What is term life insurance?
Term life insurance is a type of life insurance that runs for a specific amount of time, for example, 10, 20, or 40 years. If you pass away during this time frame, your loved ones will get a cash lump sum from your insurer. You set how long you want the coverage to last, and that affects your premiums.
So for example with a 40-year term, if you die within the 40 years of the policy, your loved ones will receive a cash lump sum from your insurer.
There are several different types of term life insurance, including level, decreasing and increasing, which can cover a range of years or a fixed loan such as a mortgage.
Many companies offer this kind of insurance, each with different policies and you should research the different types of life insurance to find one that suits your needs.
When choosing term life insurance, it's important to think about your family's needs and your long-term plans, so that you can make sure you're getting the right coverage for your loved ones if something unexpected happens.
We'll break down how term life insurance and assurance works, looking at their costs and benefits compared to whole-of-life policies.
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What are the types of term life insurance?
Term life insurance comes in three main types:
Level term insurance
With level term insurance, the payout your loved ones receives remains level throughout the term of the policy. If you pass away during the term of the policy, no matter what year that may be, your loved ones will receive the same payout from your insurer.
For example, you might take out a level term policy for a £100,000 payout over a 40-year term. Whether you die in year one or year 39, your family will receive that £100,000 payout.
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Increasing term insurance
With increasing term insurance, the size of the payout increases as the term of your policy continues. In other words, the later into the term that you pass away, the bigger the payout your family will receive.
The idea here is to combat inflation: as the cost of goods becomes more expensive, each pound in cover that you have needs to stretch that little bit further. But with increasing term insurance, you know that the cover your loved ones are entitled to will increase too.
You can set the cover to increase by a set amount each year or by the retail prices index (RPI) measure of inflation. But because you have the guarantee that your payout will increase over the term, your premiums will increase as your cover rises.
So, how does it work? If you have a £100,000 policy which increases by 3% annually, the next year that cover level will increase to £103,000. The graph below shows what your cover might increase to over a 25-year term with increasing term insurance.
Decreasing term insurance
As the name suggests, the payout your family would receive with decreasing term insurance gets smaller over the term of the policy.
This tends to be a popular option with those who have a large debt to pay off, such as a mortgage, as the payout falls in line with the money needed to clear the outstanding loan. Read our guide on mortgage protection life insurance for more information.
For example, if you took out a £100,000 decreasing term insurance policy over a 40-year term, and you passed away after 20 years, your loved ones would likely receive around £50,000.
Because the payout falls over time, this tends to work out as the cheapest of the three main forms of term insurance.
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Which is better: term or whole-of-life insurance?
Whole-of-life insurance pays out whenever you die, provided that you continue to pay premiums (at least until you reach 90).
That could mean that the payout is less than the total you have paid the insurer. Term insurance only pays out during the term of the policy and is cheaper. Each individual needs to decide which best suits their needs.
Do you get your money back at the end of term life insurance?
If you live to the end of a term life insurance policy, you get no money back.
Who does term life insurance suit?
Having some form of life insurance in place is really important if you have people who are financially dependent on you, such as children or a partner with whom you own a property, who would be left worse off if you passed away.
If you are the main breadwinner of the family, would your loved ones be able to meet your monthly mortgage repayment pay the mortgage and the other household bills without your income?
Life insurance isn't just for those who are working and earning an income, though. If you are a stay-at-home parent, the family could be worse off if you passed away, as they would need to arrange childcare, for example. Both parents need to be insured.
With term insurance, you are only getting cover for a specific period. It, therefore, suits those who want a payout to cover large loans like a mortgage, put protection in place to help with the costs of raising a family until the children are ready to leave the family home.
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How does joint term life insurance work?
While you can take out a term life insurance policy as an individual, there is also the option of taking out a joint policy with your partner.
These policies work slightly differently. Although two lives are covered by the policy, there is only one payout, which is after the first partner dies. Joint life insurance policies aren't just limited to couples – business partners could use them too.
Because there is only going to be one payout, these policies are usually slightly cheaper compared with each partner buying an individual policy – however the price difference is often very small.
There are some downsides, however. If your relationship ends, there isn't a way of dividing the cover into separate policies. This is not an issue if each partner has their own cover.
After the first partner dies, the surviving partner is left without any life insurance cover. If you want to arrange cover at that stage, it may be more costly as you're likely to be older and potentially in less-than-perfect health.
What's more, if both partners die at the same time, there is only a single payout. It is often only marginally more expensive for a couple to have separate life insurance policies resulting in two payouts in the event of both dying.
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How long should the term be?
Some insurers offering cover stretching from five years all the way up to 70 years. The appropriate term for an insurance policy will vary, but there are a few factors worth bearing in mind when working it out:
- If your primary concern is ensuring your family can pay off the mortgage after you pass away, choose a term that is at least as long as your mortgage term. Bear in mind you might remortgage, borrow to build an extension or buy a bigger house and start a new mortgage again, so buy for as long as you might need in total.
- Think about how long it may be until your children are financially independent. Raising a child is incredibly expensive, and you will want to have cover in place that provides for them at least until they are at an age when they can support themselves.
- Your likely retirement age – and the retirement age of your partner – will also be a key consideration.
- If the main aim of the policy is to provide a lump sum to cover the income you bring in, that may be less of a concern once you have hit retirement, paid off the mortgage and the children have left home. You may also want to consider a family income benefit insurance policy.
This is reliant on you and your partner saving enough for retirement. Find out more in our guide to how much will you need to retire?
What happens to my life insurance when the term ends?
The whole point of a term life insurance policy is that it covers your life for a specific term. Once that term comes to an end, you no longer have any cover in place.
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Do you get your money back at the end of term life insurance?
The policy has no cash-in value so you get nothing back.
If you die a year after the policy finishes, there will be no payout of any kind to your loved ones.
Think carefully about how long you want the policy to run for and whether you would prefer to go for a whole-of-life insurance policy. As the name suggests, this guarantees a payout when you die, no matter what age that may be.
You may want to consider writing your life insurance in trust to help protect your loved ones. You can find out more in our guide How to write life insurance in trust.
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What is renewable term life insurance?
Renewable life insurance is now rarely offered and is normally restricted to business protection planning.
Customers pay an increased premium from the outset for the luxury of being able to renew for another term at the end, at which point medical underwriting is bypassed. However, the customer’s renewed premium will be based on their increased age at that point.
Independent life insurance broker LifeSearch suggests that, in most cases, renewable life insurance policies are not considered cost-effective options.
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What's the difference between guaranteed and reviewable premiums?
Many insurers will offer you the choice of either reviewable or guaranteed premiums.
With a guaranteed premium, the price you pay each month for your cover is set in stone for the entire term of the policy. So if you go for a 40-year term, those monthly premiums will be exactly the same in year one as they are in year 40.
However, with reviewable premiums, the insurer has the right to periodically review your premiums and may opt to increase them. This isn't down to your health or circ*mstances, but simply the insurer's financial position and expectation of paying future claims.
Your monthly premiums will start out at a lower level if you go for a reviewable policy. However, as insurers have the right to raise the premiums as they wish, they may end up costing you more in the long run.
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Where can you buy term life insurance?
Many providers offer sales direct from their own websites, such as Legal & General, Aviva and Vitality. Most price comparison websites, such as MoneySuperMarket, Compare the Market and Uswitch, let you look at different life insurance products.
You can use an independent financial adviser who might be providing you with other financial advice and products, such as savings, pensions and mortgages. Or you can turn to a specialist life insurance broker such as LifeSearch.
Search the UK's leading insurers using the service provided by LifeSearch.
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