Term insurance is basic life insurance. It is the easiest type of policy to understand. A life insurance company will charge a dollar amount, known as the premium, to provide the beneficiary with a tax-free cash benefit if the insured dies in that year. A beneficiary might be a spouse, children, or anyone else the owner wants. If the insured does not die in that year, no cash benefit is paid. The premium paid to the insurance company was the cost of the death benefit protection for that year. The owner does not get the premium back if the insured does not die.
In order for the insurance company to agree to pay a death benefit to a beneficiary, the company will want to make sure that the insured does not have any health problems that will increase the odds that they would have to pay the death benefit. Therefore, the insurance company will probably ask insured to be examined by a doctor. This process of deciding whether the insurance company will issue a policy is known as underwriting.
Let us assume that you want a $1,000 death benefit. If you are 25 years old, the term cost is very low, but when you are age 100, the annual premium will be the same as the death benefit, $1,000. The following chart may help you get an idea of the cost of term insurance.
For example, your husband is a 25-year-old male. You have a child and you want her to have $100,000 to go to college if your husband dies. Let’s also assume that your child is now 2 years old. It may make sense to buy a $100,000 20-year term policy, because at 22, your child may be out of, or close to finishing college.
Often, the owner can renew these longer term policies, but the new premium will be higher if the policy is kept longer than the stated number of years.
If you know you have a lifetime need for insurance, it makes sense to look at a permanent policy as soon as possible. However, if you need a policy now, but you do not have a lot of money to pay premiums, a convertible-term policy may work for you. In a few years, if your income is higher, you will be able to afford a permanent policy and you can convert the term policy to a permanent policy.
Cash Value - The amount of total premiums paid for a policy minus the costs for insurance in whole-, universal-,and variable universal-life policies. The cash value grows tax-free in an insurance policy.
Death Benefit - The total cash payment made to the beneficiary upon the death of the insured.
Insured - The person on whose life the insurance has been purchased. If the insured dies, a death benefit will be paid to the named beneficiary.
Owner - The person or entity who owns the insurance policy. The owner may or may not be the insured. The owner can designate the beneficiary, and is responsible for paying premiums. See Life Insurance: The Impact of Ownership, Virginia Cooperative Extension publication 354-142, for more information on the impact of ownership.
Premium - The amount billed to the owner of an insurance policy (usually monthly, quarterly, or annually) by the insurance company. In term and whole-life the full premium must be paid to keep the insurance. In universal- and variable universal-life, the amount billed may or may not be a mandatory payment to keep the insurance.
Baldwin, B.G. (2002). The new life insurance investment advisor, second edition. New York: McGraw Hill.
Disclaimer: Insurance examples used in the publication are for illustrative purposes only. The premiums may not be estimates of an actual policy. Consult your insurance agent for actual insurance illustrations.
Virginia Cooperative Extension materials are available for public use, reprint, or citation without further permission, provided the use includes credit to the author and to Virginia Cooperative Extension, Virginia Tech, and Virginia State University.
Issued in furtherance of Cooperative Extension work, Virginia Polytechnic Institute and State University, Virginia State University, and the U.S. Department of Agriculture cooperating. Edwin J. Jones, Director, Virginia Cooperative Extension, Virginia Tech, Blacksburg; M. Ray McKinnie, Administrator, 1890 Extension Program, Virginia State University, Petersburg.
May 1, 2009