When you purchase life insurance, you safeguard your family’s financial future, making sure they’ll be able to sustain their lifestyle if you die. Today’s coverage options are numerous and varied, which can make it difficult to choose the right policy, and it can be even more challenging if you’re on a limited budget. One affordable option to consider is decreasing term insurance, which we’ll explore in this article.
What Is Term Life Insurance?
Term life insurance refers to policies that provide coverage for a predefined period of time, which is usually between 10 and 30 years, depending on the carrier and individual plan. Most policies that fall under this umbrella provide level term benefits, with both premiums and payouts staying the same throughout the policy's life span. However, other types of term life insurance policies are available, including increasing and decreasing term coverage.
What Is Decreasing Term Insurance?
Because it's considered term life insurance, decreasing term insurance offers coverage for a predefined period of time that typically ranges anywhere from 1 to 30 years. Unlike level term policies, however, the death benefit payout of decreasing term insurance declines in value over the life of the plan while premium rates stay the same.
How Does Decreasing Term Life Insurance Work?
Decreasing term life insurance is similar to other types of term life plans in that coverage lasts for a preset period of time up to 30 years. During this period, the value of the plan — or death benefit payout — steadily decreases, often until it reaches zero. Often, carriers will structure a decreasing term plan so that it reflects the payoff amount of a mortgage or other loan.
For example, take a policyholder who wants to ensure that his loved ones can cover a $200,000 mortgage upon his death. At the policy's inception, the death benefit would ideally be $200,000. That amount would then decrease over the lifetime of the policy, with benefits declining incrementally until they reach zero. For purchasers looking to cover a specific loan, the term of the policy should be greater than or equal to the payment schedule of their loan.
In other words, if the policyholder died immediately after purchasing the insurance, the beneficiaries would receive $200,000, which is enough to pay off the mortgage. If, instead, the policyholder died two years later, the policy might only be worth $180,000 depending on the preset decrease. This decline in value would continue throughout the lifetime of the policy.
What Is Mortgage Life Insurance?
Mortgage life insurance is a type of decreasing term insurance that’s designed to match the structure of your mortgage. It’s typically set up so that the mortgage lender is the beneficiary and the policy duration matches the number of years left on the term of the loan. The decreases in the value of mortgage life insurance should reflect the new mortgage balance each year.
Mortgage life insurance may be a requirement of certain loans, although many lenders will waive the requirement for borrowers who maintain permanent life insurance.
Should I Get Level Term or Decreasing Term Life Insurance?
If you’re deciding between level or decreasing term life insurance, it should come down to your needs. With level term life insurance, the death benefit remains the same for the policy's lifetime, which makes it a good choice for individuals who want to provide for their families' living expenses after they die. On the other hand, decreasing term life insurance isn't designed to cover long-term costs of living for beneficiaries and is usually purchased to fulfill a specific financial need.
Individuals who fall into the following categories may benefit from decreasing term insurance:
- Homeowners who want to cover the balance of their mortgage
- Business owners who are in a partnership or who are paying down startup costs
- Parents of children nearing adulthood who will require less support as they become financially independent
- Individuals who have sufficient savings to support their family after their death but who want enough insurance to pay off outstanding debts
What Else Should I Consider Before Purchasing Decreasing Term Insurance?
Decreasing term insurance has both benefits and pitfalls. If you’re considering a decreasing term policy, you should consider the following characteristics of these plans:
- Policies typically cost less than level term life insurance.
- Plans may be renewable if you wish to extend the term.
- Some policies can be customized to match your mortgage amortization schedule.
- Plans have no maturity value. At the end of the term, your policy will typically have a face value of zero, which means you won’t get any payout if you live beyond the end of its duration.
Are Decreasing Term Policies Renewable?
Your policy specifics will depend on your carrier and individual plan, but many decreasing term life insurance policies are renewable. Essentially, that means you can extend the term of your coverage without submitting a new application.
Although renewable policies can be beneficial for individuals who are paying off debts without strict term limits, such as college tuition, they tend to renew at a higher cost. When purchasing the policy initially, it may be worth extending the term to account for delays in debt payoff rather than worrying about renewing later on.
Are Critical or Terminal Illness Riders Available with Decreasing Term Policies?
Many carriers offer purchasers the option to include terminal or critical illness riders. Although they may come at an additional cost, these add-ons can provide essential benefits.
Critical Illness Riders
Critical illness riders let policyholders collect a portion of their death benefits while they’re still alive if they’re diagnosed with a covered illness. These payouts are typically tax free and can be used to pay for caretaking and medical expenses. Because covered illnesses vary widely among carriers, it’s usually best to discuss the specifics with your agent or plan representative.
Terminal Illness Riders
Terminal illness riders are often included at no additional cost. With this coverage, policyholders who've been diagnosed with a terminal illness can access a portion of their death benefits while they’re still alive to help cover expenses such as hospice or nursing home care. Most carriers define a terminal illness as a condition that gives you less than a year to live.
When Should You Recruit a Financial Advisor?
Understanding the subtle distinctions between different types of life insurance policies can be challenging. A reputable financial advisor can help you navigate the available options to make an informed choice and can guide you through choosing the right amount of coverage and ideal type of life insurance for your unique needs.