June 22, 2020
Term life insurance is a great way for families to find an affordable way to financially protect the future in case a parent passes away. It’s relatively easy to understand compared to other life insurance options. A buyer needs only to choose a coverage amount and a policy length.
This is one of the reasons term life insurance is usually the most affordable way to buy life insurance. Because the policy has an ending point, such as 10, 20 or 30 years after purchase, the insurance company is taking on less risk and is able to offer a better price than it can for permanent life insurance policies that last indefinitely until death.
Even with the simplicity of term life insurance, it can be easy to get policy features confused with other types of life insurance. Here are the top things to know about term life.
There’s No Payout When a Term Life Insurance Policy Ends
One of the biggest questions about term life is what happens when a policy comes to its end. With term life, the policy expires (unless you renew it at a higher price) and there’s no payout. A payout only comes if the insured person passes away while the policy is in force.
But remember, this is one of the reasons why term life is more affordable than other types of life insurance.
You’ll likely have the option to renew a term life policy at the end of the “term,” but your rates will no longer be locked in. You’ll pay a higher price each year you renew after the “level term” period is over. If you’re still relatively young and healthy, you might be better off buying a new policy.
You Can’t Cash Out a Term Life Insurance Policy
Family and financial situations can change over time, including over the course of a term life insurance policy. If you find you no longer want or need the policy, there’s no way to “cash it out.” That’s because term life policies contain no cash value.
You may have heard of cash value life insurance such as whole life or universal life insurance. These policies put a portion of your premium payments into a cash value account within the policy. If you want to end a cash value policy, you can terminate the policy with the company and walk away with the cash value, minus any charge for surrendering.
Since there’s no cash value account in term life insurance, stopping payment and walking away means the policy will end without any reimbursement and you will lose the coverage.
The Life Insurance Company Has to Pay Whoever Is Named as the Beneficiary
The life insurance policy is a legal contract, and both sides (you and the insurance company) must stick to the contract. One of the obligations of the insurance company is to make the payout only to those named as a beneficiary.
This is an important point if your family or financial circumstances have changed over the years. For example, you may have originally named a first spouse as the beneficiary. If you divorced and remarried, you may want the new spouse to receive the payout.
The life insurance company is not allowed to decide on its own who should get paid, or who deserves the money. It must pay the person(s) listed. Disputing a beneficiary requires a potentially long court process and could be a losing battle. That’s why it’s essential to keep your life insurance beneficiary selection up-to-date.
It’s easy to change your beneficiary any time by filling out a form from the insurance company.
Children Shouldn’t Be Named as Beneficiaries
Speaking of beneficiaries, you don’t want to name minor children as beneficiaries. This may seem odd, since one of the main reasons that people buy life insurance is to support children if you’re no longer around.
But children can’t receive a life insurance payout directly. If minor children are listed as beneficiaries, a probate court will need to name a guardian who can oversee the money until the children reach the age of majority, which varies by state.
It’s a situation best avoided because court fees will eat into the funds, and the guardian may not know your wishes for how the money should be used.
Instead, you can form a trust that can receive the funds and use the money according to your wishes.
You Can Probably Change Your Term Life Insurance Policy Into a Permanent Policy
One of the nice features about most term life insurance policies is that you have a trap door to escape to another policy. Term life policies will generally have a “conversion” feature. This is a window of time during which you can convert to a permanent life insurance policy from the same company.
You may want to do this if your circumstances have changed. For example, you may have developed health conditions that would make new life insurance unaffordable. You could use conversion to lock in a permanent policy for the rest of your life, without answering any medical questions. The cost of your new permanent policy will be based on your health status at the time of the original purchase, not your current health status.
While conversion can be a great option for certain circumstances, there are a couple potential trouble spots:
- You won’t have a wide range of options for the permanent life policy. The insurer decides what policy you can take. For example, it might offer you one type of universal life insurance as your only conversion option.
- You won’t know what the conversion price might be when you buy the term life policy. You won’t know ahead of time what you’re going to pay if you convert down the road. And the conversion price will vary based on your age at the time of conversion and the policy that the insurer is offering at that time.
Nonetheless, even with these unknowns, term life conversion provides flexibility for an uncertain future.
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