Term life insurance has two main characteristics: the insured must die for any benefits to be paid, and the contract must expire at the end of the term. A term life insurance policy, to put it another way, guarantees to pay a death benefit to a beneficiary only if the insured dies during a certain period of time.
If the insured lives beyond the set term, the contract makes no promises to pay anything. A term life insurance contract usually has no cash value attached to it. If the insured lives to the end of the stated term, the contract terminates and the policy owner receives no cash.
When is it appropriate to sell term life insurance?
In general, life insurance is recommended when a person requires or desires to give an instant estate upon death. This urge or need is usually fueled by one or more of the following factors:
1. Providing income to dependent family members until they are able to sustain themselves when the household’s head dies.
2. Liquidating consumer or company debts, or setting up a fund that will allow remaining family members to do the same if the household’s head passes away.
3. Leaving huge sums of money to children at death for college tuition or other capital needs.
4. Providing funds for federal and state estate taxes, cremation charges, and administrative fees.
5. Using a buy-sell arrangement to provide finances for the continuation of a business.
6. Holding a company liable for the loss of a vital employee.
7. Using a salary continuation plan, assisting in the recruitment, retention, or retirement of one or more key employees, as well as financing the company’s obligations to the dependents of a deceased key employee.
8. Making capital bequests to children, grandchildren, or others without incurring the costs of probate, inheritance taxes, income taxes, federal estate taxes, transfer fees, or the generation-skipping tax.
9. Charitable bequests are funded.
10. Maintaining the privacy of financial transactions. The proceeds of life insurance payable to someone other than the deceased’s estate are not included in the probate estate and are not public record. It’s fairly uncommon for a beneficiary to be the insured’s girlfriend, illegitimate child, faithful domestic helper, or have some other form of relationship with him or her that he or she does not want publicly acknowledged.
11. Assuring surviving dependents’ near-instant access to cash. The proceeds of life insurance are usually given to beneficiaries within days of the claim being filed. There is no delay, as there can be with other sorts of assets, due to state or other governmental interference due to the resolution of tax concerns or claims by the decedent’s creditors.
12. Transferring family assets to family members in such a way that state, local, and federal taxes are minimised.
Term life insurance is not the most cost-effective option for all of these death benefit requirements. Term insurance, on the other hand, may meet the demands of the insured in a variety of situations. Because term insurance is a collection of products rather than a single product, several forms of term insurance are recommended for different types of needs.
Keep in mind that term insurance, more than any other type of insurance, is primarily designed to provide death protection with little or no additional or lifetime benefits. As a result, regardless of the individual use, the two most important factors to consider while using term insurance are:
- Will death protection be sufficient?
- Will the coverage be adequate for the duration of the need?
In short, when it comes to term insurance, like with any other sort of coverage, the product must meet the problem.
Who are the most potential candidates for term life?
1. When life insurance is only needed temporarily – For example, if a parent has enough income to pay for college expenses on a pay-as-you-go basis and enough life insurance for other purposes, the parent might use term insurance to ensure payment of a child’s college education expenses in the event of the parent’s death during the child’s college years. A five-year nonrenewable term policy might be the most cost-effective option for this type of necessity. In the event of the breadwinner’s death, decreasing term plans are frequently used to pay down the mortgage on the family’s primary residence.
2. When the demand is long-term but cash flow is insufficient to get the required coverage using higher premium ordinary whole life insurance – Parents in younger families frequently have major long-term support obligations for their young children and spouses, have committed expenses that are already straining the family’s budget, and thus cannot afford the premiums required to buy the amount of coverage needed to protect their families using ordinary whole life insurance.
Term insurance, especially when purchased at a young age, provides the most coverage for the least amount of money. One-year or five-year renewable and convertible term insurance is often advised in these situations. It is generally desirable to convert to regular whole life insurance once the family breadwinner enters his or her better earning years and can afford the increased premium outlay. There will be a one-time premium increase upon conversion. However, premiums will remain constant from then on.
