Last week I wrote on reviewing your life insurance policies; today I describe a way to layer term life insurance to provide affordable life insurance protection for longer periods of time.
As a review, the most common forms of term life insurance are level term and annually renewable term. Both offer level death benefits:
- Level term life insurance premiums remain level for the ‘term.’ These policies are issued usually in terms of 5-year increments: 5, 10, 15, 20, 25, 30 and longer years. During the term, the premium remains the same and is guaranteed not to increase. The longer the term, the higher the premium, so most people don’t opt for the longest term. However, the premium does increase when the term is up. For example, let’s say you bought a 15-level term policy for $500 per year. In the 16th year you can keep the coverage but the premium will dramatically increase to several thousand dollars per year. Sometimes these policies allow you to apply for a lower premium, but the rate is dependent on your health. The new premium will be much higher because you will be 15 years older even if you are in excellent health. However, if you have some health history that precludes you from buying life insurance at standard rates, you may be rated to pay a higher premium. Many people will need life insurance after the term is up, so this big increase is a challenge.
- Annually increasing premium term life insurance is sometimes called AYT (Annual Renewable Term). The premium goes up every year. In the earlier years while you are young, the premium increase is very slight. In the later years it is like a hockey stick. The cost becomes several thousand dollars per year, and by the time you are in your 90’s, the premium almost equals the death benefit.
Will you need life insurance when you are older? Some advisers recommend that you purchase term insurance for the length of time you plan to need it. For example, if you are 40 and in 20 years your house will be paid off, children will have completed college, and the retirement fund will be well on the way to being fully funded, then you won’t need the insurance anymore–so 20-year term would be great here.
What if life changes? For many people life doesn’t go according to plan. There could be job changes, divorces, or unexpected children, or your investments might not have performed well. You might need life insurance into your 60’s and 70’s, but if you just bought 20-year level or AYT term, you could be facing very high premiums at those ages.
Layering life insurance is a way to have life insurance when you are older while keeping the premium down somewhat. Let’s assume the life insurance buyer is a 40-year old named Tom, and he needs $500,000 of life insurance in addition to his group life his employer provides. He would like to buy 30-year level term to cover him until he is 70, but the cost is a little more than he wants to pay. Tom thinks he will probably only need insurance for 20 years; by then his kids will be out of college and his house will be paid for. However, he is unsure about his career, since a lot of people in his industry have been laid off and have gone into other lines of work, sometimes for much less pay. If this happened to Tom, he might not have the house paid off in 20 years, and he might not have saved as much money for retirement. If he died at age 60, his wife wouldn’t have enough money to pay off the house and help fund retirement without his income.
Tom decides to buy both a 20-year and a 30-year level term, each for $250,000. If he doesn’t need the 30-year term in 20 years, he can drop it; but if he continues to need it, he can keep it, and he doesn’t have to worry about being older (and perhaps not in as good health) and having to pay a much higher premium then. Tom likes diversifying his life insurance too, in case one of the insurance companies has financial difficulty. Also, say 10 years from now, when Tom reviews his insurance he decides he needs more coverage longer, he might decide to replace his 20-year term that has only 10 years left with a new 20-year term, giving him full coverage until he is 70. Having two policies like this gives him some nice options as he ages.