What Is Decreasing Term Life Insurance

The benefit from a decreasing term life insurance policy reduces as time progresses, even as your premiums remain unchanged.

The primary objective of life insurance is to provide financial assistance to others after your death. However, the necessary amount of life insurance can change over time. As debts are settled, children complete their education, and savings increase, the need for life insurance often diminishes.

In such scenarios, decreasing term life insurance could be considered. This policy reduces the payout your beneficiaries would receive upon your death as time passes.

What exactly is decreasing term life insurance?

You’re probably familiar with term life insurance, the most widely used type of coverage that lasts for a specific number of years—usually between 10 and 30—and provides a tax-free lump sum payment to your beneficiaries upon death. To keep the policy active, you pay a fixed amount (known as a premium) monthly, quarterly, annual, or biannually.

Most term life insurance policies are categorized as “level” term policies. This means that as long as you continue to pay premiums, the payout to your beneficiaries remains consistent regardless of when you pass away within the policy’s term.

Decreasing term insurance operates similarly but with one significant distinction: the payout, or death benefit, decreases gradually over time.

Here’s how to set up and maintain a decreasing term life insurance policy:

• Choose your desired coverage duration. Typically, insurers offer policy lengths in increments of five years, ranging up to 30 years.
• Select an initial death benefit amount. Remember, this sum will decrease over time, usually by a fixed percentage each year, until it reaches zero when the policy expires. For instance, if you purchase a policy starting with a $200,000 death benefit and pass away halfway through the policy’s term, the payout would be approximately $100,000.
• Designate one or more beneficiaries. These individuals or entities receive the death benefit if they die while the policy is active. Generally, you can choose your beneficiaries, though, with mortgage life insurance, the lender is automatically designated as the beneficiary.
• Maintain premium payments. To keep the policy active, you must consistently pay premiums. Unlike the decreasing death benefit, the premium amount remains unchanged throughout the policy’s duration.

When should you consider a decreasing term insurance policy? Here are some scenarios to keep in mind:

• Outstanding Loans: A decreasing term life insurance policy could be beneficial if you have loans that others would need to handle in your absence, like co-signed debts or loans required by banks as collateral. It ensures that these specific financial obligations are covered as the policy’s death benefit decreases over time.
• Business Partnerships: If you’ve recently taken out a significant business loan with a partner, consider purchasing a decreasing term life insurance policy on your partner’s life. This strategy ensures that if your partner passes away before the loan is repaid, the policy’s payout can cover their portion of the debt. This avoids liquidating the business or selling assets to maintain operations.
• Budget Constraints: If you’re facing financial constraints and can’t afford more expensive options, decreasing term life insurance provides a viable, cost-effective solution. Its premiums are typically lower due to the decreasing death benefit. However, exploring other ways to save on life insurance costs is essential before committing to this type of coverage solely based on price.

In summary, while decreasing term life insurance can suit specific needs like loan obligations and budget limitations, consider alternatives like level-term policies for broader financial protection for your loved ones.

Here are the advantages and disadvantages of decreasing term insurance:

Pros:

• Affordability: Decreasing term life insurance is typically cheaper than level premium term insurance, making it a cost-effective coverage option.
• Loan Obligations: It helps cover specific debts like mortgages or loans by matching the policy’s death benefit with the outstanding balance, ensuring targeted financial protection.
• No Medical Exam: No medical exam is often required; you may need to complete a questionnaire about your health and lifestyle.
• Cons:
• Less Flexibility: Unlike level-term insurance, decreasing-term policies offer less flexibility. They may not adequately cover unforeseen expenses or long-term financial needs, potentially leaving loved ones financially vulnerable.
• Limited Availability: Decreasing term life insurance options are less common than other types, limiting choices when comparing quotes.
• Reduced Payout Over Time: The death benefit decreases gradually over the policy’s term, resulting in a lower payout if you pass away later in the policy’s duration.

Example of Decreasing Term Insurance in Action:

For instance, consider a 15-year decreasing term life insurance policy with an initial $500,000 death benefit. If death occurs in the final year of the policy, beneficiaries will receive approximately $33,000, reflecting the reduced benefit as the policy nears its end.

These points outline the key advantages and drawbacks of choosing decreasing term life insurance for your financial planning needs.

Here are some alternatives to decreasing term life insurance:

Level term life insurance:

Many insurers offer the flexibility to adjust the death benefit of a standard term life insurance policy at least once during its term. This option allows you to decrease your coverage and lower premiums as your financial needs change over time. Additionally, you can “ladder” multiple-term life policies to align with different financial obligations with varying end dates. For instance, you might have a 30-year policy for your mortgage and a 20-year policy to cover your children until they become financially independent.

Annual renewable term life insurance:

This policy provides coverage for one year at a time, renewable annually within the policy’s term without requiring a new application. While the death benefit remains constant, premiums typically increase each year. Annual renewable term insurance is suitable for individuals who anticipate needing life insurance for a limited period.

Mortgage protection insurance and credit life insurance:

Both of these are variations of decreasing term life insurance. Mortgage protection insurance and credit life insurance are designed to cover specific debts, such as a mortgage or personal loan balance, in the event of your death before the debt is fully paid off. The death benefit is usually paid directly to the lender, ensuring the outstanding debt is settled, but your beneficiaries do not receive any funds.

These alternatives offer different approaches to matching your life insurance coverage with your evolving financial needs beyond the structure of decreasing term life insurance.

Is decreasing term insurance a worthwhile investment?

Decreasing term life insurance is commonly chosen to align with decreasing financial obligations over time. However, uncertainties such as economic downturns or unexpected major life events can lead to unforeseen expenses that a decreasing term policy may not adequately cover.

While the premiums for decreasing term insurance are typically lower compared to level term policies, the coverage diminishes significantly throughout the policy term. For this reason, it’s often more advisable to purchase a level-term policy that provides consistent coverage and adjust the coverage downward later if necessary. This approach ensures better financial protection against unpredictable circumstances.

Frequently Asked Question

What is decreasing term life insurance?

Decreasing term life insurance is when the death benefit decreases over the policy’s term. It’s typically used to cover specific financial obligations such as mortgages or loans that reduce over time that reduce over time.

How does decreasing term life insurance work?

You choose a policy term and an initial death benefit amount. Over time, usually annually, the death benefit decreases by a predetermined percentage until it reaches zero at the end of the policy term. Premiums, however, remain level throughout the policy’s duration.

Who should consider decreasing term life insurance?

Decreasing term life insurance is suitable for individuals with financial obligations that decrease over time, such as paying off a mortgage or loans. It ensures that the coverage aligns with the reducing debt balance, providing targeted financial protection.

What are the advantages of decreasing term life insurance?

• Affordability: Premiums are typically lower compared to other types of life insurance.
• Specific Coverage: It’s designed to match decreasing financial liabilities, ensuring adequate coverage for particular debts.
• Simplicity: The structure is straightforward, with predictable decreases in the death benefit.

Are there any drawbacks to decreasing term life insurance?

• Reduced Coverage: The death benefit decreases over time, potentially leaving insufficient coverage if circumstances change.
• Limited Flexibility: Unlike level-term policies, decreasing-term insurance may not adapt well to unforeseen financial needs or extended coverage requirements.

Conclusion

Decreasing term life insurance offers a cost-effective solution for individuals looking to align their life insurance coverage with decreasing financial obligations, such as mortgages or loans over time over time. While it provides affordability and specific coverage benefits, such as ensuring debts are covered as they decrease, it also comes with limitations. The decreasing death benefit may not adequately address unforeseen financial needs or provide long-term financial security.