What is decreasing life insurance? How does it work?
Decreasing term life insurance, also known as mortgage term life insurance, pays out if you die while your policy is active.
The amount your loved ones will receive decreases as time goes on. This is calculated by an interest rate set by your policy provider.
Because the potential value of a claim decreases as time goes on, this type of policy is generally cheaper than a level term life insurance policy.
How does it work?
A decreasing life insurance policy pays out less as time goes on. This is because it is designed to cover the cost of a mortgage debt, which also becomes smaller over time.
If a couple bought a house together and one died, the other may struggle to cover the remaining mortgage payments by themself. Having a decreasing life insurance policy in place would help to cover the cost of the mortgage if one partner died.
Some insurers allow for joint policies, where both people are covered by the same policy. This can be set up to pay out on the first person dies, so the other person can pay off the mortgage.
A successful claim on the insurance would mean that your partner wouldn’t struggle financially and your home wouldn’t be repossessed.
Are there any disadvantages?
As time goes on, any claim on a decreasing life insurance policy will be worth less.
You should check the interest rate of any decreasing life insurance quote to make sure that cover would not fall significantly faster than the outstanding mortgage debt. Otherwise, a claim might not pay out enough money to cover the mortgage.
Level term policies pay out a set sum regardless of how much time has passed. If a death occurs ten years after someone takes out a policy, the mortgage payments over that time will have cleared a fair amount of the debt.
So there will be ‘extra’ money left over that their family can put to other uses.
Placing a policy in trust
If a life insurance policyholder dies, the money will normally be paid into their ‘estate’. This is the legal name for all of their possessions, money and debts.
After death, the estate is then distributed according to the person’s will. A life insurance policy might be part of the estate. Inheritance tax is then levied against this estate.
Inheritance tax is paid at a rate of 40% on anything above a threshold of £325,000. If a life insurance policy is placed in trust, it doesn’t form part of the person’s estate and so will not be subject to inheritance tax.
So if a life insurance claim might push the value of the estate over that threshold, it’s worth considering placing the policy in trust. Find out how to place a policy in trust.