Financial Planning 101: When is Term Insurance the Right Choice?

Over time, insurance companies have altered their products so that now there are numerous plan options and an all-time high level of complexity. Combined with a lack of consumer familiarity with insurance jargon and contract language, making a purchasing mistake has, ironically, never been easier. Priority, however, should always be placed on selecting the correct product with the appropriate characteristics to best match each individual’s need. This short piece will focus on term insurance, perhaps the easiest form of life insurance in many situations.

Before diving into the details, it’s best to simply determine the actual need for life insurance. Among other factors, a need could exist when:

  • Dependents rely on the income stream generated by one individual
  • Outstanding debt that needs sufficient funds to pay off
  • Future expenses (like college tuition) are largely unfunded
  • The proposed insured is a part or sole owner of a business
  • Estate taxes are a concern and there is limited liquidity
  • You have multiple financial obligations

Term insurance is the simplest and most cost-effective form of life insurance. As the name implies, term insurance lasts for a set number of years before coverage ends. Generally, a term policy is offered in increments of five-to-ten years, but annual and even twenty- and thirty-year policies are available. The death benefit is paid to the designated beneficiary tax-free and in a lump sum (as is the case with all life policies). Term does not build a cash value as do other permanent life insurance policies (i.e., universal, variable, whole, etc.). Among other explanations, these reasons explain why term premiums are significantly lower for the same death benefit when compared to permanent life insurance.

Term could be an ideal option for clients who may just be starting their careers and have little room for large premiums in their budget. A temporary need (i.e., a mortgage lasting a set number of years) may also be perfectly covered by term insurance. Generally speaking, temporary needs relate to debt payments and non-permanent financial obligations. For instance, a client may want to purchase term insurance for the period of time until their children have completed college or no longer are financially dependent. The amount of years remaining on a mortgage or line of credit may also serve a temporary need for clients to insure through a term contract.

Disadvantages, however, should also be considered when deciding whether term is the most suitable form of life insurance for you. Since term insurance does not provide opportunity for a cash value build-up, there is no forced savings component within the policy. Another item to consider is whether a policy owner plans to hold insurance past the original term period. If this is the case, annual premiums will increase significantly once the initial term ends or the policy owner may no longer be eligible for coverage (due to health issues). For these two reasons, term is rarely if ever recommended for estate planning purposes.

The Wealth Advisor team is more than happy to address your questions regarding your specific circumstance and discuss your risk management portfolio. We offer insurance solutions through several independent insurance broker-dealers and no employee ever receives commissions for any insurance products.