What’s the difference between level term and decreasing term life insurance?
Decreasing term life insurance is a type of life insurance where the cover reduces over a specified period. The policy provides cover over a fixed term and the amount that is paid out if you make a claim reduces each year.
By contrast, a level-term life insurance policy pays a fixed sum to your family when you die.
The key difference between level term and decreasing term life insurance is that level term will give your dependents a lump sum when you're gone while decreasing term life insurance will give them an income to live on until the end of the life of the policy.
How does decreasing term life insurance work?
A decreasing term life insurance policy is a type of fixed term life insurance. That means that you take out cover for a specified number of years. Your insurer decreases the amount they'll pay out with each passing year until the policy ends.
Decreasing term life insurance lets you decide how much cover you want, but the sum that it pays out on the policyholder's death reduces over time. It's ideal if you want to use your life insurance to pay off a particular debt.
For example, you might have a capital and interest repayment mortgage. You want to ensure that your family doesn't have to keep making the payments when you're gone.
Decreasing term life insurance is ideal for this as the amount owing on your mortgage will also decrease over time. Your life insurance can pay off your outstanding mortgage debt, giving your family one less expense to worry about should the worst happen.
Does that mean my premiums reduce over time too?
Unfortunately not. The premiums for life insurance policies are calculated to reflect the full cost of the policy so your premium stays at the same amount.
However, because the payout reduces over time it means that the overall cost is still cheaper than a policy where the payout stays the same over time.
When is decreasing term insurance right for you?
If you're looking for life insurance you might be wondering whether decreasing term life insurance is the right choice for you.
Here are two circumstances where decreasing life insurance cover will benefit you and one where it probably won't.
You have a repayment mortgage
Decreasing life insurance is ideal if you have a repayment mortgage where your payments go towards repaying the capital rather than just the interest. You can set your cover level to track the life of the mortgage so the payout will cover the outstanding amount when you're gone.
Your mortgage lender may insist that you have life insurance in place as part of your mortgage arrangements.
It helps to give your family some extra financial security as they'll have one less outgoing to worry about.
You have another type of fixed-term loan
Of course, a repayment mortgage isn't the only specific debt that you may want to pay off when you die. You may have short-term loans, such as car financing, that you'd like to cover so that your dependents don't have to make the repayments.
Decreasing life insurance can be set to cover any fixed period and be used to cover a combination of outstanding debts.
Do you have an interest-only mortgage?
If you have an interest-only mortgage you aren't paying anything towards the capital sum when you make your mortgage repayment.
A decreasing term policy is unlikely to be the right choice as the amount you owe won't decrease over time as it does with a repayment mortgage.
You can still take out life insurance to repay your mortgage but you'll be better off with a policy that pays out a fixed lump sum.
Working out how much cover you need
The amount you pay out in your monthly premiums will vary depending on the amount of cover you need.
The premiums for decreasing term life insurance generally cost less than for other types of fixed term life insurance however your insurance company will take other factors into account.
The length of your fixed-term life insurance
The amount that your decreasing term life insurance policy pays out will reduce over time so it's important to ensure that your cover is consistent with your outstanding debt.
If you're taking out insurance to cover your repayment mortgage it makes sense to match the fixed term life insurance to your mortgage term, for example, 25 or 30 years.
It's worth noting that this will only provide you with enough cover if you keep up with your mortgage repayment. If you take a payment holiday or only pay the interest for a period of time you may find that your insurance won't cover your outstanding mortgage.
Other factors that will influence the cost
When providing you with a life insurance quote your insurer will look at other factors such as your age and occupation alongside the amount of cover you need and the length of the policy.
Your insurer will also look at your medical history, whether you smoke and whether there are any significant health conditions in your family. All of these elements can increase the risk of a claim being made before the end of the policy term so will affect the cost of your premiums.
If you're taking out joint life insurance this assessment will consider both of you.
How does level-term life insurance work?
