How Does Term Life Insurance Work?

Life insurance can be used to protect your loved ones from a sudden loss of financial support. It can certainly bridge the financial gap and help your loved ones get back to their feet after your loss. The proceeds of life insurance can be used to cover immediate expenses.

These may include unpaid medical and hospital bills, funeral expenses, mortgage payments, meeting business commitments, even meeting college expenses for the children. In addition, life insurance helps maintain the family’s standard of living during such a difficult time.

It lets a person leave an inheritance. Moreover, life insurance can improve one’s credit rating. Life insurance in itself is a financial asset and may then help increase your credit score.

There are three basic types of life insurance- term life insurance, whole life insurance and universal life insurance.

The first of these three is term life insurance. This is also known as “pure” life insurance. This policy pays out the death benefit if the named person dies within the defined term. The most common terms are 10, 20 and 30 years. If the named person dies after the term expires, then there will be no payout.

This type of life insurance is typically the least expensive way to purchase a substantial amount of death benefit per premium dollar basis over a specified period of time. It meets coverage needs up to thirty years.

The disadvantages of this type of life insurance though include having no savings feature and having no lifetime coverage. Also, if the term of your policy is about to expire and you need to renew your policy, you might be shocked at how high your premium has increased, especially if your health has declined.

It may even be possible that you will not be able to renew the policy because you no longer find it affordable. Hence, experts suggest that on deciding the terms of your insurance, you have to consider the term length.

Term life insurance policies also have maximum age issues. Experts say if you’re past the age of eighty, it will be very difficult for you to get term life insurance.

There are two kinds of term insurance. There’s the “annual renewable term”. This has a term of one year (coverage), which you can renew annually. This has the lowest annual premium, but the amount of premium may increase as you age.

Hence, if your goal is to keep your initial costs down but you believe your earnings will increase significantly in the future, it is best to have this kind of policy.

There’s also the “level premium term” which you can buy for a specific multi-year period- 5, 10, 20 or 30 years. This kind of policy allows you to lock the amount of premium for a given multi-year period. Hence, this can be a smart way to insulate you from increasing amount of premium.

How much will it cost you? Well, the amount of premium that you will pay will depend on several factors- your age, health and the amount of your death benefit. Obviously, the younger and healthier you are, the lower is your life insurance premium. In the US, the most popular option for a term life insurance is a 20-year policy, worth $250,000.

The average annual life insurance cost of this policy for a 25-year-old non-smoker is $331. This will increase to $433 if the age increases to 40 and will increase to $2,495 for a 60-year-old. The amount of premium will be doubled to tripled if the person insured is a smoker.

How big should your life insurance be?

As a rule of thumb, your death benefit should be equal to seven to ten times of your annual salary. You can actually determine it in another manner.

First, determine the amount of income you wish to provide your heirs and beneficiaries after you die. From this amount, deduct all other income sources that they will be able to tap- retirement accounts, pensions, social security, etc.

For the remaining gap, this is the amount that you will fill with life insurance.

The second type of life insurance is whole life insurance. This has no predefined term, provides death benefit over the “whole” life of the insured as long as premiums are paid. Further, it accumulates cash value which the insured can withdraw or borrow against during their lifetime.

Its disadvantages, though, include inflexible premiums and a considerably lower rate of return than other investments.

Finally, the third type is universal life insurance. This policy has a cash value that is determined by short-term interest rates rather than the stated long-term interest rate of a whole life policy. Premium payments in excess of the cost of the policy are added to the policy holder’s interest bearing account. The disadvantages of this policy include decreased death benefit or increase in premium if interest rates decline.

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Steve Gebhardt

Gebhardt Insurance Group was honored by AAA Insurance for being the top New Policy Agency in Arizona for 2013 and achieving the "Emerald Achievement Award."
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