Term life insurance: What it is and how it works

What is term life insurance?

• A term life policy is a contract between you and an insurance company for a defined period, typically between 10 and 30 years. 
• During that term, you promise to pay a premium each month.
• In return, the company promises to pay a specific amount of money – a death benefit – if you pass away during the term. 
• The death benefit is paid to the beneficiaries named in your policy – typically one or more members of your family.
• Many policies are level term – your premium payments stay the same for the length of the term.
• The death benefit is tax-free (unless paid for with pre-tax money).
• When the term expires, so does your life insurance protection. You can choose to do without or get another policy.

Term is sometimes called “pure life insurance” because, unlike whole or universal life insurance, there’s no cash value component to the policy – it’s designed purely to give your beneficiaries a payout if you die during the term. However, because there’s no cash value component, you may get more coverage – a bigger death benefit for your premium dollar.  

Different kinds of term policies available

Most term policies have an underwriting process in which the insurer evaluates your age, health status (you’ll be asked to undergo a medical exam), lifestyle, and other factors in determining your premium cost. 

Guaranteed and simplified issued policies typically don’t require a medical exam, and only ask a few simple health questions. Premiums may be higher because the insurance company must assume you’re a risky prospect with health problems; if you have health issues but are able to manage them, it will usually be worth your while to consider a conventional term policy with a medical exam.

Many policies are level term – you pay the same premium each month – but other types of policies with different payment arrangements are available, including:

• Yearly renewable term: This covers you for a year at a time, with an option to renew without a medical exam for the term – but at a higher cost each year. Compared to a level plan, your premiums will be slightly lower at first, but over the full term, you’ll typically pay more. 
• Return of premium: This type of policy pays back all or a portion of your premiums if you live to the end of the term. The downside is your premiums could be anywhere from 30% to 3 times higher than with a level term policy for the same coverage. ¹ 

Look for a convertible policy

Convertibility lets you change your policy to a permanent whole life policy without having to get a new medical exam. Guardian offers an option that enables you to convert a policy at any point in the first five years – and offers an optional Extended Conversion Rider, ² which lets you do so for the duration of the insurance term.

Why convert your policy? If you’re not a diligent saver, you may be attracted to the cash value aspect of a whole life policy. If you’ve had a serious health problem – for example, a heart attack – it may be very difficult to get another policy. Or maybe you just want permanent life-long coverage. You might choose term life insurance now, but things change.

How much coverage do you need – and for how long?

Before asking how much protection you need, you should probably ask, “For how long?” If you have children, a popular rule of thumb is to choose a term long enough to see them out of the house and through college. The longer your term, the more you’ll typically pay each month.

How to estimate your coverage amount

If you have a family, you may want enough to replace the income you would have provided and cover the extra costs they’ll face in your absence – especially while your children are still at home. There are a few general rules for determining your coverage need:

• Consider 10x your salary: This is one of the simplest rules to follow, and it can provide a useful cushion for your family, but it doesn’t take all your actual needs into account.
• Consider 10x your salary, plus college expenses: If you add $100,000 - $150,000 for each child, that can help ensure they can have the education you want for them. 
• Use the DIME formula: DIME stands for Debt, Income, Mortgage, and Education. Total your debts, mortgage, and college expenses, plus your salary for the number of years your family needs protection (e.g., until the children are out of the house).
• Human Life Value*
  Some financial representatives calculate the amount you may need using the Human Life Value philosophy, which is your lifetime income potential: what you’re earning now, and what you expect to earn in the future.

In its simplest form, the philosophy suggests that you multiply your income by a variable based on factors such as age, occupation, projected working years, and current benefits.

As with every individual, the amount of recommended insurance you purchase depends on many factors. A simple way to get that number, however, is to multiply your salary times 30 if you are between the ages of 18 and 40. The calculation changes based on your age group, so please refer to the chart:

Any of those methods are a good start, but it’s also a good idea to talk with an insurance professional who can not only help calculate your need, but guide you to a coverage solution that is right for you.

Is a term life policy right for you?