Level-term life insurance pays out a fixed cash sum if you die during the life of the policy. It's another type of fixed-term insurance so you can decide how many years you want the policy to cover.
For example, you might want to take out life insurance to provide your family with a lump sum if you die whilst your children are still at home or during your working life. If you're the main breadwinner this could be a single policy. However, if your household depends on two incomes you could get a better deal by taking out a joint policy.
In contrast with decreasing term policies, level term life insurance will pay out the same amount at any point during the policy term. It allows you to decide how much you'd like to leave for your loved ones.
There are many reasons why you might choose level-term life insurance depending on your personal needs. Your family could use it to pay funeral costs, pay off the remaining balance on any debts or use it to plan for their financial future.
When is level-term life insurance right for you?
Level term life insurance gives you the flexibility of a lump sum that your family can use as they see fit, as opposed to decreasing term insurance products that are designed to pay off debts such as repayment mortgages and other debts that decrease over time.
Here are some of the benefits of level-term insurance.
Peace of mind
Choosing fixed-term life insurance that pays out a lump sum can give your family a safety net, particularly if you die during your working life. It provides them with a cash sum that they can use to pay day-to-day living expenses.
Whilst this could simply mean covering essential costs it can also help them to minimise disruption to their daily lives when they're already dealing with the loss of a loved one.
You may also want to consider adding critical illness cover. Critical illness insurance can provide your family with an income if you're ill or injured and unable to work.
Decreasing term life insurance policies can help to pay off the mortgage, meaning that they can stay in the family home and remain part of a familiar community. A level-term life insurance product can help them to continue their day-to-day activities without worrying about paying the bills.
The cost of living and interest rates can both be unpredictable, however, a fixed lump sum allows your loved ones to take advice on their financial situation and invest to provide themselves with an income.
Level-term life cover can also allow them to prioritise the order in which they pay off any debts and still give them additional funds for daily living expenses.
Inheritance tax management
If you have a large estate you may already have taken estate planning advice. Tax allowances such as the residence nil rate band may allow you to reduce your tax liability, however, there may still be a bill to pay when you're gone.
Decreasing term insurance is unlikely to be helpful here as tax bills don't tend to reduce over time. However, with the right advice, your level-term insurance could allow your loved ones to cover the tax bill without losing funds from their inheritance.
A repayment mortgage decreases over time so decreasing term insurance is ideal as it can be designed to pay off the outstanding balance when you're no longer here.
If you have an interest-only mortgage the main mortgage debt will still be outstanding. You can ensure that your level term cover pays out enough to cover the capital sum and still leave additional funds for your family.
How to get professional advice
Our life insurance brokers can help to guide you through your options and help you to choose the best life insurance for your circumstances. We can also provide you with advice if you'd like to add critical illness cover to your policy.
Contact us for a comparison quote.
Frequently asked questions
What's the difference between level term and decreasing term life cover?
The main difference between level term and decreasing term life insurance is that level term insurance will give your dependents the same sum of money throughout the life of the policy, while the amount they receive from a decreasing policy will drop over time.
Can I save money by taking out a joint policy?
One joint policy is likely to be cheaper than two individual ones. It's important to take advice on your existing financial commitments and income as there is a range of different policies available.
Some will allow you to claim after one of you dies whilst others will only benefit your beneficiaries when you're both gone. It's important to consider what suits your circumstances.
What type of policy should I choose if I want to pay off my debt?
It depends on the type of debt you have. If you have a repayment mortgage where the amount you owe decreases over time a decreasing policy is ideal.
However, if you want to settle several debts and leave your family with a cash sum a level-term policy is likely to be better.
Can I have both types of life insurance?
As long as you can afford to, you can take out both types of cover. A decreasing term policy is a cost-effective way to ensure that your repayment mortgage is paid off when you die.
You might still want to leave a cash sum for your family, to pay off debts or give them an income. Level term insurance allows you to leave them a fixed sum.