How Does Term Life Insurance Work

by | Feb 22, 2016 | Term Life Insurance


If you’re confused as to how term life insurance works, you’ve come to the right place. Of all the forms of life insurance term life is the simplest conceptually and I promise that by the end of this article you will completely understand it. The main quality that a term life policy has is that every aspect of it is clearly defined. You pay a fixed amount each month, known as the premium, to the insurance company in return for their promise that if you pass away during the length of time in which the policy is in effect, known as the term, the people you name in the policy will receive a defined lump sum payment. The people you name in the policy, your loved ones, are known as the beneficiaries. The amount that would be paid to them in the event of your death is known as the death benefit, or the payout. If you do not die during the term, no money will be paid out by the insurance company.


That is pretty much the whole story, but let’s dig a bit deeper.

What Is Term Life Insurance And How Does It Work?

A quick look online for a term life insurance quote will reveal that they seem incredibly low for the payout amounts for which you may insure yourself. Why is this? One thing that is important to know about term life insurance is that the vast majority of policyholders will outlive their policy. Well that’s good news isn’t it? Sure it is, for both the policy holder and for the insurance company. After all, if you are alive at the end of the policy term, the insurance company has received years, and possibly decades of premium payments (including interest!) from you without having to repay anything. So keep this in mind the next time you get direct mail advertising or see a chart in a magazine offering outrageously low premiums for term life insurance quotes. Those premiums are legitimate, it’s just that the payout is unlikely.

Despite the attractive term life insurance rates you should at least look at different forms of so-called “permanent” life insurance. There are many kinds of permanent life insurance, but what they all have in common is that they guarantee a payout as long as you keep paying the premiums and/or keep your policy “cash value”. This is the subject of many other articles on this site, and life insurance basics guide compares term life versus permanent life insurance at length elsewhere, but suffice it to say that permanent life insurance premiums are normally quite a lot higher than term life insurance-especially whole life insurance. Permanent life insurance has investment- like aspects to it that may or may not make sense for you, while some policies of this type also have a degree of risk that requires some sophistication on your part.

As a final note on term life, many experts advise to take advantage of the low premiums associated with term life, and invest any extra money that you have each month in conservative long-term investments. Often it is possible to buy a term policy with an extendability ryder, or supplement, through which you may extend the policy when the original term is finished.

There’s really no mystery as to how term life insurance works, and I sincerely hope that this brief article has aided you in your search for the right life insurance for you and your family.


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