Term life insurance sized to dependents and years

How it works

A policy names a face amount, such as $500,000, and a term, such as 20 years, and the insurer charges a level yearly premium for the term based on the insured's age, health, and habits at the time of application. If the insured dies within the term the beneficiary receives the face amount, which federal law excludes from income tax under conditions the IRS lists. If the term ends with the insured alive, the coverage ends and nothing is paid back. The common way of sizing it is arithmetic: the yearly amount the household would need to replace, times the number of years until the youngest dependent is independent, plus debts to clear, minus savings already in place. Workplace group coverage is often a fixed multiple of salary and ends when the job does. Premiums are not deductible.

What it gives

The death benefit arrives free of income tax to the beneficiary.

Level term premiums are small relative to the face amount for a healthy younger adult.

The term can be matched to the years the dependents actually need the income.

What it costs, or where the catch is

Nothing is paid if the insured outlives the term, and the premiums are gone.

Premiums rise steeply for a new policy at older ages or after a health change.

Group coverage through a job usually ends at separation, often when it is hardest to replace.

A worked example

Emil earns $70,000 and his family spends about $55,000 a year. His youngest child is 4, so about 18 years of support remain. He figures $55,000 times 18, which is $990,000, adds $200,000 to clear the mortgage, and subtracts $190,000 of savings, arriving at about $1,000,000. A 20 year term policy for that amount costs him about $60 a month at age 34. If he dies at 45, the $1,000,000 goes to his wife with no income tax.

Where it goes wrong

The common miss is a parent relying on a workplace policy worth one year of salary, which ends with the job and covers a fraction of the years the children need.

Who confirms it for you

For your own numbers, an insurance agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

IRS Publication 525, Taxable and Nontaxable Income. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.