Many people think they could save money by getting only five years of life insurance coverage.
It makes sense: Ten years of coverage costs less than 20 or 30 years. Shouldn’t five years of coverage cost even less?
Like any financial product, life insurance follows its own kind of logic. While it’s possible to find 5-year term coverage, the policy probably won’t be your most affordable option.
How A 5-Year Term Life Insurance Policy Works
Unlike whole life insurance, which lasts the rest of your life, term life insurance comes with an expiration date. Typically, term policies cover you for 10, 20, or 30 years before they expire.
Ironically, this limitation can add flexibility as you arrange your coverage. Life insurance coverage needs usually change as the decades pass.
For example, a 30-year-old working mother with young children and a new mortgage will likely need more coverage now than she’ll need in 20 years.
In 20 years, when her term policy expires, the children should be grown and financially independent. The house should be paid off, too.
Maybe she even has enough savings and other assets to cover final expenses and provide some financial flexibility for her family members.
If she’s not quite ready to go without insurance, she can still replace the expiring term policy with a smaller term policy or with a whole or universal policy which could last the rest of her life.
Nobody can predict the future with 100 percent certainty, but a life insurance policy’s term should generally extend beyond your longest-term debt or last long enough to cover you through a particular season of life.
Who Needs 5-Year Term Life Coverage?
Naturally, people with shorter-term needs like the idea of a 5-year term policy. Possible uses could include:
- Extending Coverage: Maybe you didn’t pay off a large debt as soon as you’d hoped or you moved to a new town and incurred new debts. If so, you might want a 5-year term policy to cover you as you finish paying off debts.
- Coverage During College: When you have a college-aged child, you may want a 5-year policy in case you died and your child had no other way to pay tuition.
- As Collateral for a Loan: A small business loan may require life insurance as collateral assignment. If you plan to pay off the loan within a few years, you may like the idea of buying only five years of life insurance coverage.
- Key-personnel coverage: Business partners like to have life insurance coverage on each other, especially in the early years of a startup when a partner’s death could have disastrous consequences on the company.
- Temporary but Dangerous Work: Someone who plans to work in a dangerous job such as roofing or mining over the next few years may like the idea of a 5-year term policy, especially considering the higher premium rates for people with dangerous jobs.
- Retirement Protection: Clients approaching retirement often like the idea of a 5-year term policy because it could prevent their spouses from needing to spend retirement savings or cash out of investments early if the unexpected happened.
You can probably think of more scenarios in which five years of term life coverage make sense.
Very often, however, our clients find they can save more money with something other than a 5-year term life policy.
Why 5-Year Coverage Costs More
Anyone who’s shopped for life insurance coverage already knows: Higher risk insurance policies require higher premiums. If underwriters didn’t assess your risk and charge a premium to reflect that risk, an insurance company may not have the money to pay future claims.
An insurance company uses factors such as your age, health, family health history, occupation, driving record, and credit history to measure your risk and set your premiums.
Based on these principles, a 5-year term policy should cost less, not more than a 10-year policy. So what’s the deal?
Along with your risk factor, your premium also compensates the insurance company for its cost of doing business. The company has to pay its staff members, maintain its buildings, and come up with advertising campaigns.
Because a 5-year policy gives the company fewer months to collect your premiums, a greater percentage of your payment goes to these overhead costs.
This drives up your monthly payments. As a result, few companies even offer 5-year coverage.
And this scarcity inflates premiums even more because there’s less competition to drive down rates.
Options to Consider Instead of 5-Year Term
If you’re thinking about buying 5-year term life coverage, you should first consider whether any of the following options could provide the same protection you’d need:
A 10-Year Term Policy
As we said above, 5-year coverage costs about the same and often more as 10-year coverage because life insurance companies have fewer months to spread out business expenses.
If you’re going to be paying rates for a 10-year policy, you may as well get 10 years of coverage. Plus, 10 years of coverage will be helpful if:
- You Underestimated Your Needs: If you thought five years of coverage would be enough, but it turned out otherwise, you’d have the option of keeping your insurance active without taking further action or paying more.
- Your Life Changes Unexpectedly: Life is nothing if not unpredictable. Maybe your children didn’t leave the nest as soon as you’d expected or you decided to work several more years before retiring. The extra five years of coverage would be nice to have in place.
Worst case scenario: If you bought a 10-year policy but didn’t need it beyond the first five years, you could simply let the policy lapse, typically without any penalty from the insurance company.
An Annually Renewable Policy
Rates will be higher for annually renewable coverage, but if you’re certain you’d need coverage for only a short time — a year or two, for example — you can still save with this kind of coverage.
Annually renewable insurance must be renewed each year, typically at a higher premium than the year before. It’s a helpful product if:
- You’re Just Buying Some Time: If you’re improving your health, changing jobs, or taking other action to lower your risk and increase your access to better premiums in the future, an annually renewable policy could give you coverage in the meantime.
- An Existing Term Policy Is Expiring: If you have term life coverage that’s ending, it may automatically convert to an annually renewable policy unless you take other action. Keeping this coverage until you find a permanent solution sometimes makes sense.
- You’re In Transition: Changing jobs or starting a new business can make you more vulnerable financially. An annually renewable policy could provide a temporary boost in coverage until you get things under control.
In any of these scenarios, an annually renewable policy makes more sense than paying more for five years of level premiums.
However, if you think you may renew the policy more than one or two times, you could likely save with a 10-year term policy.
Whole Life Insurance
Some clients, once they begin the process of getting covered, opt for permanent life insurance to avoid going through the underwriting process again.
Whole life coverage provides permanent access to a death benefit in exchange for your premiums, and it also includes an added cash value which grows the longer you have the policy.
You’re less likely to save money with a whole life policy, compared to a 10-year term policy, but the added cash value can work like a savings account or even an investment which gives you more long-term flexibility.
Because of their complexity, many people prefer to work with a financial advisor before buying a whole life policy, especially if the policy includes an investment component.
Companies Offering 5-Year Coverage
Despite all the reasons not to buy a 5-year term life insurance policy, some people will still want to buy just what they need and don’t mind paying more each month.
If you’re shopping for a 5-year term, here are some companies to consider:
- Minnesota Life: Minnesota Life specializes in 5-year coverage and can often beat other companies’ rates. The company has excellent grades from independent ratings agencies, which means your beneficiary shouldn’t have trouble filing a claim if necessary.
- New York Life: New York Life’s premiums may be a little higher, but the company has the highest ratings for financial stability, which gives many shoppers even more peace of mind.
- EMC National Life: EMC National Life has been in the business for nearly 50 years. It has good financial ratings and its premiums tend to be higher than rates with Minnesota Life or New York Life. However, the company can sometimes offer more flexibility with its underwriting guidelines.
Bottom Line: 5-Year Term is a Limited Market
Because of its limitations and higher costs for coverage, many 5-year term life policy shoppers end up buying a 10-year policy or annually renewable coverage.
Shoppers in need of business loan collateral or key-person business coverage often stay with a 5-year term policy because they aren’t as concerned about finding the lowest premiums.
Give us a call or reach out in the comments section below if you’d like to explore your options, either for 5-year coverage or other life insurance products.