Term life insurance: what it is and how it works
Term life insurance could pay out a lump sum if you die within the term of your policy. This guide can help you learn about term life cover – including how it works, who it can be most suitable for, and how to take out a policy.
When take-out life insurance, you’re usually doing so to make sure your family could pay for all the things they need to if you die. In many cases, the things they need to pay eventually reduce or completely go away.
Your need for life insurance may not last forever – because life changes. Partners get older, children grow up, debts can get paid off. The money that would be needed if you died today is probably different to what would be needed if you died in 20 years’ time. If you died in 40 years’ time, perhaps no money would be needed at all.
This is why you can choose term life insurance. It’s a kind of life insurance cover designed to protect you for the time that you need protection, so you’re not paying for life insurance any longer than you need to. When you take out a term life policy, you choose how long you’ll be insured for (the policy term) – and if you die during the term, your policy can pay out a lump sum. If you don’t die during that time, your policy ends when the policy term expires, and you’re no longer insured.
Having a term policy can make the cover very affordable. It can be cheaper than the kind of life insurance that covers you for your whole life, for example. It can be a good way of protecting only the period of time you need – and it can also a good way of protecting yourself according to what happens to your needs over time. This is because you can either buy level term life cover or decreasing term life cover.
Decreasing term life insurance
Term life cover is designed to pay out a lump sum if you die during your policy term. If you buy decreasing cover, the amount paid out decreases over time. So, if you die in 5 years’ time, the payout would be higher than if you died in 20 years’ time, for example.
Decreasing term life cover can be suitable for you if your needs decrease over time, and eventually go away. In other words, if the money you’d need in 20 years’ time is less than what you’d need in 5 years’ time. This may often be the case if you have an outstanding mortgage, or if you have children who’ll eventually become financially independent.
Decreasing term life cover:
- Designed to pay out a lump sum if you die
- Covers you for a fixed policy term (e.g. 10, 20 or 30 years)
- The lump sum amount decreases over time
- Often cheaper than level term insurance
Level term life insurance
Term life is designed to pay out a lump sum if you die during your policy term. If you buy level cover, the amount paid out stays the same over time. So, if you die in 5 years’ time, the payout would be the same as if you died in 20 years’ time, for example.
Level term life cover can be suitable for you if your need for life insurance may potentially stay the same over time, but could eventually go away. In other words, if the money you’d need in 20 years’ time could be the same as what you’d need in 5 years’ time – but you only want or need to protect your family for a set period of time.
Level term life cover:
- Is designed to pay out a lump sum if you die
- Covers you for a fixed policy term (e.g. 10, 20 or 30 years)
- The lump sum amount paid out always stays the same
- Usually more expensive than decreasing term insurance, but cheaper than whole-of-life cover
Who is term life insurance suitable for?
Term life insurance can be appropriate for anyone whose need for life insurance could eventually go away.
Most people buy life insurance because they have financial commitments or dependents – but if those commitments reduce or dissipate over time, and those dependent may eventually become independent, your need for life insurance could end at some point in the future. With term life insurance, you can time it so your cover ends at the same as your financial liabilities do.
Term life insurance is often designed to cater these scenarios. It can be a way of making sure you don’t pay for life insurance any longer than you need to.
Here are some examples:
Reason for buying life insurance
How term life cover meets this need
Help make sure your loved ones could pay off your debts – e.g. a mortgage
If you die after your debts are paid off, you may no longer need life insurance to cover them. With term life insurance, you can time it so that your policy ends in line with your debts being paid off, so you’re not paying for life insurance for any longer than you need to.
Example: If your remaining mortgage term is 25 years, you could buy term life insurance to cover you for 25 years.
Help make sure your children would be provided for without you and your income
Children usually are financially dependent on their parents, but tend to become independent as they complete education and start earning their own money. Whether you’re a single parent or you’re parenting with a partner, there’s likely to be a financial shortfall in your household if you die while your children are still dependent on you. Term life insurance can help protect your children’s financial future for the time that they’re dependent on you (and beyond, if you prefer).
Example: You could buy term life insurance to help make sure your children would be covered financially until they reach age 21. If your youngest child is 1, you may need life insurance with a term of at least 20 years.