3. When the policyholder has better investment options outside the insurance policy than inside the policy – If the policyholder has investment options that will pay a higher tax-free or after-tax yield while maintaining the same level of safety as the insurance policy, it may be better to buy renewable term insurance and invest the early years’ premium savings outside the insurance contract. They should not, however, make this “buy-term-and-invest-the-difference” decision only on prospective yield differences within and outside the policy. Many features not available on an outside investment may be provided on a cash value policy, including: (a) creditor protection; (b) a minimum rate guarantee; (c) premium waiver in the case of disability; (d) loan provisions; and (e) a variety of flexible nonforfeiture and settlement options.
4. To ensure a savings account – Many parents start putting money down for their children’s college educations long before they enter college. A diminishing term policy is typically the best way to ensure that the essential savings fund is available if the parent passes away before the funding is completed. Term insurance can be used to ensure a sufficient savings reserve in a variety of other situations.
5. In the event of death, for liquidity – One of the most common uses of life insurance is to provide estate liquidity as well as to pay estate and inheritance taxes. Term insurance applications for estate planning and estate liquidity are very limited due to the average ages involved.
However, temporarily special or extenuating circumstances not directly related to the payment of death taxes may necessitate the need for cash. A good example is new business starts. Until the business reaches a critical break-even point or achieves minimum profitability, the higher premiums of cash value insurance are prohibitive due to the cash flow requirements of launching a new family business.
Similarly, a successful small business owner is not uncommon to invest practically all of his or her assets in the company. When a company expands and embarks on capital improvement projects, such as building a new warehouse or plant, or embarks on new projects, such as developing and selling a new product line, the general lack of liquidity becomes much more acute. If the business owner passes away while the expansion project is underway, not only will the expansion project be jeopardised, but the entire business as well.
Although liquidity in the case of death will always be an issue (which may be best addressed with a whole life policy), a term policy is frequently the greatest method to mitigate the temporarily extra liquidity risk during these expansion times. A similar argument may be applied in the event of a liquidity crunch. An executive who has received significant restricted stock bonuses from his or her company, an investor who has committed a significant portion of his or her portfolio to a temporarily illiquid position, and a real estate developer who is subdividing and developing a large tract of land are all examples.
6. For business purposes – In many cases, term insurance is the most appropriate type of insurance for business purposes. When the ages of the business owners are different, one issue with funding buy-sell agreements with a cross-purchase arrangement is the comparatively high premium cost that the younger business owner must pay for coverage on the elder owner. Term insurance, or a combination of term insurance and regular life insurance, may initially be a more cheap option.
Similarly, when insuring key personnel, term insurance may be the most cost-effective option. Especially, if these individuals are working on unique initiatives where their expertise is vital to the accomplishment of the task or project.
7. When insureds want more death benefits in addition to other permanent forms of life insurance or packages of policies – Insurers frequently combine level, increasing, or decreasing term riders with permanent forms of life insurance to create a combination of death and living benefits that fits a person’s specific needs and resources. When a person cannot afford the premiums required to completely insure using whole life insurance alone, they can utilise a participating whole life policy combined with a decreasing term rider. The package can be designed so that the policy holder utilises dividends from the whole life to purchase paid-up additions to replace term insurance when the face amount of the term insurance decreases over time.
Another example is family policy. The typical family package policy includes some level of ordinary whole life insurance for the primary earner. The half of that amount in term insurance for the spouse, and around half of that amount in term insurance for each of the children. The insurance firm saves money by covering multiple people under one policy rather than issuing individual policies for each person. The savings aid in lowering the family’s overall insurance costs.
8. To ensure coverage if you lose your job or lose your employer-provided coverage — Renewable and convertible term insurance is a low-cost way to address the possibility of continued coverage in the case of unemployment or the termination of employer-provided coverage.
What are the benefits of term life insurance?
1. When a person originally purchases a term insurance, it lets him obtain the highest death benefit for the least amount of money spent on premiums. However, this does not necessarily imply that term insurance is the most cost-effective kind of coverage for the need of the entire period of coverage. Because term premiums rise with each renewal. The premium cost at later ages will be significantly more than the level premium offered for a regular whole life policy. The policy is written at the equal age limit as the original term policy.
