What is Decreasing Term Life Insurance?
Decreasing term life insurance is a type of life insurance coverage that lasts for a certain amount of time, has a level premium, and a decreasing death benefit that declines at a predetermined rate over the policy term. At the end of the term, the death benefit reaches $0.
How decreasing term insurance works
When you buy life insurance, you choose between two main categories: permanent and term insurance. Permanent coverage lasts the insured’s lifetime with the original policy specifications intact. Term insurance, on the other hand, lays out a specific premium and benefit for the agreed-upon term (say, 10 or 30 years).
Most term life insurance policies come with a fixed death benefit in exchange for the policy owner paying fixed premiums throughout the term. That means that whether the insured dies in the first few years of coverage or near the end of the policy term, the beneficiaries will receive the same amount of money.
Alternatively, you can choose decreasing term life insurance. With these types of policies, you pay a fixed premium through the life of the policy, but the death benefit decreases at a set rate on a regular basis, usually monthly or annually. You might buy a decreasing term policy with a $500,000 benefit that decreases by 5% annually, for example.
Long story short, both traditional term policies and decreasing term policies come with set premiums you pay over a specified term. The difference comes down to the size of the death benefit over time.
Why do people buy decreasing term life insurance
The main draw of decreasing term life insurance is it’s affordable. Because the decreasing death benefit reduces risk for the life insurance company over time, they’re able to offer lower-cost premiums. Decreasing term coverage is cheaper than standard term life insurance, which is already cheaper than permanent life insurance. In other words, it’s some of the most cost-effective life insurance you can buy.
Many people choose decreasing term insurance when they’re taking on a sizeable amount of debt. You might buy this policy in tandem with taking out a mortgage or a business loan, for example. The idea is that the policy’s death benefit can decrease alongside your debt. In fact, some decreasing term policies can even be customized to match your amortization schedule.
The drawback of decreasing term life insurance
The main problem with decreasing term life insurance is that by the end of your policy term, you’re paying premiums for very little potential return. You’ll be stuck paying the same amount of money you paid at the start of your policy, when the death benefit was sizable, even as that benefit dwindles to zero.
Because level-benefit term life insurance is already relatively affordable and it offers a consistent benefit throughout the term — and potentially beyond, with renewability and conversion options — it may be a better fit for your long-term needs.
Level Term vs. Decreasing Term Life Insurance
Level premium term life insurance provides a set death benefit for the entire term in exchange for a set premium. On the two opposite sides of the spectrum, you have annual renewable term, also known as increasing premium term, and decreasing premium term.
Annual renewable term has a level death benefit and an ever-increasing premium while, as the name implies, decreasing term’s death benefit is on a downward slope. All term policies have their place, but the most common—by a longshot—is level premium term.
Level premium term fills the regular need of providing a death benefit to a family without breaking the bank. Annual renewable term offers the lowest possible premium for a level death benefit where you are technically only ever paying for the cost of insurance. Decreasing term works best to manage a specific liability such as a mortgage or other debt.
The chart below illustrates the effect of a decreasing death benefit as opposed to a level death benefit.
Decreasing term insurance vs. credit life insurance
It can be easy to confuse decreasing term life insurance with credit life insurance because both have decreasing benefits and, generally speaking, most people buy them to cover specific debts. There is one key difference, though. Credit life insurance policies name the lender as the beneficiary, which means that if you die with outstanding debt, the policy benefit goes straight to the bank or financial institution.
With decreasing term insurance, on the other hand, you can name anyone you want as the beneficiary. You could name your spouse as the policy beneficiary, for example. They would then have the option to use the benefit to pay off any outstanding debts or to divvy it up or divert it elsewhere. They might choose to use part of the money to cover your funeral expenses, for example, while keeping the remainder in savings to make ongoing payments toward your debt comfortably.