Understanding the Different Types of Term Life Insurance

This column discusses the several types of individual term life insurance policies. As discussed in the last column, term life insurance is a popular form of life insurance coverage. Unlike permanent (cash value) life insurance, term life insurance is not designed to be in effect for a lifetime, nor does a term life insurance build up any cash value. Once the term life insurance policy expires, so does the death benefit protection.

Term life insurance can be an appropriate choice if an individual has a need for life insurance for a set number of years, whether it be 10, 15, 20, 25 or 30 years. But term life insurance comes in several types. Each type is discussed.

SEE ALSO:  Understanding Term Life Insurance

Level Term Life Insurance

A level term life insurance policy is for most policyholders the standard type of life insurance policy in which the policy premiums and the death benefit remain constant (level) until the end of the term. The term could be 10, 15, 20,25 or 30 years. For example, a likely candidate for a 10-year level term policy would be an individual who has some short-term debt such as a car loan or excessive credit card debt.

A likely candidate for a 30-year level term life insurance policy would be parents with small children. Parents typically need a substantial amount of death benefit protection, at least until their children are through college. Level term life insurance can give individuals that type of protection at a reasonable premium cost.

Many term life insurance policies are limited by the age of the applicant. For example, an individual between ages 75 and 80 may only be able to get an insurance policy for a 10-year term. These limits vary from one insurance company to another insurance company, but common limits for individuals aged 50 and older are:

• 75 -80 years old: 10- year level term policy

• 70-75 years old: 15-year level term policy

• 60 -70 years old: 20-year level term policy, or

• 50 -60 years old: 30-year level term policy.

Annual Renewable Term Life Insurance

Annual renewable term (ART) life insurance guarantees that the policyowner/insured can renew coverage from one year to the next for the term of the life insurance policy. During the term of the policy, the policyowner will be able to renew each year without reapplying or taking another medical exam to reaffirm eligibility. The design of an ART life insurance policy is to cover short-term life insurance needs. With respect to insurance premiums, they are the for most life insurance companies the least expensive term life insurance policy.

Decreasing Term Life Insurance

Decreasing term life insurance is another type of life insurance which is used to cover a specific financial need, usually a loan or other type of outstanding debt. From whom an individual purchases a decreasing term life insurance policy can make a difference with respect to naming a beneficiary.

If an individual buys a decreasing term life insurance policy from an insurance company, then anyone can be named as beneficiary. If the insurance is bought as part of a long-term loan (such as a mortgage), then the lender -the bank or mortgage company – is the beneficiary. This type of term life insurance is cheaper than level term life insurance because of the shrinking death benefit.

As an example of how decreasing term life insurance works, suppose Frank wants to cover his mortgage so that his wife Rachel can keep the house if Frank passes away. They just bought a house with a 30-year mortgage for $750,000. Frank buys a 30-year decreasing term life insurance policy with a $750,000 death benefit and lists Rachel as the beneficiary. If Frank dies in the first year, Rachel gets the $750,000 death benefit. Note that the $750,000 death benefit is decreasing each year as Frank pays down his mortgage principal. If Frank dies during the third year of the policy Rachel will receive a reduced benefit of approximately $690,000. The $690,000 is the amount of mortgage principal left to be paid at the time of Frank’s death.

With decreasing term life insurance, the policyowner’s death benefit will decrease over time. But the percentage that the death benefit decreases over time will depend on the terms of the life insurance policy and the type of coverage purchased.

Return of Premium Term Life Insurance

Return of premium life insurance is a type of term life insurance in which if the policyowner keeps the insurance policy in force by paying the premiums each year throughout the term of the policy, then the policyowner will receive a lump-sum payment of the premiums paid should the policyowner outlive the term of the policy.

The premium cost of return of premium life insurance is typically higher than traditional term life insurance. But the policy owner will receive a tax-free lump-sum payment of accumulated premiums once the term expires.

The minimum term for a return of premium life insurance policy is 20 years. Return of premium life insurance could be a good option for individuals looking to set aside money for retirement, as the money they receive at the end of the term is tax-free.

However, it is important for individuals to consider other saving options before investing in a return of premium life insurance policy. A downside to using return of premium life insurance as a savings vehicle for retirement is the that lump sum of previously paid premiums does not include any interest.

Some financial planners will argue that if an individual instead buys a level term life insurance policy and invests the difference between what is to be paid in premiums associated with a return of premium life insurance policy compared to level term life insurance for the same death benefit and contribute those yearly differences in a Roth IRA, then the future value of the Roth IRA will far exceed the value of the lump sum payment.

Credit Term Life Insurance

Credit term is short term life insurance designed to pay off a specific debt such credit card debt or a mortgage. The beneficiary is usually the lender.

One of the key advantages of credit term life insurance policies is that most credit term life insurance policies do not require underwriting. That is, no medical exam or answering questions about one’s health in order to qualify for the credit term life insurance policy. This can make a credit term policy an appropriate choice if an individual is in poor health and cannot get any other type of life insurance coverage.

Convertible Term Life Insurance

Convertible term is an option on many individual term and group life insurance policies, including FEGLI. Convertible term coverage is so named because the policyowner has the option of converting term insurance into permanent life insurance without having to provide evidence of insurability – meaning no health exam, no questions that have to be answered about one’s health.

Convertible term insurance can be a viable choice if the policyowner prefers permanent life insurance but cannot currently afford the premiums if they were to apply for a separate permanent (cash value) life insurance policy. Conversion may be an option only during a specific window of time such as the first 10 years the term insurance is in force.

Note that once the full death benefit of a term insurance policy is converted to permanent life insurance, then the premiums will be higher. This is because permanent -cash value- insurance is more expensive than term insurance and the premiums will be based on the policy owner’s age when the term insurance policy is converted.