May 6, 2019 12:00 PM PT

Decreasing Term Insurance

What is decreasing term life insurance?

Decreasing term life insurance provides a death benefit that gradually decreases over the life of the policy. In other words, the monthly premiums remain the same, but the amount of coverage provided goes down over time.

The idea is that as you age, you will pay off debts and have fewer financial obligations and liabilities. Therefore, your family will need less of a financial payout after you die.

Here's an Example:

John has $20,000 in student loan debt, $8,000 in auto loan debt, and a $1,000 per month mortgage. He buys a $100,000, 15-year decreasing life insurance policy.

His monthly premiums never change—about $35. But each month, the $100,000 death benefit decreases. Over 15 years, John pays all of his student and auto loan debt, as well as most of his mortgage. He is now essentially debt-free, has a secure job, and savings in the bank.

After 15 years, the death benefit has reached $0 and the term policy will end. But John's paid his debts and now has enough savings to pay for a funeral should he pass away.

Decreasing term insurance is commonly used as coverage for:

Mortgages
Personal loans
Business loans
Auto loans
Student loans

Policy terms range from 1 to 30 years. Reductions in coverage occur monthly or annually.

How decreasing term life insurance works

The death benefit for decreasing term is designed to mirror the amortization schedule of a mortgage or other loan debt.

An amortization schedule is a table of loan payments. It shows the amount of the principal and interest for each payment until the loan is paid off.

At first, your payment is typically applied to the interest. But the more you pay off, the less interest you have, until the majority of payments cover the loan's principal amount.

Decreasing term insurance works in a similar way. Your monthly premium goes towards paying off the death benefit. Each month (or year, depending on your policy), your death benefit will decrease.

As you age, the risk of a life insurance carrier having to pay a death benefit increases. This increased risk warrants the declining death benefit.

At the end of the term, the death benefit will be $0 and you will no longer owe premiums.

Who can buy decreasing term life insurance?

Decreasing term life insurance can be purchased by most people ages 18-75. As with other life insurance policies, premiums vary based on:

Age
Health
Occupation
Term length

This type of insurance may be difficult to obtain if you are terminally ill, such as having a cancer diagnosis. However; if you have a chronic illness, like diabetes, but are generally in good health, you may still qualify (though your premium may be much higher).

A decreasing term policy alone probably isn't sufficient for all of your life insurance needs. This is especially true if you intend for the death benefit to be used to take care of children or other needs.

Advantages of Decreasing Term Life

Here are a few primary benefits of decreasing term life policies.

Helps Beneficiaries: This policy ensures your beneficiaries will be able to pay off your debts if you pass away.
Coverage When You Need It: If your need for life insurance decreases in later years, you don't have to continue paying for coverage.
Assures Lenders: If you own a small business, this type of life insurance shows commercial lenders that your company can cover initial costs and pay back business loans.

Drawbacks of Decreasing Term Life

This type of coverage may seem like the right fit if you are only purchasing a policy to help cover debts. But consider these drawbacks:

Higher Cost: Typically the premiums are higher than a traditional term, though they may be lower than whole or universal life options.
Lower Benefit: Even though your death benefit will be lower, you're still paying the same amount of money through the duration of the term.
Limited Options: Few companies offer this product, so you likely won't have a lot of purchasing options.
Less Control: You can't name your beneficiary. In fact, the beneficiary for the policy is the creditor (like the bank that owns your loans).

Talk to a life insurance agent to figure out if a decreasing term or term layering is right for you.

An Alternative: Term Layering

If you are undecided about a decreasing term policy, consider term layering, or term laddering.

With term layering, you can stack two or more traditional term life policies and get the same basic outcome as with decreasing term coverage.

Here's an Example:

John and Sarah, mid-30s, are married with two young children. John has student and auto loan debt to pay off over the next 10 years.

However, John wants to ensure his children are taken care of until they are adults.

So he opts for two term policies: one for 10 years for $100,000 and one for 20 years for $500,000. This ensures he has coverage to pay off his loans until they are paid off and then maintain long-term coverage for his children.

Bottom Line

If you are buying a life insurance policy to cover your mortgage, student loan, credit card loan, or other debts, a decreasing term life insurance policy might be the right choice.

As you age and the amount of money you owe decreases, you won't need as much life insurance to cover those debts. Decreasing term gives you the benefit of having only the coverage you need for the amount of time you need it.

Talk to a life insurance agent to see if decreasing term life policies are suitable for your circumstance and needs.

Write to Caitlyn Callahan at feedback@creditdonkey.com. Follow us on Twitter and Facebook for our latest posts.