mathematicians) know a bunch of tricks to shift costs around inside a policy.
They cannot get rid of costs, but they can move them around. This is why products like 10-year, 20-year, and 30- year level premium policies exist. Level premium policies mean the premiums stay level for a specific period of time… after which, the full cost of the insurance must be realized.
The costs for these policies are as follows…
For a 10-year level term policy:
A 10-year level term policy holds down the rising cost of insurance for the first 10 years using level premium funding and clever pricing mechanisms which are not possible in the later years of the policy.
Total premiums for the same $1,000,000 of insurance are $5,467,896.
Note, these premiums are slightly higher than for the annually-renewable term policy, implying a small, non-zero, level of cash reserves held by the insurance company for this policy.
For a 20-year level term policy:
A 20-year level term policy holds down the rising cost of insurance for the first 20 years using level premium funding and clever pricing mechanisms which are not possible in the later years of the policy.
Total premiums paid for this policy are $5,377,412 for the same $1 million of insurance. This is slightly less than for the annually-renewable term policy, indicating that either the insurer takes a loss on this product (unlikely) or it is a profitable product and very few (if any) policyholders actually carry the term policy out to maximum insurable age (more likely).
In all cases, the premiums are not wildly out of proportion to one another, demonstrating the cost for insurance is the same, or comparable, across all policy types.
This same general pricing and premium pattern exists at all ages, both genders, and all risk classes.
What Is Your Long-Term Financial Plan?
Now for the tricky part.
The most difficult part of using term life insurance in your financial plan is actually not the insurance part at all… even with the dizzying array of riders and options.
The real complication is the impact of the premium in the wider context of your financial plan.
As you can see, level premium term policies present an interesting challenge to you, the policyholder. You are tasked with the mission to build up a savings which will eliminate the "need" for insurance… insurance which becomes increasingly impractical to pay for as you get older.
Listen to me now and hear me later: Term life insurance is never bought in a vacuum.
Implicit in every purchase is the fact that you must save up and invest money on your own to cover the rising cost of insurance after the level premium period ends or… drop the coverage after those insurance costs rise and go without life insurance coverage.
Either way, you must save up money to either reduce, supplement, or replace your term insurance coverage. If you do not, the plan failed.
This is why the "whole life versus buy term and invest the difference" debate exists.
The premise is you start with a whole life policy, with a specified death benefit amount, calculate the required premium for that death benefit and then… use an alternate strategy of buying term (at a much lower initial premium) and… invest the remaining dollars you would have otherwise used to pay whole life premiums.
Most research done to date show most people neglect to "save the difference," which is a problem (obviously). Others save less than what they would have otherwise put into whole life insurance.
But, either way, whole life insurance is used as the standard by which term insurance is measured when viewed in the context of a savings and insurance plan.
This is what creates the inherent complexity of a term + savings plan.
The term insurance portion of the plan must be fully replaced before the policy expires or else you would have been better off using whole life insurance.
Some people will argue it's OK to save up less than the term insurance death benefit before the policy expires but… this implies the plan was destined to fail from the start. The premise of "buy term and invest the difference" is that you'll "self-insure."
"Self-insurance" (despite being a flawed concept) means you've saved up enough money to replace your life insurance amount - you no longer need it.
You (and by extension, your family or business partners) either needed that insurance money or… you didn't. If you didn't, then… you paid too much for your life insurance and your agent oversold you… which is unlikely because life insurance companies never sell an individual more insurance than what he or she is worth (economically).
Remember, the reason you're buying the life insurance death benefit is because the death benefit is what you're worth (economically). You're buying your future income and savings - income and savings that's presumably needed whether you live or die.
So… the goal then is to check to see that you can actually save up and replace your term insurance amount before it expires.
How To Buy Term Life Insurance
Non-Convertible Term Insurance
Once you've figured out how much life insurance you need (or once you've had your agent figure this out for you), have your insurance agent or advisor design a customized term life insurance plan that matches your investment plan's time horizon… including both the accumulation phase and income phase of your financial plan.
For example, if you plan on retiring in 20 years, your insurance should cover you at least until then. If you've decided to buy non-convertible term insurance, and do not plan on ever buying whole life insurance, your insurance advisor and investment advisor should work together to coordinate a risk retention fund.
Assuming you want to be financially secure and stable (who doesn't?), plan on saving enough money to create an income for yourself (and possibly your spouse) later on in life as well as a separate savings dedicated to your final expenses and other expenses which would normally be paid out of whole life insurance death benefit proceeds (the risk retention fund).
This separate savings cannot be used for income or other expenses and should be held in an investment account you cannot easily access. It will be used to pay for your final expenses and any charitable donations you want to make.
This plan should also take into account the time value of money, investment fees, and taxes. If you want some form of term insurance after age 65, forget it. In most cases, it's cost prohibitive and (in most cases) will cost more than you can reasonably earn on your savings over the long-term.
Convertible Term Insurance
If you plan on converting your term insurance to whole life, then your insurance plan needs to take into account the time value of money as well as conversion options to permanent insurance (either whole life or universal life) before you plan on retiring or before a target age when term life insurance is likely to become too expensive (i.e. after age 65).
Either Way…
In most cases, for most people, it makes sense to own at least some amount of convertible term life insurance.
Learn More About Life Insurance
Protect yourself, your loved ones, and build real lifelong financial security. Learn (almost) everything you need to know about life insurance by reading The Rogue Agent's Guide To Life Insurance.
About The Author
David C. Lewis, AKA The Rogue Agent, is a licensed independent life insurance agent (License No./NPN: 8462895), specializing in life insurance planning and The Perfect Policy™ design concept. He is also the owner of Monegenix®. To learn more about him and his work, read his full bio.
