Level- vs. decreasing-term life insurance: What’s the right policy for you?
E*TRADE from Morgan Stanley01/18/23
Summary: If you’re looking for financial protection at an affordable price, level- and decreasing-term life insurance are two options to consider. Learn the key difference between the types of policies and how they can help you prepare for the unexpected.
If you’ve recently shouldered a major liability like taking out a mortgage or experienced a significant life change such as the birth of a child, securing a life insurance policy is an important next step to help protect your loved ones—and your long-term financial goals. Losing an income earner could derail your family’s financial plans such as saving for retirement and college or paying down a mortgage or business loan. If the worst were to happen, would they be able to stay on track?
Term life insurance is one type of policy that offers financial protection: You choose the length of the term and the amount of coverage, so you can tailor it to your needs and keep premiums affordable.
You can also consider whether you want the death benefit1 to remain level or decrease over the term of the policy, which is another way to find coverage that fits your specific financial needs and budget. How do you know which is right for you? Here’s a breakdown to help you decide.
Level-term life insurance
With a level-term policy, you purchase insurance for a set period and coverage amount and pay the same premium for the term of the policy. If you pass away while the policy is in effect, your named beneficiaries receive a death benefit equal to the amount determined in your policy.
So, if you purchase a 20-year policy with $500,000 in coverage, a level term would provide a $500,000 death benefit for all 20 years.
This type of policy can provide broad coverage within a specific time frame. For example, if you only need life insurance until your youngest child finishes college, you can find a policy that fits that timeframe.
Decreasing-term life insurance
With a decreasing-term policy, you also purchase insurance for a set period, but the coverage amount diminishes over the term. It’s intended to cover financial obligations that decrease over time, like a business loan or mortgage.
Using the same example above but with a decreasing death benefit, if you purchase a 20-year policy to cover a $500,000 mortgage, coverage may decline 5% to $475,000 in the second year, then to $450,000 in the third year, and so on until there is no benefit by the end of the 20-year term.
Since the death benefit is customized to match your loan’s amortization, these policies may cost less than those that offer a level benefit.
Which policy is right for you?
In short, both types of policies offer coverage for a set term but with key differences in their death benefits. Choosing a policy will depend on several factors including your individual and family financial situation. Here are two questions to consider:
- Are you looking to protect a loan or a decreasing financial commitment? If so, consider a decreasing-term policy. This may be a good option for someone who wants to match a loan schedule to help keep a company in business or a family remain in their home.
- Are you looking for more general protection? If so, consider a level-term policy. This may be a good option for someone who wants to cover a broad range of expenses for their loved ones, like raising children, paying for college, or daily living expenses.
Of course, there are pros and cons of both types of policies, but identifying what is most important to you can help you find a policy that fits your unique financial needs.