The two principal characteristics of term insurance are: the insured must die for any benefits to be paid and, by definition, the contract expires at the end of the term. Stated more specifically, a term life insurance policy promises to pay a death benefit to a beneficiary only if the insured dies during a specified term.
The contract makes no promise to pay anything if the insured lives beyond the specified term. Generally, no cash values are payable under a term life insurance contract. If the insured survives the specified term, the contract expires and provides no payment of any kind to the policyowner.
1) When should term life be purchased?
In general, some type of life insurance is indicated when a person needs or wants to provide an immediate estate upon his or her death. This need or desire typically stems from one or more of the following reasons:
A. Providing income for dependent family members until they become self-supporting after the head of household dies.
B. Liquidating consumer or business debts, or to create a fund, enabling the surviving family members to do the same when the head of household dies.
C. Providing large amounts of cash at death for children’s college expenses or other capital needs.
D. Providing cash for federal estate and state inheritance taxes, funeral expenses, and administration costs.
E. Providing funds for the continuation of a business through a buy-sell agreement.
F. Indemnifying a business for the loss of a key employee.
G. Helping recruit, retain, or retire one or more key employees through a salary continuation plan, and finance the company’s obligations to the dependents of a deceased key employee under that plan.
H. Funding bequests of capital to children, grandchildren, or others without the erosion often caused by probate costs, inheritance taxes, income taxes, federal estate taxes, transfer fees, or the generation-skipping tax.
I. Funding charitable bequests.
J. Preserving confidentiality of financial affairs. Life insurance proceeds payable to someone other than the deceased’s estate are not part of the probate estate and are not a matter of public record. It is not unusual for a beneficiary to be a lover, illegitimate child, faithful domestic servant, or have some other type of relationship with the insured that he or she may not want to be publicly acknowledged.
K. Assuring nearly instant access to cash for surviving dependents. Life insurance proceeds are generally paid to beneficiaries within days of the claim. There is no delay, as might be the case with other types of assets, because of the intervention of state or other governmental bodies due to settlement of tax issues, or because of claims by the decedent’s creditors.
L. Directing family assets to family members in a way that minimizes state, local, and federal taxes.
Generally, term insurance is not the most effective type of life insurance for all of these death benefit needs. However, term insurance may serve the insured’s needs in many circumstances. Because term insurance is not just one product, but rather many variations on a general theme different types of term insurance are indicated for different types of needs.
Keep in mind, term insurance, more than any other type of insurance, is pure death protection with little or no ancillary or lifetime benefits. Therefore, the two overriding considerations in the use of term insurance, regardless of the specific application, are:
- Will death protection alone meet the need?
- Will the coverage last as long as the need?
In short, with term — as with any other decision about the appropriate type of coverage — the product must match the problem.