What Is Decreasing Term Insurance? Is It Right for You?
A decreasing term life insurance policy is one in which the benefit decreases on a monthly or annual basis. The policy's size continues to shrink until either the policy pays out or the coverage period expires. A decreasing term life insurance policy is typically used to cover a loan or other financial obligation that will decrease in size over a specified time period.
For example, if you only need enough life insurance to cover your mortgage so that your family can keep your home after you die, the death benefit of a decreasing term policy can be structured to decrease as you pay off the outstanding balance. Because of the decreasing death benefit, decreasing term life insurance is frequently less expensive than a term life insurance policy.
How does decreasing term life insurance work?
The payout structure of decreasing term insurance, also known as DTA insurance, differs from that of a standard term policy or level term life insurance. While the face value of a level term life insurance policy remains constant throughout the policy's term, the death benefit for decreasing term insurance decreases either monthly or annually. However, the two policies are similar in that they both have fixed premiums and term lengths ranging from five to thirty years.
- Assume you purchased a $500,000 face-value 25-year decreasing term life insurance policy. Your beneficiaries would receive the full $500,000 death benefit if you died during the first year of coverage. If the policy's coverage was reduced by 4% per year, the death benefit would be $480,000 in year two (a $20,000 reduction). This reduction would be applied annually until the policy paid out if you died, or until the policy's term expired after 25 years.
Year | Decreasing Term Death Benefit | Level Term Death Benefit |
0 | $500,000 | $500,000 |
5 | $400,000 | $500,000 |
10 | $300,000 | $500,000 |
15 | $200,000 | $500,000 |
20 | $100,000 | $500,000 |
25 | $0 | $500,000 |
Terminal and critical illness riders
Most decreasing term life insurance policies include or permit the addition of terminal and critical illness riders. A terminal illness rider is typically included at no extra cost and allows you to access your policy's death benefit while still alive if you require funds to cover expenses such as hospice care, the hiring of a caretaker, or nursing home residence. The money is usually distributed on an as-needed basis and can amount to up to 80% of the death benefit. However, you will not be able to use the rider unless you have been diagnosed with a terminal illness, which means you have less than 12 months to live.
When added to a decreasing term insurance policy, a critical illness rider is optional and often comes at an additional cost. This rider allows you to collect a portion of the death benefit for expenses in the same way, but the funds are usually paid in a tax-free lump sum. The life insurance company determines whether you're critically ill, and it's only considered a diagnosis if you've had a serious issue, such as a heart attack, ALS, kidney failure, stroke, or cancer. Because insurers differ in their list of different conditions covered by the rider, we recommend researching the providers' critical illness policy.
Why buy decreasing term life insurance?
If you are looking for life insurance to cover debts, loans, or other financial obligations, decreasing term life insurance can be a useful tool to cover obligations that are shrinking in size over a set period of time. After you die, a decreasing term policy can help ensure that your beneficiaries receive enough money to pay the remaining portion of your debt. You could use decreasing term insurance to cover the following debts:
- Mortgage loans
- Auto loans
- Personal loans
- Business loans
For example, the death benefit of a term life insurance policy can be structured to match your outstanding mortgage, and as mortgage payments are made on a regular basis, the face value of the policy decreases. If you died, the policy would pay out to your designated beneficiary, who would then be able to pay off the mortgage.
Decreased term insurance policies are similar to credit or mortgage life insurance policies in this regard. Credit life insurance policies, on the other hand, name the lender as the beneficiary, which is usually the bank. Decreasing term life insurance policies differ in that anyone can be named as a beneficiary. Instead of the money going directly to the bank, you may want this flexibility to allow your loved ones to decide how to allocate the funds from the death benefit.
- For example, your partner may prefer to stop making mortgage payments and instead put the money toward your child's education. This would not be possible with a mortgage life insurance policy, where the death benefit is applied directly to the loan repayment.
Similarly, when small businesses borrow money for operations, the owners may buy decreasing term life insurance in case one of them dies. This would help ensure that any costs were continued to be paid.
Aside from loan payment coverage, you may want to consider a decreasing term life insurance policy if your financial obligations will decrease over the term of the policy. For example, if your children are off to college or starting their first job, you may have less need for life insurance coverage in the next five to ten years. In this case, a decreasing term life insurance policy, in which the death benefit begins large and then gradually decreases over time, may provide you with the most assurance.
Cost of decreasing term life insurance
A level term life insurance policy is usually more expensive than a declining term life insurance policy. Because the death benefit of a decreasing term policy decreases with each period, the insurance company will not require such high premiums from you due to the decreasing risk you present. It is critical to remember that the premiums for both types of policies remain constant throughout the term life.
Choosing the best decreasing term insurance
In recent years, the availability of decreasing term life insurance has decreased, but it is still available from a few reputable insurance companies. Farmers, Banner Life, Prudential, Protective Life, and John Hancock are all companies that offer decreasing term insurance policies. Farmers Insurance, for example, offers a policy with coverage starting at $25,000 and term lengths of 15, 20, 25, and 30 years.
When looking for the best decreasing term insurance for yourself, choose a policy that will cover unexpected situations. Purchasing coverage that is slightly longer than the term of your outstanding mortgage, for example, can be beneficial if you have to delay mortgage payments at any point. It can be beneficial to consider potential situations like this in advance so that you can select the best coverage possible.
We also recommend comparing quotes from multiple insurance companies when shopping for insurance coverage to ensure you are getting the best rates possible. Because life insurance companies evaluate applicants differently, if you have a pre-existing condition, you may be able to get a significantly lower rate with one insurer versus another.
When you should choose level term life insurance
If you die, level term life insurance gives your beneficiaries more flexibility to cover unexpected expenses. For example, you could purchase a policy large enough to cover the mortgage (similar to decreasing term insurance) and, as your outstanding balance decreases, your family could use the excess coverage as they see fit. The funds could be used for a variety of purposes, including education, food, travel, and/or unexpected financial difficulties.
Furthermore, level term insurance provides a consistent and higher death benefit throughout the policy's term. Unless you are confident that your need for life insurance will decrease over time, we recommend a more consistent policy, such as level term life insurance.
If your financial needs change after you've purchased life insurance, you won't be able to increase your coverage without purchasing a new policy or going through a scheduled reexamination. Furthermore, depending on the insurance provider, if you pay off your debt and require less coverage, you may be able to reduce the face value amount on level term insurance.