UPDATED: Mar 26, 2020
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You already know you need term life insurance. And you may have even figured out how much you need as well. That’s all you have to decide, right?
Not so fast.
The type of life insurance and the coverage amount are certainly two crucial choices to make. Congrats for making them, by the way.
But you’re not done. In fact, arguably the most important choice to make remains. And that is the policy’s term length.
In other words, how long do you need this term life coverage to last? You see, term life eventually ends. Well, technically it doesn’t end until age 95. But at the end of the term period, the price shoots up so high (think 10 – 20 times higher, or more) that most people let it expire. It’s true. I see it every day.
That’s why it’s imperative to get this part right. Because if you race past this question without much thought, you’re likely to find yourself regretting your haste ten or fifteen years from now. Go too long, and you’ll pay more than you should have. Fall short and, well, you could be left with no coverage when you need it.
Available Term Periods (Lengths)
You can buy term life insurance for term periods of 10, 15, 20, 25 or 30 years. As I mentioned earlier, most modern term life policies do not technically expire until age 95, regardless of the term period. The term period simply locks in the policy cost for that specific time.
So if you buy a 10-year term policy, your rate will not increase for ten years. However, once the term period expires in year eleven, the rate guarantee is gone, and the cost will go up significantly.
The longer the term period, the higher the cost. So 30-year is more expensive than 20-year, which is more expensive than 10-year. The reason is simple: you’re paying for a longer rate guarantee. Naturally, that is going to cost more.
Some life insurance companies offer a term period as short as one year, sometimes called Annually Renewable Term (ART). These policies can be renewed for one-year intervals, hence the name. However, these policies are not always cheaper than say, a 10-year term policy, because the life insurance company has to recover all of it’s costs right up front. Longer policies allow them to spread these costs out over many years.
How do You Figure Out How Long You’ll Need It?
It shouldn’t take an advanced math degree to solve this problem. You don’t need an abacus, compass or fancy calculator. All you need is a simple formula. Grab a pen and write down the answers to these questions:
- How many years until my youngest child is no longer dependent?
- How many years until my mortgage is paid off?
- How many years until my spouse and I retire?
- How many years until my other long-term obligations are gone?
Your answers might look something like this:
8 years, 14 years, 18 years and 10.
Use the largest number of years and select a policy for that time frame. A 20-year policy works best in this example, as it provides coverage until all – or most – of your long-term obligations are met.
Keep in mind this is a starting point and not necessarily the final answer. Your situation may justify a shorter or longer policy. For example, you may have another policy or coverage through work that could cover some of these obligations. Or you may have other needs not listed here that take you out longer than 20 years.
Layering – A Lost Art
Another option for selecting your policy’s term length is to layer multiple policies together to cover your needs. Think about it; you’re needs are likely to change gradually over time. Children grow up and move out. Mortgages eventually get paid off. Retirement – although it may not feel like it sometimes – gets closer every day. You get the idea.
Well, layering allows you to systematically reduce your life insurance coverage over time as your needs change and your ‘obligations’ start supporting themselves. It can be a very effective strategy that can save you a lot of money over the years. I’ve seen some families save 25% or more on the cost of a single policy.
What Happens if I Pick the Wrong Term Length?
If you choose a term length that is too long, you can always simply cancel the policy when you realize you no longer need it. The biggest penalty for this is you’ve likely paid more over the life of the policy then you should have. So it cost you some money. Stinks yes, but not the end of the world.
Ending up short, however, is a different story. Let’s say your 15-year term is nearing its end, and you realize you need it for another six or seven years. You know the premium is going to skyrocket in year sixteen, and you won’t be able to afford it. Here’s how it’s likely to play out:
Best Case Scenario
You’ve taken care of your health and danced a little with Lady Luck along the way. You can still qualify for coverage at a good rate. So you let the policy expire and you buy another one. It will cost more than the last, but not nearly as much as keeping that old one.
Worst Case Scenario
Time hasn’t been so good to you, or you haven’t been so good to you. Either way, you can’t qualify for a new policy now because of health issues. This is where the rubber meets the road, and you have a tough decision to make. You can keep the old policy and pay the higher rate, or go without.
But wait — there may be another way.
Conversion is Your Salvation.
I like to refer to term policy conversion as the ultimate do-over. You can think of it as a ‘Plan B.’ If you mess up and choose a term length that ends up being too short, you may be able to convert the policy to a permanent policy, even if you’re no longer the picture of good health that you were ten years ago.
With term policy conversion, you do not need to show evidence of good health. Most policies are convertible to a permanent policy from the same company with the same rating class you got on the original policy. Meaning, you could keep your preferred rate even if you’re in bad shape.
But conversion is not cheap. Permanent life policies are expensive compared to term life. And you’re older now, so that won’t help matters. But if you’re in a pinch, it may be a viable option.
Remember to consider the term length for your policy very carefully from the get-go. Discuss it with your agent. Think about all of the what-ifs. Plan now for success later.