What is Term Life Insurance?

Term life insurance is a policy which provides financial coverage during a set amount of time. Often considered the 'simplest' form of life insurance, it is best suited for providing coverage or income for a short term and on a limited budget.

How Term Life Insurance Works

A term life insurance policy covers the policy holder up to the age specified in the contract. Should a policy holder die before the term is over, a beneficiary will receive a death benefit. Term life insurance policies may be renewed for a premium at the end of a given term if the policy holder's life should exceed the term.

Term life is less expensive that universal life insurance because it does not build up any equity. You are fully covered during the term of the policy, but you do not receive cash back when the term is over.

[InvestingAnswers Recommended Reading: How Much Life Insurance Should You Own?]

Why Term Life Insurance Matters

Term life insurance is generally considered one of the more inexpensive ways to secure a death benefit. Because term life insurance will expire when the policy holder reaches a certain age, it is important that policy-holders ensure that renew their the policy when it expires.

Term life is popular with young families who need protection, but also need to keep prices low. It is often intended for income-replacement needs.

Term Life Insurance Example

To illustrate, suppose Bob has a term life insurance policy that covers him financially in the event of death until the age of 40. Should Bob somehow die before the age of 40, the terms of the policy cover him and pay a financial benefit. If Bob lives past the age of 40, however, his policy will not yield any financial benefit. He must renew the policy for another term under new conditions.

Term Life Insurance vs. Whole Life Insurance

As explained above, term life insurance pays out a death benefit for a specific pre-determined period of time -- a term -- usually from covering your dependents from one to 30 years. Because most term policies expire before the policy holder dies and consequently never pay a claim, term life insurance coverage tends to be the most affordable.

On the other hand, when you pay your whole life insurance premium, you are guaranteed that your beneficiaries will receive a death benefit if you die when the policy is active. However, unlike with term life insurance, part of each premium payment is set aside for you, the policyholder, allowing the 'cash value' of your policy to steadily build over time. This means that if you run into financial problems, you may borrow against these cash values to help you through hard times.

Here's another way to contrast the two life insurance policies: Term life insurance may be great for young married couples who are just starting out but need a way to protect their spouse or children (i.e., the beneficiaries), while whole life insurance is best suited for individuals who expect evolving financial needs during their lifetime and have low tolerance for investment risk.

[InvestingAnswers Recommended Reading: How to Pick the Right Life Insurance for You.]

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.