As a fee-only financial advisor, I advocate for financial strategies that put your long-term wealth and security first without the burden of extra fees. When I got my first “career job” I bought a whole life insurance policy and read the book Bank On Yourself. I talked to a few insurance brokers, and they all recommended a whole life policy where I could build cash and access it in the future tax free. It sounded like a no-brainer. When I joined Tony in 2015, we started talking about the purpose of life insurance and what I was trying to achieve. I quickly realized there were better places to put my money like maxing out my 401(k), funding a Roth IRA or Backdoor Roth IRA, etc. This isn’t to say Whole Life and Universal Life are never appropriate, but I do believe they are far less appropriate than the frequency with which they are sold.
Depending on your family’s situation, term life insurance may be one of the most effective tools to protect your family’s financial future. Unlike whole life or universal life insurance which often come with high costs and complex structures, term life insurance is straightforward and affordable and may be a better fit for your family. This guide is meant to be comprehensive and answer questions you may not have thought of yet. We’ll explore the benefits of term life insurance, how much coverage you need and when to buy so your loved ones are protected.
What is Term Life Insurance and Why Does It Matter?
Term life insurance is a policy that provides coverage for a specific period, usually 10, 20 or 30 years. If the policyholder dies during the term the insurer pays a death benefit to the beneficiaries. This type of insurance is designed to provide financial security during critical life stages, such as when you have young children, a mortgage or other big financial obligations.
Why term life insurance?
- Cost Effective: Term life insurance is much cheaper than whole life or universal life insurance so you can get a lot of coverage without breaking the bank.
- Simple: Policies are straightforward with no investment components or hidden fees, unlike whole or universal life insurance which often have high commissions and administrative costs.
- Options: Choose a term that matches your financial obligations, like your mortgage or until your kids are self-sufficient.
- Security: Term life insurance protects your loved ones from financial stress.
While term life insurance allows you to avoid the high fees and low returns of whole or universal life policies, remember that any insurance product is only suitable for you and your family if you do a thoughtful assessment of your goals and obligations.
Term Life Insurance Benefits
- Affordable for High Coverage
Term life insurance gives you large death benefits at a fraction of the cost of permanent policies. For example, a healthy 35-year-old can get a $500,000, 20-year term policy for $20-$40 a month compared to hundreds of dollars for a similar whole life policy. This affordability means you can put more of your money towards savings, investments or other financial goals.
- Customized to Your Needs
Term lengths can be tailored to your financial obligations. For instance, a 20-year term might cover the years until your kids are grown, while a 30-year term could cover your mortgage. This way you’re not paying for coverage you don’t need.
- No Unnecessary Investment Components
Unlike whole or universal life insurance which bundles insurance with investment accounts, term life insurance is pure protection. Whole life policies have high fees and low returns compared to dedicated investment vehicles like index funds. By choosing term life and investing the premium savings elsewhere you can build wealth more efficiently.
- Tax-Free Death Benefit
The death benefit from a term life insurance policy is generally paid to beneficiaries tax-free, to cover expenses like funeral costs, debts or living expenses.
- Convertible Options
Many term policies offer the option to convert to a permanent policy later without a medical exam, so you have flexibility if your needs change.
How Much Term Life Insurance Do You Need?
This is a tricky question and the answers are nuanced. Determining the right amount of coverage depends on your financial situation, goals and obligations. As a fee-only advisor I recommend a practical approach to make sure your family’s needs are met without overpaying for coverage you don’t need. Here’s how to calculate your needs:
- Replace Your Income
A common rule of thumb is to buy coverage equal to 10-15 times your annual income. For example, if you earn $75,000 per year, aim for $750,000 to $1,125,000 in coverage. This will ensure your family can maintain their standard of living for several years.
- Cover Major Debts
Include enough coverage to pay off significant debts, such as a mortgage, student loans or credit card balances. For instance, if you have a $300,000 mortgage, factor that into your coverage amount.
- Account for Future Expenses
Consider costs like college tuition for your kids or ongoing living expenses. A family with young children may need coverage to support them until they’re financially independent, typically age 22-25.
- Factor in Final Expenses
Funeral and burial costs can range from $7,000 to $12,000. Make sure your policy includes enough to cover these expenses.
