Term Life Insurance Pros and Cons
Term life insurance is designed for temporary coverage without any of the bells and whistles that come with permanent policies. This is a benefit and disadvantage simultaneously, depending on your financial objectives. The main pro of term life is that you're buying pure life coverage without incurring additional charges for potentially unnecessary features involving savings and investment. As a result, premiums you're getting maximum death benefit at minimum up front cost. The main con of term life is that you're getting time-limited coverage with climbing premiums that can ultimately leave you uninsured.
Term Life Pros
In situations where an individual needs life insurance for a definite span of time, term life's limited coverage is ideal. In most cases the point of life insurance is to protect against the risk of losing the income stream of a household provider in the event of premature death, leaving the family in a precarious position. In many situations this risk exists for a limited time.
Consider a traditional young couple just starting a family. The father works to provide income and pay the bills while the mother takes care of the child and performs household duties. A young family such as this isn't likely to have large sums of cash in reserve. If the income provider died, the mother and child would be left in great financial risk. Similarly, if the mother died, the father would be left with the cost of providing childcare. In this case, both parents are good candidates for term life insurance.
Permanent life insurance might not be necessary because as the family matures, the child grows up and becomes self-sufficient and the parents retire. At retirement, income from work drops to zero and the family depends on their retirement savings to carry them through. At this point there is no longer a risk of losing income. In fact, should one parent die, the other will be well-supported by a retirement savings originally planned for two.
In the above scenario the couple is better offer purchasing a 20-30 year term life policy to hold them over until retirement, when the risk of income loss and child-care expenses disappears. If the couple can accurately gage the length of coverage, they will save a lot of money over buying a permanent whole life policy.
Biggest Bang for Your Buck
All forms of life insurance include a mortality charge that pays for pure coverage — the death benefit. This benefit is paid for by statistically determined mortality charges regardless of whether you're buying a term, whole, universal, or variable policy. Individuals just looking for maximum death benefit with least investment are better off with term life because permanent policies include charges for additional features, which are not desired in this case.
Arguably, one can opt for pure death benefit coverage by buying a term policy and investing funds on the side in a separate savings account rather than pay the fees associated with whole, universal, or variable life insurance. Whether this strategy wins-out depends on many factors, including stock market and interest rate performance, the willingness to micro-manage a savings portfolio, and pure luck.
Low Up-front Cost
Term life insurance premiums correlate directly with mortality charges, which in turn correlate directly to the policyholder's statistical likelihood of death. In non-level life insurance policies, where premiums increase every year in accordance with increasing morality charges, young individuals can secure much lower premiums if they're just looking for temporarily coverage. Permanent life insurance such as whole, universal, and variable try to level out premiums, which necessarily means higher up front costs to reduce what would have been exorbitant premiums pass age 60 under non-level term life.
Term Life Cons
The greatest problem with term life insurance — and any temporary form of life insurance for that matter — is that policyowners have a hard time determining how long they need it for. It's hard to predict your future 20-30 years ahead, which results in a scenario where you may think 20 years of term life will suffice, only to learn that you need additional years of coverage.
Non-guaranteed term life policies expire and leave no assurance of one's insurability or premium costs. Consider the case of John, a 30-year-old man who buys a 30 year non-guaranteed term life insurance policy to protect his wife and two children. John expects his children to be self-sufficient by the time he's 60 and for his retirement savings to kick in. But he has a third child in his 40's who needs college tuition and the market is in a downturn just as John retires.
In this case John delays retirement and is forced to purchase additional life insurance to protect his family. But, at 60 years old, John has health problems and doesn't pass the medical exam, or passes, but gets downgraded and his premiums skyrocket. Clearly John was burned by limited coverage.
Non-level term life insurance comes with rising premiums. Each year, as the policyowner ages and his or her risk of death rises, premiums increase. For young policy owners this isn't a problem, but eventually non-level term premiums can escalate out of control, leaving you up against a brick wall of fees.
Rising mortality charges exist in all life insurance, regardless of type, but if you're looking for coverage into retirement, a permanent life policy can counteract the effect by guaranteeing consistent premiums. This is done by averaging premiums costs until the age of 95 or 100, in effect having the policyowner pay larger premiums in the early years to reduce premiums in the later ones.
A well-planned non-level insurance policy is theoretically identically to a level one in terms of overall cost, but it's hard to plan that far ahead with any accuracy. If you want a life-long coverage or the peace-of-mind of guaranteed premiums, term life insurance is not the right tool.
No Capital Build-up
Many people like the convenience of growing wealth along side their life insurance. The very idea of paying 30 years of premiums just to outlive the policy and see it expire seems like a waste. But in all likelihood this is exactly what happens with most term life insurance; only 1-2% of term policies ever payout because their policyowners always out live the contract. In short, term life doesn't accumulate capital.
Alternatively, permanent life, like whole, universal, or variable insurance, uses premiums to fund cash value savings accounts. Regardless of circumstance, permanent life payments won't go to waste — the death benefit gets paid out at the time of death along with the accumulate cash value plus interest. Moreover, you can dip into the funds, giving the policy use while you're still alive.
Term life insurance contracts offer virtually no leeway. The term of coverage and death benefit amount are set in stone. There is no option to increase premiums should you later decide to do so, perhaps necessitated by unforeseen events. Throughout your career, your income will rise and fall many times along with your family's cost and standard of living. Trying to predict these changes is more miss than hit.
Alternatively, permanent life products like universal life enable policyowners to adjust premiums and death benefit to their changing lifestyles. And although this flexibility comes at a premium, often times it's worth it.
Paying Mortality Charges with After-Tax Dollars
Every dollar spent on term life insurance is first taxed by the IRS. On the other hand, permanent life policies allow you to pay mortality charges out of their saving components or asset portfolios, which grow tax-free. Over spans of 20-30 years, the savings of paying mortality charges with pre-tax dollars adds up, giving permanent life policies a distinct edge over term insurance.
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