What is term insurance? What are the different types of term insurance available? How do you choose between term insurance and permanent life insurance? Jacqueline Koh, ChFC®/S, CFP, a licensed financial practitioner and an active member of IFPAS, shares in this article.
Term insurance is a pure life insurance that guarantees payment of a stated death benefit if the insured person dies during a specified period of time. Often referred to as a temporary insurance, term insurance has an expiration date, and it does not build cash value.
The problems include the need to reapply when the term insurance expired, and this is subject to the new age of entry and more importantly subject to new health underwriting.
Five main types of term insurance
There are 5 main different types of term insurance, namely Level Term Insurance, Increasing Term Insurance, Decreasing Term Insurance, The Return Of Premiums Plan and Convertible Term Plan.
Level term insurance
Level term insurance offers a guaranteed level cash lump sum as death benefit, with level premiums fixed throughout the specified period. This is the most popular term life insurance.
Increasing term insurance
Increasing term insurance has an automatic increase on the guaranteed death benefit every year at the rate you chose. Underwriting is not required, even when you subsequently suffers health problems and become uninsurable. The premium will also increase accordingly each year. The rising death benefit can mitigate the impact of inflation.
Decreasing term insurance
Decreasing term insurance has a death benefit that declines each year to zero, according to a predetermined schedule. A good example is mortgage insurance, where the death benefit is matched to the declining home loan. You would not be able to apply more than your current mortgage. Interestingly, the premiums for decreasing term insurance may be similar to the level term insurance, where the latter would be preferred.
Return of premiums plan
Return of premiums plan will refund all your premiums if you live to the end of the term. The catch is the premiums can be much higher than a level term insurance.
Convertible term plan
Convertible term plan can cost more as the plan locks in your good health status and allow conversion within a stipulated period to a permanent life insurance. The problem is the higher premiums given the higher age at the time of conversion to a permanent life insurance. A convertible term insurance may be your best choice now, but things can change. For example, if you develop serious health issues subsequently, you may want to convert to a permanent life insurance as it would be difficult to get another policy.
Coming to terms with term insurance
In most cases, when term insurance has a specified short tenure, the term insurance can expire without paying a death benefit. This can help to lower the overall risk to the insurer, as compared to a permanent life policy. The reduced risk enables insurers to charge lower premiums.
With a positive longevity perspective, term life insurance has adopted 2 key functions of permanent life insurance: maximum term coverage to age 100 and limited pay option to build cash values.
Maximum term coverage to age 100
Since the first limitation of term insurance is the expiration date, the maximum expiration term chosen can be up to age 100.
Take note the longer your term, the higher premiums you will pay each year for a given coverage amount. The term insurance can cost as much as a permanent life insurance, if the tenure is maximised. Yet the term insurance will expire at age 100, while the permanent life insurance can continue beyond age100.
Limited pay option to build cash value
The second limitation of term insurance is it does not have cash value / surrender value. With limited pay options for present value to offset future value, the surrender value will be applicable. If you fail to pay a premium on time and your policy has enough surrender value, the insurer can grant you an automatic premium loan. This is to prevent your term insurance from ending immediately. This is the benefit of cash values for permanent life insurance.
Temporary or permanent life insurance?
How long do you want the life insurance for?
Choose your coverage term carefully to protect you and your dependents. Generally, it is easier to get insurance when you are younger and in good health. In face of uncertainty, it is better to get a longer-term policy than a shorter one. Your life insurance policy should last as long as your financial obligations and outstanding liabilities. When your coverage expires, you would need to self-insure using your own savings and assets.
Who are your beneficiaries for your life insurance?
For coverage more than $150,000, it is important to make a life insurance nomination to name your beneficiaries. Life insurance death benefits transfer to beneficiaries are tax-free.
How much life insurance do you want?
Your life insurance coverage depends on various factors, including age, health, lifestyle,and financial responsibilities. A general rule of thumb is to get 10 times of your annual income. The premium is only a small percentage of the total death benefits.
Best of both worlds
Term insurance is an effective booster to cover temporary high liabilities for a home loan or a risky business venture.
Term insurance can add a temporary financial cover for your family responsibilities; especially aged parents, young children or individuals with disabilities or special needs.
Term insurance cannot cover you beyond age 100. You may include permanent life insurance, with critical illness coverage, to protect you and your loved ones for as long as you live.
Term insurance should not be used for estate planning due to the expiration date. You can include permanent life insurance for legacy planning to ensure estate has the intended liquidity for the purpose of asset distribution and asset equalisation.
Term life insurance does complement permanent life insurance to give you the best of both worlds in protection. You need to consider the financial needs of your family, your own financial standing on the affordability and suitability of the plans.
Remember to keep a regular review with your trusted Financial Consultant.
About the author
Jacqueline Koh is a licensed financial practitioner and an active member of IFPAS. She currently holds the ChFC®/S, CFP designations.
The article “Term Life Insurance 101” by Jacqueline Koh first appeared on Tuesday Times, an online publication by IFPAS.
*** Editor’s note: As always, the content above has been prepared for informational purposes only. It does not take into account the needs of any particular person and is not intended to provide, and should not be relied on for financial or legal advice. When in doubt or in need of assistance, seek professional advice.
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