2. If you only need life insurance for a short period of time, term insurance is the ideal option. Likewise, If you only need protection for a few years, term insurance is usually the best option. If one needs the protection for 15 or more years, however, some sort of cash value life insurance is usually the best option. Similarly, If one needs the protection between 10 and 15 years, the optimum option is determined by the facts and circumstances of the case. If the length of the need for protection is between 10 and 15 years, term insurance will generally be better than cash value insurance at issue ages below 45, and worse at older issue ages.
3. Younger people can obtain high face amounts of coverage for a low initial cost, potentially more than they require. It ensures them to have the coverage they require when their needs and family commitments grow in the future, even if they are uninsurable.
4. The conversion feature of renewable and convertible term insurance allows policy holders to obtain bigger death benefits than they could otherwise afford, as well as the flexibility to lock in payments and accumulate cash values as their ability to pay rises.
5. Level, declining, and growing term insurance can be paired as riders with other types of permanent insurance. It is to build a package that suits a person’s specific death protection, savings, and cost goals.
6. Unless the estate is named as the beneficiary of a life insurance policy, the proceeds are not part of the probate estate. As a result, the proceeds can be delivered to the beneficiary without delay due to estate administration.
7. The death benefit amount or to whom the death benefit is payable (if paid to someone other than the deceased’s estate) are not in public records.
8. The proceeds of a death benefit are normally exempt from federal income taxes.
9. The proceeds of a death benefit are frequently free from state inheritance taxes.
10. Personal loans can be secured with life insurance policies as collateral. Term plans are often sufficient if the borrower has a good credit risk. And the loan he takes is quite likely to be repaid unless he or she dies.
What are the drawbacks of term life insurance?
1. Term insurance does not offer the same tax-free, automatic savings as permanent coverage.
2. Premiums rise until they become unaffordable at a later age. One of the most compelling reasons to purchase whole life insurance is that coverage is useless, if it cannot be held until the time comes when it is most required.
3. Term insurance often has a low loan value and little or no living benefits.
4. Term insurance only covers the insured for the duration of the contract, not for the rest of their lives. In other words, term insurance may run out before the need arises. At a later age, when the necessity for insurance still exists, a person may become uninsurable.
5. Life insurance, in general, is not available to people who are in poor health. Persons in relatively poor health, on the other hand, can often receive insurance at substandard rates (a reference to the insured person’s health rather than the insurance company’s quality or strength). It is resulting in higher premiums. For people who fall into the subpar rating groups, it is easier to get regular whole life insurance than term insurance.
Are there any fees or other acquisition costs?
In most cases, life insurance is sold at a set price. The life insurance companies determine premiums according to their own marketing tactics and classifications. The insurance company’s rate includes a loading (a specified part of each premium payment). Loading will typically cover the following items: (1) commission payments to agents; (2) premium taxes payable to the state government; (3)Charges associated with running an insurance company, such as rent or mortgage payments and salaries; (4) federal income taxes; and (5) other relevant expenses, such as claims handling and policy change services.
The majority of an insurance company’s costs are incurred when the policy is issued. An insurance company’s front-end costs may take five to nine years, or even longer, to recover. The state premium tax, which is levied on all life insurance premium payments, is a recurring cost. This tax amounts to around 2% of each premium payment on average.
On term insurance policies, the total commission paid to the selling agent is typically lower than on cash value policies. There are two reasons for this. For starters, term insurance policies have cheaper initial premiums than permanent life insurance policies. As a result, even if the commission rates were the same, the total amount paid would be less. Second, commission rates on term policies are often lower than commission rates on permanent policies. While the total commission on a permanent policy is typically equal to about one year’s premium, with about 55 percent to 80 percent paid in the first year, commission rates on term insurance policies are typically around 40% to 60% of the first year’s premium, with about 5 to 8% of each subsequent premium.
Several life insurance providers offer no-load life insurance policies. That is, they do not pay the selling agent a commission. These companies’ rates, on the other hand, are often comparable to those charged by companies that pay commissions to agents. Although these no-load policies have no commission charges. These businesses appear to spend about the same amount of money on direct mail and other marketing. They do this to sell their policies as other companies do in commissions to agents to advertise their products.