Level or Decreasing Term Life Insurance

A life insurance policy can help to protect your loved ones should the worst happen, but did you know that not all policies are the same? Choosing the right policy for your circumstances is vital to ensuring that your loved ones are financially protected in the event of death.

If you want to follow in the footsteps of the 5.8 million adults in the UK who have considered life insurance in response to the COVID-19 pandemic [1], the following guide will help you to consider your options in more detail.

When taking out life insurance, it is often possible to select either a decreasing term or a level policy. Both types of life insurance have a variety of benefits and this guide has been designed to provide you with all the information you need to make an informed choice. Please note that this is a general guide and it is vital to ensure that the specific policies you may be interested in are appropriately suited to your needs and circumstances.

What is level term life insurance?

Level term life insurance policies are designed to financially protect your family in the event that you can no longer do so. Policy payouts can be used to cover:

• the costs of your funeral
• household bills
• an outstanding mortgage

Additionally, they can also be used to provide an inheritance or generally allow your loved ones to experience a good standard of everyday living.

Level term life insurance policies will pay out in the event of your death, provided that this occurs during the fixed term of your cover. If your death occurs outside of the term of the policy, your loved ones will not receive a payout. Let’s take a look at an example here.

Say you take out a level term life insurance policy to the value of £100,000 that is fixed for 25 years. If your death occurs at any time during that 25 year period and a valid claim is made, the policy will payout £100,000. However, if your death occurs outside of that 25 year period, your policy will have ended and no payout will be made.

Level term life insurance policy payments are fixed and will remain the same unless changes to your policy are made. Additionally, the payout your policy will offer in the event of your death will also remain the same unless amendments are made.

Level term life insurance policies could be an ideal choice for covering interest-only mortgages and general household debts.

What is decreasing term life insurance?

With a decreasing term life insurance policy, the value of the payout in the event of death will reduce over time in a similar way to how repayment mortgages decrease.

This type of life insurance policy is typically taken out to cover a specific debt, which will decrease over time as repayments are made.

Let’s look at an example of decreasing term life insurance.

Say you take out a decreasing term life insurance policy to cover a £250,000 repayment mortgage. After the first year of monthly payments, the total amount owed on this mortgage is £238,000. The value of the life insurance policy will remain in line with the value of the mortgage and therefore the payout figure will also be reduced. The final settlement figure that would be paid out to your beneficiaries in the event of your death will take into account the length of time the policy has been active and how much it has decreased since the start of the term.

It is important to keep in mind that this type of policy may not completely pay off an outstanding mortgage. If this is something that is particularly important to you, you will need to take steps to ensure your insurance policy is adjusted to align with any new mortgage terms or arrangements that are made. Additionally, you will also want to ensure that your mortgage interest rate is not higher than your policy interest rate as this will likely mean that your outstanding mortgage will not be paid in full in the event of your death. You should also check that the length of your insurance policy will cover the full duration of the term of your mortgage.

Which type of life insurance policy should I choose?

The type of life insurance policy you take out needs to be aligned with your unique needs and circumstances. In fact, there are many similarities between both decreasing and level term policies including the fact that both can be written in trust, which may help you to avoid or minimise inheritance tax.

But to ensure you begin your search on the right foot, here are some bullet points to keep in mind.

With level term life insurance:

• Policy payments remain the same throughout the term, unless you make changes.
• A fixed amount will be paid out in the event of your death, which will be agreed when the policy is purchased.
• Your beneficiaries could receive a cash payout in the event of your death during the term of your policy, which can cover an outstanding mortgage, everyday expenses, childcare, and more.
• Your monthly premiums will be determined using a variety of factors, including your age, smoking status, and general health.

This means that a level term policy could be the ideal choice if you want to ensure that your loved ones remain secure financially in the event of your death.

With decreasing term life insurance:

• Policy payments remain the same throughout the term, unless you make changes.
• The total payout amount that will be made in the event of your death will decrease over time, in the same way that a repayment mortgage will decrease over the length of its term.
• Monthly premiums are typically lower than level term policies.
• Decreasing term life insurance policies are generally a good choice if you want to ensure that a repayment mortgage is covered in the event of your death. Please note that this type of policy is not suitable for those with an interest only mortgage where the full mortgage amount remains due at the end of the term.

What do I need to be aware of before applying for a life insurance policy?

If you are thinking about taking out a life insurance policy, it is important to understand exactly what you need your policy to cover. So, you need to consider:

• The value of your insurance policy
• Whether you want to take out a decreasing or level term policy
• The length of time you want your policy to run for
• Whether critical illness cover may be a good addition to your policy
• Whether your circumstances are likely to change, which would affect the terms of your policy

What are joint life insurance policies?

Depending on your circumstances, you may wish to take out a joint insurance policy with your partner. Joint policies mean that there is no need for both partners to take out an individual policy.

The cost of a joint policy could be around 25% lower than two separate policies, however this type of insurance typically only pays out on the first death, with the policy ending thereafter. So, if you want to essentially double your level of cover, taking out two individual policies would be the better option.

Why should I consider a life insurance policy?

In the event of your death, would your partner still be able to:

• Cover mortgage repayments and household bills?
• Maintain your current lifestyle?
• Afford childcare and education costs?

If the answer to any of those questions is no and you want to ensure that your loved ones will remain financially secure in the event of your death, it is worth considering taking out a life insurance policy.

There is no right or wrong way to protect your loved ones. There are a variety of different insurance policies available, each with its own set of benefits and levels of cover. So, when considering life insurance, the most important thing you can do is focus on selecting a policy that will provide the level of protection that will meet the needs and circumstances of your loved ones.

It is also important that you can comfortably afford the monthly premiums associated with your preferred policy, as failing to keep up with these payments is likely to render your policy invalid.

What will affect the cost of a life insurance policy?

There are a variety of factors that will impact the cost of your policy including your occupation and smoking status. Your insurer will typically also ask about your general health and your family medical history.

The level of cover you want to take out and the length of your term will also impact your premiums, as will your age when you take out your policy. The older you are, the higher your premiums will be as insurers will take the view that it is more likely a claim will be made on your policy than on a policy covering someone who is considerably younger.

Are there any other types of life insurance that I should consider?

As it is important to consider a full range of options, you may also wish to look further into the benefits of the following types of cover.

Increasing term life insurance

Increasing term policies operate in the same way as decreasing term policies insofar as a payout will be made on a valid claim should your death occur during its term. There is one key difference between the two however, as the level of cover offered by this type of policy will increase over time to ensure that its value is protected against inflation.

Term-based insurance policies will only pay out in the event of death during a specific period of time. If you want to ensure that your loved ones will receive a payout when you die, a whole life policy could be the right option for you. Provided that you continue to pay your monthly premiums, a whole life policy will remain valid for the rest of your life.

Family income benefit

This type of insurance policy will not pay out a lump sum in the event of a valid claim. Instead, your beneficiaries will receive a tax-free payment every month to ensure they can maintain a good standard of living including continuing to comfortably pay the mortgage, bills, and cover any other regular expenses.

Insurance policies have helped millions of people to reduce the financial pressures that can arise in the event of a death. In fact, the Associaton of British Insurers and Group Risk Development has revealed that in 2021, £6.8 billion [2] was paid out in income protection, critical illness, and life insurance claims. An average of 18.6m was paid out every single day, with the average term policy paying out almost £62,000.

References

• [1] ftadviser.com
• [2]expressandstar.com