Decreasing Term Life Insurance: A Quick Guide

The image shows an older couple and a caregiver discussing decreasing term life insurance.

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All types of life insurance can be divided into two basic categories: term and permanent. Permanent policies include whole life insurance, universal life insurance, and variable universal life insurance. This type of insurance is more expensive because it also builds up cash value over time.

Term insurance provides pure death benefit protection and is less expensive than permanent insurance. Decreasing term insurance falls into this category. (And there is no such thing as decreasing permanent life insurance).

Types of term life insurance

Term insurance has no cash value but costs much less than permanent coverage. As the name states, term insurance has a death benefit amount that lasts for a specific period of time or term. The term can last anywhere from one to 30 years. When the term is up, the coverage also terminates unless it is renewed. But the cost of the policy will go up with every renewal because the insured will be that much older at the end of each term.

Term insurance generally becomes cost-prohibitive once the insured gets into their sixties or seventies, and most insurers will not issue term coverage past the age of 80 or 85. Term life insurance is often purchased by young families who need a greater amount of life insurance coverage but don’t have much money to spare. It is also appropriate for other insureds that need a set amount of coverage for a specific period of time.

There are several types of term life insurance options available in the marketplace today, and each one is designed to cover a different type of need. They are broken down as follows:

Level term life insurance

Level term coverage is one of the most common forms of term insurance. As the name states, the premiums for this type of term coverage remain level throughout the term and do not increase or decrease.

This type of term insurance is the best coverage for those who are on a fixed budget and need to know exactly how much they’ll have to pay and for how long. A 30-year term policy is an example of this.

Increasing term life insurance

This type of term insurance allows the insured to increase the amount of coverage as time goes on, such as when he or she is making more money and can then afford higher premiums for a higher death benefit. These policies start out being relatively small and cheap and increase in both price and face amount as time goes on.

The advantage to using this kind of policy is that it allows the insured to qualify for the coverage when they are still young and in good health. Then, as they get older, they can add to the death benefit without having to go through additional underwriting.

Guaranteed renewable term life insurance

Guaranteed renewable term coverage means that the insured is guaranteed to be able to renew your coverage when the current term is up. The premiums will be higher when the time comes to renew, but the insurance company can’t turn the insured down if he or she elects to continue with the coverage beyond the renewal date.

Annual renewable term insurance is one kind of guaranteed renewable coverage where the insured elects to extend coverage out for another year at a higher premium. The advantage to this is that the insured only pays for the term coverage for exactly the term length that he or she needs.

Convertible term life insurance

This type of life insurance is typically a form of level term coverage that allows the insured to convert the policy into a smaller amount of paid-up permanent coverage. Convertible term insurance is the only kind of term coverage that can be sold in a life settlement transaction because of its conversion feature. The conversion feature usually comes at an additional cost, so insureds that purchase this form of coverage usually intend to convert their policies at some point.

Decreasing term life insurance

This is another form of level term life insurance because the premiums remain the same throughout the term of the policy. However, the policy’s death benefit decreases over time. The death benefit in some policies decreases on a monthly basis while others only decrease once a year.

These policies are usually not cost-effective by the end of the term, meaning that the insured is paying more for less coverage by the end of the term. This is true even if the policy is purchased from one of the best life insurance companies. For this reason, many financial planners eschew these policies in favor of level term policies.

Grandparents celebrating with their grandchildren in the park after paying off their debts with decreasing life insurance.

Decreasing term life insurance policies are not always the best option. Nevertheless, many forms of credit life insurance such as mortgage protection insurance come in this form.

Check your life insurance quotes for this type of insurance against those for other more conventional types of policies and see how they stack up. Just know that any type of decreasing term policy will not have a critical illness rider or any other type of ABR, such as a terminal illness rider.

Why would I want to buy decreasing term life insurance?

Decreasing term insurance is typically used to provide repayment of a specific debt that is either in the name of the insured or one of the insured’s loved ones. The benefit amount of decreasing term insurance is always shrinking in value over a set period of time. The decreasing term policy is usually structured so that the face value always equals or slightly exceeds the amount of the insured’s financial needs.

The primary advantage of decreasing term coverage is that it usually doesn’t come with underwriting requirements, so those who are in poor health can still buy this type of insurance. Decreasing term policies are sold in terms ranging from one to 30 years.

Mortgage life insurance is probably the most common form of decreasing term life insurance in the marketplace today. Many mortgage lenders require that the homeowner gets this kind of coverage so that they are covered if the homeowner dies prematurely. In most cases, the mortgage life insurance policy is structured so that the amount of coverage always equals or slightly exceeds the amount of the mortgage balance.