- Consider Your Partner’s Needs
If your spouse relies on your income, factor in their financial needs, especially if they don’t work or earn significantly less.
Example Calculation:
A 40-year-old with a $100,000 annual income, a $250,000 mortgage, two young children and $10,000 in potential final expenses might need:
- Income replacement: $100,000 x 10 = $1,000,000
- Mortgage: $250,000
- Final expenses: $10,000
- Total coverage needed: Approximately $1,260,000
A 20-year term policy for $1.25 million could be plenty of coverage at an affordable premium.
When Should You Buy Term Life Insurance?
Timing is everything when buying term life insurance. The sooner you buy, the better, as premiums are lower when you’re younger and healthier. Here’s when to consider buying or reviewing your coverage:
- When You Start a Family
Having a child is a trigger to buy term life insurance. A policy will ensure your children are financially supported if you pass away unexpectedly. A 20- or 30-year term can cover the years until your children are independent.
- When You Take on Major Debt
Buying a home or taking out significant loans (e.g., student loans or business loans) is another reason to buy coverage. A term policy will ensure your debts are paid off so your family doesn’t inherit financial burdens.
- When You Get Married
If your spouse relies on your income, term life insurance can be a safety net. Even if both spouses work, coverage can help maintain financial stability during a tough time.
- When You Change Jobs or Start a Business
A new job or entrepreneurial venture often brings financial changes. Make sure your coverage reflects your current income and obligations.
- Before Health Issues Arise
Premiums are based on age and health. Lock in a policy while you’re young and healthy to save thousands over the policy’s term. If you develop health issues later, you may face higher premiums or be denied coverage.
Pro Tip: Review your policy every 3-5 years or after major life events (e.g., having another child, paying off a mortgage) to ensure your coverage still matches your needs.
Why Avoid Whole Life and Universal Life Insurance?
As a fee-only advisor, I may shy away from whole life and universal life insurance due to their high costs and complexity. Here’s why:
- High Fees: Whole and universal life policies often include commissions, administrative fees and investment management costs that eat into returns. These fees can consume a big chunk of your premiums.
- Poor Investment Returns: The investment component of permanent policies usually yields lower returns than a diversified portfolio of index funds or ETFs.
- Inflexibility: Permanent policies lock you into long-term commitments, making it harder to adjust coverage as your needs change.
- Complexity: The combination of insurance and investment features can be confusing, leading to bad financial decisions.
Instead, many families can benefit from the adage “buy term and invest the rest.” This strategy opts for term life insurance and invest the premium savings in low-cost, diversified investments.
How to Choose the Right Term Life Insurance Policy
- Get Quotes
Compare rates from multiple insurers, as premiums can vary significantly. Online tools or working with an independent, fee-only advisor can make the process easier.
- Choose the Right Term
Pick a term that matches your financial obligations. A 20-year term is often good for young families, a 30-year term for those with longer-term debt like a mortgage. You can also stack coverage of different terms so some coverage falls off when debt falls off or when kids graduate from college.
- Get Enough Coverage
Use the calculation above to determine your coverage needs. Don’t underinsure, as that could leave your family exposed.
- Check the Insurer’s Rating
Look for insurers with high ratings from A.M. Best or Standard & Poor’s so they can pay claims.
- Add Riders
Add-ons like a disability waiver of premium or accelerated death benefit can enhance your policy without much cost.
Protect Your Family with Term Life Insurance
Term life insurance is a fundamental part of smart financial planning, offering affordable, flexible protection for your loved ones. If you choose term versus whole or universal life insurance, you may avoid unnecessary fees and complexity, so you can focus on building wealth through smart investments. Calculate your coverage needs based on your income, debt and future expenses and buy a policy as soon as you have dependents or significant financial obligations. The sooner you act, the cheaper and more effective your coverage will be.
Never forget, the goal of life insurance is to be a bridge that allows you time to accumulate enough funds via your various investment plans (i.e., 401(k)s, Roth IRA, investments accounts, etc.) that you are can replace it with actual dollars. Thus, you’ve reached the ultimate goal of being self-insured.
Ready to get started? Get quotes from multiple providers or consult a fee-only financial advisor—like MN Wealth Advisors—to ensure your policy aligns with your financial goals.