Decreasing Term Life Insurance
B.A. Risk Management
Life Insurance Agent
You might have heard about level term life insurance but what is decreasing term life insurance? In this extensive guide, you’ll find everything you need to know about it.
Decreasing term life insurance is term life insurance that offers a death benefit that decreases throughout the policy.
In other words, the coverage shrinks over the life of the policy even though the premiums stay constant throughout the contract.
It means you pay the same amount of premium every month or year but your death benefit reduces as each month/year passes.
If you are still not sure how it works, consider this: as you age, your liabilities will shrink because you’ll pay off your debts. So, your family will need a smaller payout to get rid of debts you might leave behind.
Generally, the following debts are common reasons to buy a decreasing term life insurance policy:
- Personal loan
- Business loan
- Auto loan
Decreasing term life insurance vs. level term insurance
In a level term insurance policy, it’s you (the policyholder) who decides:
- How much would be paid out if you were to die within the policy term?
- How long the insurance policy covers you.
Even though you determine the coverage amount and the length of coverage when you buy a decreasing term life policy, your choices are basically determined by the size of the debt you have to repay and the period of time – in case you (the policyholder) die.
Since the death benefit decreases rather than staying the same throughout, a decreasing term policy can be cheaper than a level term one. This also reduces the risk of the insurer having to pay out a larger sum of money.
Who needs decreasing term life insurance?
This insurance is typically purchased to pay off a specific debt – a debt that reduces over time. The insurance pays out if the borrower (or their partner) dies and the term is usually determined to line up with the associated debt.
Also referred to as mortgage life insurance, it is generally bought by homeowners who want to ensure their mortgage will be paid off in the event of their death.
In fact, some mortgage lenders require life insurance to be set up before they approve your loan. The payout can be used to settle the mortgage, guaranteeing that the property will remain with your family, even if the worst happens.
However, there is more to decreasing term insurance than covering mortgages. Some people buy it because they don’t think a big payout will be needed if they die in 25 years rather than 15, for instance.
They simply want to save money on premiums so this kind of insurance coverage is a better choice for them.
But keep in mind that a decreasing term policy is not suited for people who have an interest-only loan since capital debt can only be paid off at the end of the term of the loan.
Do you want an inexpensive form of life insurance?
As we mentioned earlier, decreasing term insurance is clearly cheaper than universal or whole life insurance. The death benefit in this type of policy basically mirrors the amortization plan of a high personal debt which is usually not covered by an income or personal assets.
This insurance offers a pure death benefit minus the cash pool. That’s why decreasing term insurance has lower premiums for almost similar benefit amounts to a life insurance policy (both temporary and permanent.)
What are the additional benefits of buying decreasing term life insurance?
As you know by now, this policy is mostly used to protect personal assets. Many small business partnerships also choose it to protect indebtedness against operational expenses and startup costs.
Speaking of small businesses, if one partner dies, proceeds from the death benefit (in case of a decreasing term policy) can help in two ways:
- Pay off the remaining debt for which the deceased partner was responsible, or
- Fund the continuing business operations
Factors to keep in mind when comparing decreasing term life insurance
In order to measure the pros and cons of decreasing term insurance policy offered by different providers, you need to understand a few things:
Choose the right policy: It’s not all about the price! Don’t just choose the cheapest policy you can find out there. You have to make sure the policy you buy offers you the right coverage.
Determine the details: You will also need to decide for how long you want the term to last and what size the sum insured should be. Remember, both these things are usually similar to your outlying debt.
Carefully read the terms: Last but not least, check out the terms and conditions of the policy thoroughly. See how many claims are paid out and if it includes the right to legal advice. Also, check if it includes the ability to increase coverage or whether or not it offers an accidental death benefit.
Does decreasing term insurance have any drawbacks?
Even though decreasing life term insurance offers the best loan protection by aligning the life of the loan with the death benefit, it may not be the right option for other kinds of loans. That’s because:
- You have to pay the same amount of premium every month (or year) for a gradually decreasing payout
- The premiums can be relatively higher
- Since decreasing term insurance is considered an out-of-date product, very few insurers offer it
- Instead of your loved ones, your creditor is the beneficiary (we recommend never putting the bank as a beneficiary as mortgages often change banks)
Term laddering: an alternative to decreasing term insurance
If you think the cons outweigh the pros of decreasing term insurance for you, you might want to consider term laddering, which is also known as ‘term layering’.
The idea behind term layering is as you grow older, you become more ‘self-insured’. The goal here is to have settled all your debts by the time of your retirement, so you can leave a significant amount of funds to take care of your family.
Term layering allows you to group 2 or more term life insurance policies so the end result is very similar to the decreasing term insurance.
Think of it like this: if you are in your late 30s or 40s, your children might be your biggest vulnerability. In case you have a considerably larger debt, you want to make sure that at least until your children reach adulthood, your debts are covered by life insurance.
Here’s an example. Mark is 32 years old, married with two kids, ages 1 and 3.
For the next 20 years, Mark will want to make sure he has as much coverage as possible until his kids are able to take care of themselves. He has a 30-year mortgage, so a 20-year term life policy will leave a 10-year lapse in coverage.
Moreover, Mark realizes he doesn’t need maximum coverage for the complete 30-year term since his children will most likely be self-sufficient in another twenty years. So, he will not sign up for a full 30-year term insurance policy.
In order to achieve both of these goals, Mark should buy two different term insurance policies – one for 20 years and 30 years. The face amounts will be $500,000 and $250,000. This enables him to lock in 30 years of coverage and receive impressive rates.
After his 20-year policy expires, Mark will not have to worry about that policy’s monthly premium any more. He will just have to handle that 30-year policy to cover the mortgage.
And when the 30-year term policy expires, Mark can either buy a new policy or renew it and convert it to a permanent policy. Not a bad deal!
Make the process stress-free. Work with an experienced insurance agent.
No matter what type of life insurance you are shopping for, a lot of factors come into play when choosing the best type for YOU. In order to make sure you get the right life insurance plan, consider working with a reputable and experienced insurance broker.
We not only know which life insurance companies are the best, but we can also save you a lot of time and headache while shopping and comparing life insurance quotes.