In fact, many mortgage lenders actually sell this type of policy to the homeowner as a second line of business. There are also life insurance agents that sell this type of policy and who work closely with real estate agents and mortgage brokers. But a homebuyer who is not offered this type of coverage during the homebuying process may be hard-pressed to find this type of coverage on his or her own, since only a select few companies offer this type of coverage today.

An example

A 30-year old nonsmoking male could buy a 20-year decreasing term policy with an initial death benefit of $275,000 to cover his mortgage. The monthly payment for this amount of initial coverage might be around $45 per month. The amount of coverage will decrease in tandem with the amount of equity that is accumulated in the home. As the policyholder ages, the risk to the insurance company increases, so the decreasing death benefit helps to offset this risk.

But mortgage insurance can cost up to three to five times what a traditional term policy costs, mainly because there are no underwriting requirements. For this reason, it is not always the best life insurance to buy if the insured has a choice, and other types of coverage can better meet the insured’s life insurance needs.

However, it is still cheaper than any type of cash value policy that has an equivalent death benefit. The insured in the example above might have to pay a monthly premium of $120 or more for the same amount of coverage from a universal life policy. (Of course, the death benefit with the UL will not decrease over time.) But many financial planners still view this as a disadvantage in most cases.

Another key disadvantage of decreasing term insurance is that in most cases, you don’t get to name your own beneficiary. The mortgage company or other lender will require you to name them as the sole primary beneficiary in order to recoup their loan balance if necessary.

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Some credit card companies also offer consumers decreasing coverage so that their balances are cleared out if something were to happen to them. Or a standalone policy could be used to cover financial obligations such as the remaining balance on an auto loan, a boat or other RV loan, a personal loan, or a business loan. It could also just cover the insured’s beneficiaries if they are growing progressively less financially dependent on the insured as time goes on and they get older.

Decreasing term coverage may also make sense if you simply want to cover your family with a larger death benefit at first, then reduce it as time goes on and your kids grow up and you accumulate other assets. You may not need further coverage by the time your kids go off to college or you pay off your debts.

Can decreasing term life insurance have accelerated death benefit riders?

Decreasing term life insurance cannot have accelerated death benefit riders, because the amount of the accelerated benefits would slowly go to zero over the life of the policy. The face amount of ADBs needs to stay constant in order to be used by the insured and cannot shrink.

If the insured was to become disabled, then he or she would most likely need the full amount of ADBs in order to cover his or her lost earnings and medical bills. If the ADB shrinks over time, then the insured would have practically no ADB coverage by the end of the term. ADBs are therefore impractical additions to include with a decreasing term policy.

The life settlement alternative

If you have debts such as mortgage payments that you want to pay off but no money to do it with, then you may want to consider selling your insurance policy to a life settlement company. You’ll need to be at least 60 or 65 years old and own either a cash value policy or a convertible term life insurance policy with a face amount of at least $100,000.

If you meet these criteria, then you can approach one or more life settlement companies and tell them you’d like to sell your policy. They will require a copy of your policy along with all of your medical records to evaluate how much they can give you. They may also require a medical exam in some cases. The company will then come back to you with an offer for a lump sum cash payout.

If you accept the offer (from the company offering you the most money, of course), then you will sign the ownership of your policy over to the life settlement company. The company will then name itself as the new primary beneficiary and will also assume the responsibility of paying the policy’s monthly premiums until you die. The company will then collect the death benefit and thus recoup its premium outlay plus what it paid you for the policy (and also make a profit).

In most cases, the insured will collect an amount upfront that is equal to at least two to three times the amount of cash value in the policy. This is much more than the insured could get from a simple policy withdrawal or loan or from surrendering the policy and taking the remaining cash surrender value.

It should be noted that there are usually tax consequences for life settlement transactions. And the tax rules at the state level can differ widely from one state to another. For example, the laws in New York may be very different from the laws governing this type of transaction in Florida, Rhode Island, or other states. Insureds should therefore consult with their tax advisors before selling their policies.

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If you have one or more major debts that you would like to pay off if you die, then a decreasing term policy could be just the type of policy that you need for your life insurance plan. Consult your financial or tax advisor or your life insurance agent for more information on this type of coverage and how it can work for you.

If you’re considering a life settlement and want to know how much you could sell your life insurance for, try our instant life settlement calculator. 

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.