The Basics of Term Life Insurance

Should you "buy term and invest the rest," or fuel your life insurance with "the power of cash value"?

Term life insurance is often touted for its "pure insurance protection," which includes none of the cash value features inherent in whole life policies. Term life insurance covers you for a specific period of time - as short as one year, or as many as 10, 20, or even 30 years. You can also buy term insurance that covers you until you reach a certain age, usually 65 or 70. Term insurance policies expire at a set time.

Generally, you purchase term life insurance if you want to protect your loved ones from debts. For example, if you and your spouse own a home, and you were to die tomorrow, your spouse could be stuck paying the mortgage on his or her own. If you had a term life insurance policy, your spouse could have enough money from the policy's death benefit to pay off the mortgage.

Term insurance doesn't just cover specific debts, however. If you have children or if your spouse does not work, term insurance can protect your family's finances, providing money for college and living expenses if you die before your children are fully grown.

Medical exam is usually required

When you apply for term life coverage, the insurance company will probably require a medical exam before issuing a policy. Some companies require a medical exam for all policies, but others require the exams only for policies with a substantial face value. The examination is basic, covering your height, weight, medical history, and blood and urine testing. With the blood and urine tests, the insurer looks for specific medical problems. Positive results could affect your premium, or even your ability to buy a policy.

Smokers will pay more for life insurance, although cigar smokers might get less expensive premiums than those using cigarettes. If you smoke marijuana, but not cigarettes, you still must admit to being a smoker on the policy application. Insurers don't generally differentiate between different types of smoke inhalation. (Marijuana users must also disclose their drug use.)

As you age, the likelihood you will die sooner increases. That's why older individuals pay more for life insurance. Many term policies give you the option to renew your coverage at the end of the term without undergoing another medical exam. You also can lock in low premiums by asking for a "level premium" policy. That means for a specific time period, say 20 years, your premium rate stays the same. After that term expires, your rates will increase.

If you have trouble finding life insurance because of illness or a troubled medical history, you can turn to guaranteed issue life insurance coverage, also called "quick issue" or "simplified issue" insurance. Guaranteed issue policies require no medical exam, but you pay a higher premium in exchange for the guaranteed coverage. That's because the insurance company takes on more risk in insuring people without knowing their medical condition. Guaranteed issue policies can require waiting periods before coverage kicks in, and often require yearly fees. They might be the only option for some people. A life insurance broker can search the marketplace for a guaranteed issue policy that meets your needs.

How long a term?

When you are researching what kind of policy you should buy, your income, short-term and long-term debts, and financial obligations to your loved ones are among the factors to consider.

Figuring out which term you should buy - 10 years, 20 years, 30 years, or some other number - requires a major review of your debts, financial needs, dependents' needs, and when all these might change. Jack Dolan of the American Council of Life Insurers suggests you ask yourself, "When will my dependents reach financial independence?" Also look at major debts, such as mortgages or other loans, and at how much money your spouse or dependents would need in order to pay them off if you die.

Guenther Ruch of the Wisconsin Insurance Commissioner's office says it's a good idea to review your life insurance needs carefully, both when you buy the policy and on a regular basis throughout your life. "You may not have the coverage you need. You may have more than you need," Ruch says.

Ruch has the following recommendations for anyone buying life insurance, or anyone who already has coverage:

• Schedule a routine "check-up" with your insurance providers at least once a year.
• Shop around for identical products and services. Not every company charges the same rate.
• Remember an insurance policy is a legal document. Read it carefully, and make sure you understand what your policy states.

Determining the best coverage for your family is an important financial decision, both now and for the future. " Consumers can save themselves hundreds, and sometimes thousands, of dollars if they know how to shop wisely for insurance," says May Chao, executive director of the Consumer Protection Board of New York-state.

"If you are purely interested in financial protection for your family, that's what life insurance is designed for. So when your children are grown, reconsider your life insurance needs," Dolan says. You might still need coverage if a spouse or other relative depends on you. On the other hand, you might be able to scale back on the amount of life insurance you own.

"Perhaps you want to leave assets for your heirs, or for charity, or you need the death benefit for business planning purposes. These are all areas where life insurance can play a role, but it's really designed for financial protection," Dolan says. For that reason, after you've purchased life insurance coverage, you should periodically evaluate whether your current coverage amount is still right for you.

Term vs. whole life insurance: The cash value debate

Variable universal life insurance (VUL), a form of whole life insurance, is popular because it offers a pool of money known as cash value that builds up with interest over time. The interest earned is based on the performance of the stocks, bonds, and mutual funds in which you choose to invest the cash value.

Some financial planners advocate VUL policies because they force you to save money in the cash value component. Others recommend you buy term insurance for the cheaper premium, and then invest the money left over in mutual funds or other investments. VUL also allows you to change your death benefit - and subsequent premium payments - over time.

Cash value in life insurance should not be considered a traditional investment, because any partial withdrawals or loans will reduce your death benefit. Also, if you partially withdraw your cash value or take out a loan against it, and the cash value exceeds the premiums you have paid into the policy, you will face a tax bill. In addition, every year you own the policy, more of your premium goes to pay for the cost of insuring you, and less goes toward the cash value.