3.3 Term Life Insurance Types and Features

Term life insurance provides protection for a specified period — the term — and pays the death benefit only if the insured dies during that period. It is pure protection: there is no savings or cash-value component, which is why term costs far less per dollar of coverage than permanent insurance.

Core Characteristics

• Coverage lasts for a set term (commonly 1, 5, 10, 20, or 30 years, or to a stated age such as 65).
• It builds no cash value and pays no living benefit.
• It is temporary — the policy expires at the end of the term with nothing payable if the insured survives.
• Premiums are the lowest of any life product for the same face amount, ideal for large temporary needs like a mortgage or child-rearing years.

Exam tip: Term is sometimes called the insurance that provides "the most coverage for the least premium" — true only because it has no cash value.

Types of Term by Death-Benefit Pattern

Term policies are classified by how the face amount behaves over the term:

Level Term

Level term keeps the death benefit and premium constant for the entire term — the most common form. A 20-year, $500,000 level term policy pays $500,000 whether death occurs in year 1 or year 20.

Decreasing Term

Decreasing term has a face amount that drops on a schedule, often matching a declining mortgage balance, while the premium stays level. It is frequently sold as mortgage protection or credit life.

Increasing Term

Increasing term has a death benefit that grows over time. It rarely stands alone; it usually appears as a rider, such as a return-of-premium feature or a cost-of-living rider added to a base policy.

Renewable and Convertible Features

Two options make term far more flexible and are heavily tested.

Renewable Term

A renewable provision lets the policyowner renew coverage for another term without proving insurability (no new medical exam). However, the premium increases at each renewal because it is based on the insured's attained age — the older age reached at renewal. This protects an insured who has become uninsurable.

Annually Renewable Term (ART) is the purest example: the face amount stays level while the premium steps up every year with attained age, starting very low and climbing steadily.

Convertible Term

A convertible provision lets the owner exchange (convert) the term policy for a permanent policy — such as whole life — without evidence of insurability. Conversion is usually allowed up to a stated age or date.

The new permanent premium can be set two ways:

• Attained-age conversion — premium based on the insured's age at conversion (lower immediate cost).
• Original-age conversion — premium based on the age when the term policy was first issued (requires a back-payment of the premium difference plus interest, but locks in a lower rate going forward).

Re-Entry Term and Return of Premium

Re-entry (revertible) term offers a low "select" premium to insureds who periodically re-qualify by providing new evidence of insurability. Those who stay healthy keep the low select rates; those who cannot re-qualify pay higher ultimate rates. The tradeoff: lower cost in exchange for repeated underwriting.

Because ordinary term pays nothing if the insured survives, insurers offer a Return of Premium (ROP) rider. For a higher premium, the insurer refunds the total premiums paid if the insured outlives the term. The refund is generally income-tax-free because it is a return of the owner's own money, not a gain.

Term Insurance Taxation and the MEC Trap

The death benefit of any life policy — term included — is generally received income-tax-free by the beneficiary under Internal Revenue Code Section 101(a). Term builds no cash value, so it has no living tax issues, but agents must understand the boundary that protects permanent policies.

A permanent policy can lose its tax advantages if it is over-funded and becomes a Modified Endowment Contract (MEC). The IRS applies the 7-pay test: if cumulative premiums in the first seven years exceed the total of seven net level annual premiums that would pay the policy up, it is a MEC.

Worked example: if the 7-pay limit is $4,000 per year ($28,000 over seven years) and the owner pays $6,000 in year one, cumulative payments ($6,000) already exceed the cumulative 7-pay limit for year one ($4,000), so the contract becomes a MEC. Distributions from a MEC are taxed LIFO (gains first) and a 10% penalty applies before age 59½ — the same penalty regime as a premature retirement-account or annuity withdrawal.

Choosing Term vs. Permanent

A quick decision framework helps clients match product to need:

• Choose term when the need is temporary and large — a 20-year mortgage, the years until children are independent, or a business loan.
• Choose permanent when the need is lifelong — final expenses, estate liquidity, or a desire to accumulate tax-deferred cash value.

Many buyers begin with low-cost term while young and use the convertible feature to shift to permanent coverage as income and lifelong needs grow — without re-qualifying medically. This "buy term and convert" path is a common, exam-favored recommendation because it preserves insurability while keeping early premiums affordable, and it avoids the over-funding that could trigger the MEC rules described above on a permanent policy.