Life Insurance: When to Consider Decreasing Term
decreasing term life insurance is a type of life insurance that begins with a high face value and very low premium—sometimes even lower than level term. The premium remains level for the duration of the policy, but the face value drops over time, sometimes annually, and sometimes in five year intervals.
Since premiums remain the same each year as the face amount decreases, you may wonder why a person would even consider purchasing decreasing term. Indeed, not many companies sell it, however in some circumstances it could be a good idea.
Decreasing term life insurance is actually the original mortgage insurance, also known as mortgage protection insurance. Although there was not a one to one correlation, the idea was that for just a few dollars over the monthly mortgage payment, a borrower could have insurance that would pay the mortgage in the event of the insured’s death. Just as your mortgage drops very slowly in the first 10 years or so, since you are paying mostly interest in those years, the value of the insurance also drops slowly. In later years, the decrease escalates, and after the last year of renewal, the insurance ends.
Mortgage companies still offer decreasing term. Most term insurance companies only sell level term initially, but offer a conversion to decreasing term when the initial policy expires. If, however, you are able to purchase a decreasing term from the start, you will get a much higher initial face value. This could be useful for protecting a business loan, or for providing a pot of money for a young family. Ideally, the high face value will not be needed in later years, especially if you also maintain a savings program.
Like any other kind of term, decreasing term life insurance plans have no cash value, although some companies do offer a separate savings plan as a means of providing funds once the insurance expires. However, this means that you have no particular obligation to keep the policy once you have exhausted the need for it. You have nothing to lose except the coverage.
Decreasing term insurance has its place, but one caution is in order. That is, do not base your purchase of life insurance on the hoped-for existence of a retirement plan such as an IRA. If you plan to have a savings plan that will replace the life insurance, you want to be sure it in an unqualified savings account—meaning it will be funded with money on which you have already paid taxes. The last thing you want to happen is for your heirs to have to pull a large sum of money out of an IRA to pay for your final expenses and provide the family with an immediate “survival” mechanism. Furthermore, if a beneficiary has to cash out an IRA for estate taxes, they can very quickly lose as much as 80% of the IRA to a combination of income taxes and inheritance taxes. If you have reason to believe that your estate will some day be substantial, there is no better way to protect it than with the largest whole or universal life you can afford.