Decreasing Term Life Insurance

What Is Decreasing Term Life Insurance?

Decreasing term insurance is a term life insurance policy with coverage — or death benefit — that decreases over time, usually annually, until the term ends.

Premiums usually remain constant throughout the contract, with the terms ranging from one year to 30 years depending on the insurer. Similar to a term life insurance policy, you purchase a decreasing term life insurance policy for a fixed length of time, after which, it expires.

Decreasing term life insurance is usually used to guarantee the remaining balance of a temporary financial obligation.

Decreasing term life insurance is one of many types of life insurance tailor-made for specific purposes. It is not a fit for everyone who needs life insurance. Despite the lower costs compared to level term insurance, it may provide less coverage for your heirs when you need it.

Stephen Kates, CFP®, Licensed Life Insurance ProducerPrincipal Financial Analyst for Annuity.org

Stephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.

How Does Decreasing Term Insurance Work?

Unlike a level term life insurance policy, the payout or death benefit of a decreasing term life policy lessens over time. This helps provide affordable coverage for a set period.

When you purchase decreasing term life insurance, you choose the level and length of coverage. Each year, your coverage will drop by a certain amount until reaching zero by the end of the term. Since your payout declines, decreasing term insurance often has lower rates than other types of term life insurance.

For example, let’s say you purchase a decreasing term life insurance policy for $500,000 of coverage on a 25-year term with a 4% reduction rate. Each year, your coverage would decrease by $20,000, or 4% of the original $500,000.

If you were to die in the first year of the term, your beneficiaries would receive the full $500,000 death benefit. Each year after that, however, the total payout would decrease 4%. So, if you died in the tenth year of the term, the payout would be $300,000. If you died in the final year of the decreasing term, your beneficiaries would be entitled to $20,000.

The death benefit would reach $0 when the policy ends after the full 25-year term.

Pros and Cons of Decreasing Term Insurance

One of the major advantages of decreasing life insurance is the lower cost premiums, compared to similar term life insurance policies. However, decreasing term may not be the right choice for someone who has dependents. Before you purchase a policy, explore some of the advantages and disadvantages.

Advantages

Decreasing term insurance’s affordability, relative to level term or permanent life insurance, is a draw for potential buyers. It has modest premium rates for comparable payout amounts.

Decreasing term insurance is also commonly used to pay off any debts, such as a mortgage or small business expenses. Benefits and the length of the policy can be scheduled to match the amortization of a mortgage or of personal and business loans.

For example, in the case of a small business, should one partner die, the death benefit from the decreasing term policy can help provide financial security and keep the business running for the other. The payout can also help cover debts from the deceased partner.

Disadvantages

The declining death benefit over time is the biggest drawback of a decreasing term policy. As time goes on, your beneficiaries are entitled to less and less compensation should you pass away.

Another disadvantage is that decreasing term may not provide sufficient coverage for an individual’s life insurance needs, particularly to cover lost wages if that person has dependents or others for whom they are financially responsible.

And while a decreasing term insurance policy may be cheaper, remember that is because it fundamentally offers less coverage than level term or permanent life insurance. Some prefer a traditional life insurance offering instead.

Is Decreasing Term Insurance Right for You?

Whether decreasing term insurance is right for you depends on the reason you are buying it and what you hope to insure with it.

If you were a small-business owner, decreasing term insurance can be useful to protect against debts, such as startup costs and operational expenses. It can also provide protection for a surviving business partner in the event of the death of one or more partners. This insurance might also be required to guarantee a commercial loan.

For many individuals, however, decreasing term insurance may not provide the protection for loved ones and beneficiaries that other types of life insurance can.

Consider how the decreasing death benefit overtime could impact you or your beneficiaries. While there might be some savings on monthly premiums relative to other kinds of insurance, decreasing term insurance may not provide the coverage needed should you experience life changes like the birth of a child or tuition payments.

Likewise, something unexpected can happen, such as a disability or loss of income prior to the policyholder’s death — decreasing term insurance doesn’t have the flexibility in those cases that other types of life insurance do.

Also, consider what coverage you may need down the road when discussing decreasing term insurance as a possible policy.

Alternatives to Decreasing Term Insurance

There are several alternatives to decreasing term insurance if it isn’t the right choice for you.

Other Insurance Options

Level term life insurance

• Level term insurance offers steady premiums and guarantees greater financial protection than decreasing term insurance over a specific length of time (usually between 10 to 40 years). Level term life insurance can be an effective replacement for basic income and can cover large expenses like funeral costs or health care bills.
• Term life insurance is far more affordable than most people assume. Roughly 43% of millennials overestimate the cost of term life insurance by up to six times the actual amount, according to a data report from Limra.

Term laddering

• The process of laddering your life insurance policies involves building coverage with multiple policies of differing amounts. Each policy expires at a different time, leaving you with continuous coverage but decreasing premiums.
• You might ladder policies to protect your family most when you are younger and expenses are high. This allows for less coverage later in life when your mortgage is paid off and your children have moved out. This strategy can save you money on premiums over the long term.

Permanent life insurance

• Permanent life insurance (which doesn’t expire) builds cash savings that earn interest over time.
• Because of their higher premiums, permanent policies typically make the most sense for high-income earners looking for additional tax-deferred savings after maxing out other options. It’s best suited for those who want to leave a tax-free inheritance for their heirs or for people with lifelong dependents, such as a family member with disabilities.