By Boyce F. Lowery, CLU®, ChFC®
As an insurance expert, I often get asked, “What is the best kind of life insurance policy to have?”
“Obviously, it’s the one that is in force on the date of death of the insured!”
While that statement may be true in some regard, that’s not the most helpful answer for those looking to buy life insurance, or even to those wondering if they made the right choice. The fact is there isn’t one best kind of life insurance policy, despite those who may think otherwise. Like every other financial vehicle that exists, all life insurance policy types have pros and cons.
Today we are going to talk about term life insurance, how it works, and the advantages and disadvantages of this popular choice of many pundits.
Types of Term Plans and How They Work
Term insurance is a life insurance policy that provides a level premium, and usually a level death benefit, for a specified number of years. There are different lengths of terms that can be purchased, from one year all the way up to 30 years.
People usually choose their term period based on the length of time they anticipate needing coverage. The coverage might be to provide for lost income of the deceased insured, to pay off a mortgage or other debt, to provide college funding, to pay for final expenses and/or other estate planning needs. For instance, a parent might only want insurance coverage until his or her children are grown. Another person might only want coverage until retirement age or until the mortgage is retired. Sometimes, multiple term plans for different term periods are utilized to more fully customize the coverage desired.
The shortest term plan available is annual renewable term insurance. This kind of term plan usually makes economic sense only if coverage is needed for up to three years or so or the intention is to convert to permanent coverage during that timeframe. This is so because the premium cost for annual renewable term plans goes up every single year and quite rapidly.
Five-year term plans, while available, are not competitively priced compared to the most competitive 10-year term plans. The most commonly utilized term plans are 10-year, 15-year, 20-year, 25-year, 30-year and level term to age 65.
Also available are return of premium term plans for those who want 100% of their premium payments refunded to them at the end of the term period. In today’s market, a 30-year return of premium plan has lower premium payments that a 20-year return of premium term plan. Both are less expensive than a 15-year return of premium term plan.
Another kind of term insurance is called second to die term. This insurance covers both spouses in a marriage and provides a death benefit only after the second spouse dies. The surviving spouse doesn’t receive any benefit after the first spouse dies, only the heirs get a payout after both insureds have died. Second to die term is most commonly used for funding a potential estate planning liquidity need. Most commonly, the second to die term plan option is selected when cash is short or it is uncertain that the second to die coverage will be needed long term because of pending tax law changes.
Advantages of Term Life Insurance
One of the greatest advantages of term life insurance is the price. Of all the different kinds of life insurance, term requires the least cash flow to provide the desired coverage. This is a major driver in term insurance popularity because the lower price point makes these policies available to more people. For younger healthier individuals, term life insurance is extremely inexpensive.
Also, term life insurance policies are widely available, making it easy to purchase a policy. They are easy to understand, which can appeal to those intimidated by complex financial instruments including permanent insurance products. Another benefit is the fact that they can be designed to cover a specific period of time, which is great for temporary insurance needs.
Disadvantages of Term Life Insurance
While term policies require less cash flow to fund them than other types of life insurance policies, they can also be the most expensive policies to own in the long run. How? If the insured outlives the term period, there typically is no return of the premiums paid, let alone a any interest earned. Thus, even the higher-premium types of policies can be more cost-effective because they generate a return. Sometimes, depending on the type and structure of the higher premium policies, the return on the excess cash paid for them can exceed 5% to 7%. Further, that return is tax advantaged and the cash is often accumulated without market ups and downs.
Another concern with term insurance is that coverage may expire at a time when it is needed most. If things don’t turn out as originally planned, purchasing a new policy in the future when the current term expires will result in much a much higher premium, even if the insured is still in good health. If the insured isn’t in good health or is too old, the policy owner may not even be able to secure the coverage they need after the current term policy expires.
Term insurance also doesn’t take advantage of important asset protection provisions provided to life insurance policy cash values in many states. Neither does term insurance take advantage of the many other benefits provided by a properly structured cash value life insurance policy.
Things to Keep In Mind When Purchasing Term Life Insurance
A lot of people naturally default to the cheapest option when shopping, whether it be for groceries or life insurance. But is the cheapest always the best? The answer is definitely not, especially when it comes to life insurance. There is so much more to buying the right term policy than finding the least expensive premium.
For instance, if you are going to buy a term policy, pay very close attention to the language of the term conversion provision. The conversion language is very important because it lays out the terms of when and to what type of policy you can convert should you choose to do so. Most policies sold today stipulate that there will be a policy made available for conversion during the term conversion period. Such a policy is inferior, in my opinion. The policy owner, when informed, will want to purchase a term policy that allows the conversion to ANY permanent policy being sold by the insurer at the time of conversion. Insurance companies that stipulate a particular policy for conversions have generally priced that particular policy available for conversion in a way that protects it from conversions being made where the insured is less than healthy. That makes that policy much more costly than one being sold to those who go through underwriting to determine cost. Separately, also be sure the term policy allows conversion for the entirety of the level term period, usually capped at the insured’s age 65 or age 70.
Also, if you are buying your term policy from a company that allows conversion to any plan they sell at the time of conversion, make sure that the company has options that make the conversion attractive. If they don’t have any competitive policy options to which to convert, your conversion option may not be nearly as valuable as you think. One other benefit of the best term plans is that they offer a conversion credit after the first year to help offset some of the cost of conversion during the first policy year.
Choosing a Life Insurance Policy
When it comes to choosing a life insurance policy, it helps to work with an experienced, fully independent professional. There are so many options that only an industry expert can help you find the exact policy that best fits your needs. If you’re looking to buy life insurance, whether term or not, give us a call at 888-827-0146 and we can help you find the best policy for your unique situation.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the owner of Suncrest Advisors, he aims to provide financial security and peace of mind to business owners, executives and professionals, and high net worth individuals across the United States. Along with more than four decades of experience, he is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit https://suncrestadvisors.com/ or connect with Boyce on LinkedIn.