What Is Decreasing Term Life Insurance?
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This type of coverage has a lot of similarities to term life insurance, except the payout gets smaller over time.
Policies typically last 10 to 30 years, with the payout slowly decreasing to $0 by the end of the policy’s term.
Decreasing term life insurance may suit you if you have a set financial obligation that lessens over time, such as a mortgage or business loan.
The main purpose of life insurance is to help others financially when you die. But the amount of life insurance you need today may not be the amount you'll need years from now. For many, life insurance needs tend to lessen over time as debts get paid off, kids graduate college and nest eggs grow.
In these cases, decreasing term life insurance might be an option. With this policy, the money your beneficiaries will receive upon your death decreases over time.
What is decreasing term life insurance?
You may be familiar with term life insurance. The most popular type of coverage, it lasts a set number of years — typically 10 to 30 — and pays a tax-free lump sum of cash to your beneficiaries when you die. You pay a fixed amount (called a premium) monthly, quarterly, annually or biannually to keep the policy active.
Most term life insurance policies are what's known as "level" term policies. This means that as long as you keep up with premiums, the payout stays the same no matter when you die within the policy's term.
Decreasing term insurance works largely the same way but with one key difference: the payout, or death benefit, gets smaller over time.
If your mortgage lender has offered you a life insurance policy, it most likely has a decreasing term. This is because the outstanding balance on a mortgage decreases over time, and if you die before paying it off, the policy protects the lender's interest.
How decreasing term life insurance works
These are the steps for setting up and maintaining a decreasing term life insurance policy:
Decide how long you want your coverage to last. Depending on your insurer, you may typically choose a policy length in increments of five years, up to 30 years.
Choose a starting death benefit. Remember, this amount will shrink over time, typically by a set percentage each year, until the death benefit reduces to zero and the policy ends. Let's say you buy a policy with a starting death benefit of $200,000. If you die midway through the policy, the payout will be around $100,000.
Name one or more beneficiaries. Your beneficiary is the person or entity that receives your death benefit if you die while the policy is active. In most cases, you can choose your beneficiaries. However, with mortgage life insurance, the lender is the automatic beneficiary.
Pay your premiums. You must pay insurance premiums to keep the policy active. Unlike the death benefit, the amount you'll pay stays the same.
Many insurers require a life insurance medical exam as part of the term life insurance application process. This helps insurers get a complete picture of your health and determine your rates. But with decreasing term life insurance, you'll likely be able to skip the medical exam and simply answer questions about your health and lifestyle.
When should a decreasing term insurance policy be considered?
Here are a few situations where you may want to consider a decreasing term life insurance policy.
You have an outstanding loan
Not all loans need to be paid off after you die. But a decreasing term policy might be helpful if you have co-signed debt or another type of debt that others would need or want to pay in your absence. If your bank requires you to buy a life insurance policy as collateral for a loan, decreasing term life insurance might also be the best option.
For other expenses or financial needs you'd like to cover for your loved ones, consider a level term policy instead.
You have a business partner
If you recently took out a large business loan, you may want to buy a decreasing term life insurance policy on your business partner's life.
For example, suppose you and a business partner are responsible for paying back a loan. In that case, you can insure your business partner's life and be the owner and sole beneficiary of the policy. That way, if your partner dies before the loan is paid off, the death benefit can be used to pay your partner's portion of the loan so that you don't have to liquidate the business or sell other assets to keep the business afloat.
You're strapped for cash
Decreasing term life insurance may be good in a pinch if you can't afford much else. It's among the cheapest types of life insurance, thanks to its decreasing death benefit. However, if price is your primary consideration, explore other ways to save on life insurance before opting for this coverage.
The pros and cons of decreasing term insurance
Pros
Affordability. Decreasing term life insurance tends to be cheaper than level premium term insurance. However, comparing quotes is still worth it.
Helps with meeting loan obligations. A decreasing term policy with a death benefit matching the balance of a loan can ensure you're only paying for the coverage you need.
No medical exam. You likely won't need to take a medical exam, though you may have to complete a questionnaire about your lifestyle and medical history.
Cons
Less flexibility. If you get a decreasing term life insurance policy to cover expenses other than a loan, you may expose your loved ones to financial hardship if you fail to estimate future needs correctly. And unlike level term life insurance, you probably won't be able to convert your policy into permanent life insurance.
Limited availability. Decreasing term life insurance isn't common, so you'll have fewer options when comparing life insurance quotes.
Low payout in later years. Because the death benefit drops over time, your beneficiaries will get less money if you die toward the end of your policy's term.
Decreasing term insurance in action
Here's how decreasing term life insurance might look for a 15-year policy with a starting death benefit of $500,000. Note how you'd leave beneficiaries roughly $33,000 if you died within the last year of the policy.
Alternatives to decreasing term life insurance
Decreasing term life insurance isn't the only way to tailor a life insurance policy's death benefit to your future needs. Consider these options:
Level term life insurance
Many insurers allow you to reduce the death benefit of a regular term life insurance policy at least once. This helps you lower your premiums if you no longer need as much coverage later in life.
You can also "ladder" multiple term life insurance policies to cover financial obligations that end at different times. For example, you could take out a 30-year policy to match your 30-year mortgage and a 20-year policy to cover your kids until early adulthood, when they will likely start earning their own money.
Annual renewable term life insurance
Another way to pay for your needs is to get an annual renewable term life insurance policy. This type of policy provides coverage for one year at a time. At the end of each year, within the policy's term, you can renew your coverage without having to go through the application process. The death benefit stays the same, but your premium will probably increase yearly. Annual renewable term insurance is typically best for people who only need life insurance for a few years.
Mortgage protection insurance and credit life insurance
Both mortgage protection insurance and credit life insurance are variations of decreasing term life insurance. These policies cover your mortgage or other personal loan balance if you die before it's paid off. The death benefit typically goes to the lender, meaning your loved ones won't get any money.
Is decreasing term insurance worth it?
While decreasing term life insurance is often used to cover financial obligations that diminish over time, life is unpredictable. A downswing in the economy or a significant life event can cause unforeseen expenses that the payout from a decreasing term life insurance policy might be unable to cover.
While the premiums may be lower than those for a level term life insurance policy, you get significantly less coverage over the policy term. That's why it's usually better to buy a level term policy and reduce its coverage later if needed.
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