Term Life Insurance

There are two broad categories of life insurance contracts:  "Term" life insurance and life insurance with an investment component to it, generally referred to as "Cash Value" life insurance.  Let's start with Term life insurance.

Term life insurance has no investment component to it.  In other words, it is pure death protection without any cash value build-up within the policy.  Therefore, Term life insurance is significantly cheaper than Cash Value policies since all you are buying is the death protection rather than death protection and an investment.

Annual Renewable Term Life Insurance

Since Term life insurance is solely death protection, in pricing the policy the life insurance company will charge a smaller premium in your younger years (when the actuarial risk of death is less) and will charge correspondingly higher premiums as the insured policy holder gets older.  The best example of this is a type of Term life insurance known as "Annual Renewable" Term life insurance.  Here the premium will change every year, increasing slightly each year as the insured ages.  The policy is generally non-cancelable except for non-payment of premiums through a stated age – 65 or 70 (premiums generally become too expensive for most people’s budgets about this age).

Level Term Life Insurance

A variation on the Annual Renewable Term life insurance contract is a Term policy for which the premium is level for a 5, 10, 15 or 20-year period.  If you are trying to budget your resources as tightly as possible, you could lock in your premium outlay over that chosen period of time.  The level premium is generally guaranteed over the applicable term.  Usually these type of policies have a conversion option and the policy may be converted to a more expensive Cash Value policy at any time within the applicable term (but is not automatically renewable into another Level Term policy at the expiration of the term).

We will talk about the great variations in cost of Term life insurance under the How To Shop for the Cheapest Term Life Insurance sub-section below.  It could change the fundamental fact I am pointing out to you in this paragraph.  When you buy a Level Term policy, all things being equal, you should hang on to the policy for the full 5, 10, 15 or 20-year duration.  This is because the level premium policies are priced in a way that overcharges premium in the earlier years and undercharges it in the later years.  Remember that with Term Insurance, the inherent premium cost of the policy increases over time as the insured ages.  So if the premium is level for a 5, 10, 15 or 20-year period, the life insurance company must be accomplishing this premium structure by overcharging at the beginning and undercharging at the end of the lock-in period.

However, because of competitive pressure, the price of Term life insurance (including Level Term) has declined significantly in recent years.  With the general ease that consumers now have in shopping for life insurance policies (discussed below) and the decline in the cost of Term life insurance generally, you may not stay with the Level Term policy for its full term if you are insurable.

Group-term Life Insurance

Group-Term life insurance is another variation of Term life insurance.  It is an extremely common form of fringe benefit that many employers provide to their employees.  It is the employer who shops around not the employee.  The employer purchases one large Group-Term contract from an insurance company under which each of the employer's full-time employees get individual life insurance coverage, usually based on a percentage of salary.  The employer often pays for the entire premium cost for this type of insurance.

Although the employee is getting an employer paid life insurance benefit under this arrangement (thus providing another form of compensation to the employee), the employee usually receives the Group-Term life insurance benefit tax-free.  Only when the employee received Group-Term life insurance coverage in excess of $50,000 is there a small inclusion of additional wage income.

Example:  Mark and Joe are employees of Acme Corporation, which provides a Group-Term life insurance benefit to all of its full-time employees.  The death benefit is one times annual salary.  Mark's salary is $50,000 and Joe's is $75,000.  Therefore, Acme provides Mark with Group-Term life insurance protection in a face amount of $50,000 and provides Joe $75,000 Group-Term coverage.  The company's premium cost to purchase Mark's coverage is $200 per year and is $350 per year for Joe's.  None of the $200 of premium cost expended for Mark's benefit is included in Mark's income since the amount of Mark's Group-Term life insurance protection for the year does not exceed $50,000.  Joe will have an income inclusion for the year that will be added to his wage income and reported on his Form W‑2.  The amount of the income inclusion will be based on the $25,000 of insurance in excess of the $50,000 tax-free threshold and will further be a function of Joe's age that year.

Mortgage and Credit Life Insurance

Whenever you borrow money (for example, a mortgage loan from a Bank or a loan to purchase an automobile), the lender will almost always ask you if you desire to purchase credit life insurance.  This form of insurance is decreasing Term life insurance (the face amount of the life insurance protection decreases every year).  The purpose of the credit life insurance is to pay off your outstanding debt (which is decreasing over time as you pay it off).  This sounds like a great idea, and, indeed, lenders sell a ton of Credit life insurance.

What do I think?  Rarely, if ever, buy it.  The reason is that it is the most expensive type of Term life insurance.  If you do need additional death protection, buy more Level Premium Term or Annual Renewable Term life insurance.  You'll get a much greater amount of coverage for the money.  One instance where Credit life insurance is highly advisable is if you are otherwise uninsurable, as normal evidence of insurability may not be required.