While term life insurance can provide the most coverage per premium dollar, alternative types of life insurance – such as permanent life insurance – can offer additional benefits. A term-life policy offers protection, but chances are you’ll pay premiums for many years, live to the end of your policy term, and your family may never see a payout of the death benefit. Another insurance option is a permanent policy, such as whole life insurance, which can provide:

• Life-long coverage³
• A tax-advantaged cash value component with guaranteed growth⁴
• Tax-advantaged access to the policy’s cash value⁵

Whole life costs more than term, but the policy’s cash value can provide several benefits that you can use while you’re still alive: You can borrow against your policy’s cash value, use it to pay premiums, or even surrender it for cash to use in retirement. With a mutual company, such as Guardian, whole life policies can also earn annual dividends  which can further increase your cash value and/or provide other benefits⁶. A term policy has no cash value component. 

Here are some of the other differences between the two types of policies:

There can be a significant cost difference between a term policy and a whole life policy early on, but when you consider all the financial benefits – and the guarantee of an eventual payout – you may feel whole life is a better overall value for your situation. Also, term or whole life doesn’t have to be an either/or proposition: Many people have a whole life insurance policy for permanent coverage and cash value purposes, then get an additional term policy to provide increased death benefit protection – for example, while children are growing up.

How do you buy term life – and what does it cost? 

Coverage at work: Many employers offer group life insurance, either as a mandatory (employer-paid) or voluntary (employee-paid) benefit. Either way, it can be a way to start getting protection, because group premiums are typically lower than those for individuals. You may also be able to get a group policy through a member association. However, the total amount of coverage available may be limited, for example, up to three times your salary. If coverage is paid for with pre-tax dollars by the company, then the benefit is also taxable. And if you leave the company, you could lose your coverage.

Buying as an individual: Even if you have some coverage through work, it may not be enough for your needs – but term life is generally easy to shop for. Many companies, including Guardian, make it simple to compare rates by giving you an instant online quote. Before choosing a company, look for the following qualities: 

• Financial strength:⁷ You want to be confident that the company will be around when your family needs a death benefit payout years down the road. Look for insurers with strong Financial Strength Ratings  like Guardian. That includes a rating of at least “Superior” (A+) from A.M. Best (the insurance industry’s number one rating agency), a “Very Strong” (AA-) from Standard & Poor’s, or an “Excellent” (Aa1) from Moody’s.
• A company that underwrites its own policies: Some companies act as middlemen who sell policies from another insurer. This can add costs to premiums, and an extra layer if you want to change your policy – or down the road when your family needs a payout.
• Guaranteed term renewability: If you become critically ill near the end of your term, you’ll want to be able to renew without taking another medical exam. Some companies offer this on a year-to-year basis – and while you can expect your rates to rise substantially, it may be worth it based on your situation.

Look into customizing your coverage with optional riders

These can add flexibility and value to a policy and can be relatively affordable. Some of the more popular term riders offered by Guardian include:

• Extended Conversion Rider: All Guardian term policies are convertible to whole life for the first five years of the term; this rider lets you extend that to the end of the term.
• Waiver of Premium Rider:⁸ Waives premiums due while the insured is disabled. 
• Accelerated Terminal Illness Rider: Available at no additional premium, this allows for early payment of a portion of the death benefit if the insured is diagnosed with a terminal illness.
• Charitable Benefit Rider: Available at no additional premium, Guardian will add an extra 1% to your death benefit to be paid to the charity of your choice, over and above the amount paid to your beneficiaries.⁹ 

One final note – Even though term is the simplest form of life insurance coverage, it helps to

talk things over with a knowledgeable professional before you buy. If you don’t know such a person, Guardian can connect you with a financial representative who will listen to your needs, find solutions within your budget, and help you decide. Whichever way you choose to explore your options, do it soon. Remember: the longer you wait to get life insurance, the more you’re likely to pay. 

Frequently asked questions about term life insurance

What is the difference between whole life and term life insurance?

Both types of policies pay a death benefit to your beneficiaries. However, a term life policy does so for a limited time period, such as 10, 20 or 30 years. Whole life can provide permanent, life-long coverage with an added cash value component. Cash value can provide several benefits you can use while you’re still alive: you can borrow against it, use it to pay your premiums, or even surrender it for cash to use in retirement. 

What is group term life insurance?

This is term coverage you can get through work or an association. Rates are typically attractive compared to an individual policy, but coverage may be limited – and if you leave the company or association, you may lose it.

What happens to term life insurance at the end of the term?

When your policy’s term expires, so does your life insurance protection. You can choose to do without or get another policy.