Life Insurance: 5-Year Term Option Explained

Term life insurance is a type of insurance that provides a death benefit for a specified period of time, typically between 10 and 30 years. While it is possible to obtain term life insurance for five years, these policies are becoming less common, with no insurance carriers offering them as of 2022. Term life insurance is a simple and cost-effective way to ensure financial protection for loved ones, with premiums based on age, health, and life expectancy. This type of insurance is particularly attractive to young people with children, offering substantial coverage at a low cost. When considering term life insurance, it is essential to evaluate the duration of financial commitments, such as mortgages and dependent care, to ensure adequate coverage.

How does a term life insurance policy work?

Term life insurance is a type of life insurance policy that provides coverage for a certain period of time, or a specified number of years. If the insured person dies during the specified term, the insurance company will pay the policy's face value to the beneficiaries. The beneficiaries can use the cash benefit to settle healthcare and funeral costs, consumer debt, mortgage debt, and other expenses. However, they are not required to use the insurance proceeds to settle the deceased's debts.

When you buy a term life insurance policy, the insurance company determines the premium based on the policy's value (the payout amount) and factors such as age, gender, and health. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, family history, and similar information.

Term life insurance policies typically last for a set period, such as 5, 10, 15, 20, 25, or 30 years. The duration of the policy should be based on the length of your financial commitments, such as the number of years left on your mortgage or until your children are financially independent. You can also find annual renewable term life insurance policies, which allow you to renew coverage annually for a set period without reapplying, although premiums typically increase with each renewal.

Once the term of a policy expires, the policyholder can either renew it for another term, convert it to permanent coverage, or let the policy lapse. Term life insurance policies do not usually build cash value, and there is no payout if the insured person survives the policy term or if the policy expires before their death.

What are the different types of term policies?

Term life insurance is the simplest form of life insurance. You pay a premium for a period of time, typically between 10 and 30 years, and if you die during that time, a death benefit is paid to your family or anyone else you name as your beneficiary. There are several types of term life insurance policies. Here are some of the most common ones:

• Level Term or Level-Premium Policy: This is the most common type of term life insurance. It has a fixed monthly payment for the life of the policy, which is usually between 10 and 30 years. The death benefit is also fixed.
• Yearly Renewable Term (YRT) Policy: These are one-year policies that can be renewed each year without providing evidence of insurability. The premiums increase each year as the insured person ages.
• Decreasing Term Policy: These policies have a death benefit that declines each year according to a predetermined schedule. The policyholder pays a fixed level premium for the duration of the policy.
• 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. However, the premiums are usually much higher than those of a regular level-term policy.
• Guaranteed Issue: These policies do not require a medical exam and only ask a few simple health questions. The premiums may be higher than those of other policy types because the insurance company assumes the insured is a risky prospect.

When choosing a term life insurance policy, it is important to consider the length of the term, the premium cost, and the death benefit amount. It is also essential to work with a reputable insurance company that offers strong financial strength ratings and guaranteed term renewability.

How much term life insurance coverage do you need?

The amount of term life insurance coverage you need depends on your financial and family situation. If you have others depending on you financially, you should get a term life insurance policy lasting as long as those obligations.

• Your income: You should get enough coverage to replace your income for a certain number of years. This will depend on how long your dependents will need financial support, such as children or a spouse who doesn't work.
• Your mortgage: If you want your life insurance to cover your mortgage, consider how many years you have left until it is paid off.
• Future expenses: Think about any future expenses that your life insurance will need to cover, such as college fees for your children.
• Existing assets: Don't forget to subtract any existing assets that can be used to cover expenses, such as savings or existing life insurance policies.

There are several methods you can use to estimate how much coverage you need, such as:

• The "10 times income" rule: This involves multiplying your income by 10 to get an estimate of how much coverage you need.
• The DIME method: This stands for Debt, Income, Mortgage, and Education. It involves adding up these four amounts to get a more comprehensive view of your financial obligations.
• The years-until-retirement method: This involves multiplying your annual salary by the number of years left until your retirement.
• The standard-of-living method: This method is based on the amount of money your survivors would need to maintain their standard of living if you die.

Keep in mind that these methods are just estimates and may not give you an accurate idea of how much coverage you truly need. It's important to do your research and consider all your financial obligations and goals when deciding how much term life insurance coverage to get.

Why would you convert to a whole life policy from term?

There are several reasons why you might want to convert your term life insurance policy to a whole life policy. Here are some of the most common ones:

Change in Health

Converting to a whole life insurance policy allows you to extend your coverage without going through the underwriting process. This can be a valuable option if your health changes for the worse. If you wanted to get a new term life policy to extend your coverage, you would have to pay astronomical rates or could even be uninsurable. However, if you convert, your current health won't affect the premium on a whole life policy or your insurability.

Budget Increase

You might have wanted to buy a whole life policy from the get-go but couldn't afford the higher premium. If you're making more money now, it can make sense to convert if the higher premium fits within your budget.

Cash Value Asset

One of the benefits of a whole life insurance policy is that part of your premium goes towards the cost of insurance, and part of it goes towards building cash value. Some people want cash value life insurance so they can access the cash during retirement (or for other reasons) tax-free. It shouldn't be a substitute for saving for retirement in an account such as a 401(k), but it can be part of a financial plan.

Leave a Legacy

If you want to be able to leave an inheritance for your children but don't want to scrimp during retirement just to ensure there's cash left to pass on, converting to a whole life policy can help. A whole life policy can be in force no matter when you die and will pay a death benefit to your beneficiaries.

Cover Final Expenses

Even if you're not worried about passing on money to your children, you might not want to saddle them with paying for your funeral. So, converting enough of a term policy to a whole life policy to cover final expenses could make sense.

Peace of Mind

Term life insurance provides adequate coverage, but there's an expiration date on the policy, and premiums can increase substantially when it's time to renew. Whole life insurance, on the other hand, provides long-term peace of mind as it offers permanent coverage as long as you pay your premiums.

How much you can expect to pay for a term life policy

The cost of term life insurance is based on several factors, including age, gender, health, lifestyle, and the length of the policy.

Term life insurance is usually the least costly life insurance available because it offers a death benefit for a restricted time and doesn’t have a cash value component like permanent insurance. For example, a healthy, non-smoking 30-year-old man could get a 30-year term life insurance policy with a $250,000 death benefit for an average of $18 per month as of October 2024. At age 50, the premium would rise to $67 a month.

The average cost of life insurance is $26 a month. This is based on data provided for a 40-year-old buying a 20-year, $500,000 term life policy, which is the most common term length and amount sold.

Term life insurance rates for a $500,000, 20-year term life insurance policy for preferred applicants in good health are as follows:

• Average annual rates for men: $300
• Average annual rates for women: $260

For smokers, the rates increase:

• Average annual rates for men: $540
• Average annual rates for women: $410

The cost of a $500,000, 20-year term life policy for a 40-year-old nonsmoking applicant in good health is as follows:

• Average annual rate for men: $400
• Average annual rate for women: $330

For smokers, the rates more than double:

• Average annual rate for men: $1,040
• Average annual rate for women: $840

The cost of term life insurance also depends on the length of the policy. For a $500,000 term life policy for a nonsmoking 40-year-old applicant in good health, the annual rates for various term lengths are:

• 10 years: $240 for men, $200 for women
• 15 years: $330 for men, $270 for women
• 25 years: $530 for men, $430 for women
• 30 years: $670 for men, $540 for women

Frequently asked questions