Understanding How DTA Insurance Works
The payout structure is a key difference between a DTA insurance policy and a standard term policy or term life insurance. An example of the payment structure of a decreasing term life insurance policy would be as follows:
A client purchases a 30-year decreasing term life insurance policy. The policy comes with a face value of $850,000 and an annual 6% reduction. Should unforeseen circumstances occur and the client passes away in the first year, their beneficiaries would receive the full $850,000 payout or death benefit.
Should the client pass away in the second year, the death benefit to their beneficiaries would be the face value minus the reduction of 6% ($51,000), which is $799,000. The reduction will continue yearly until the client passes away and the policy pays out, or the 30-year term comes to an end.
In terms of a standard term policy (or a level term life insurance), the face value of $850,000 would remain constant over the policy’s life.
Both policies come with term lengths, which can go up to 30 years, and they both charge constant premiums over time.
Reasons to Consider or Purchase Decreasing Term Insurance
1. Allows the purchases to cover their financial obligations, debt, or loans
Choosing the ideal cover is dependent on one’s financial situation and the reasons for seeking the purchase of insurance coverage. Decreasing term insurance is ideal for individuals who wish to cover their financial obligations, debt, or loans. The instrument is ideal because it complements the size decrease of the debts and financial obligations over a fixed period of time.
2. Provides beneficiaries with a means to settle debt obligations
Decreasing term insurance provides aid for one’s beneficiaries to settle debt obligations should anything happen. Examples of debts that can be covered with decreasing term insurance include personal loans, business loans, loans for vehicles (or auto loans), and mortgage loans.
3. Allows the purchaser to select their beneficiary and how the funds should be allocated
Decreasing term insurance allows the purchaser to select their beneficiary, and that individual is free to choose how the funds being paid out should be allocated.
In credit or mortgage life insurance policies, however, the lender is usually listed as the beneficiary. Hence, should the policyholder pass away, the funds go directly towards servicing the debts or repayments. It is what makes them different from DTA insurance.
4. Provides small business owners with debt financing
Furthermore, decreasing term insurance is ideal for small business owners who may seek debt financing to support the operations of their businesses. If the business owner passes away, there is a contingency plan for the repayment of the debt.
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Decreasing term life insurance is a policy where the benefit declines on either a monthly or annual basis. The size of the policy continues decreasing until either the policy pays out or until the end of the coverage period. A decreasing term life insurance policy typically works best to cover a loan or other financial obligation that will reduce in size over a known period of time.
For example, if you want just enough life insurance to cover your mortgage so that your family would be able to keep your home after you pass away, a decreasing term policy’s death benefit could be structured to decrease as you pay off the outstanding balance. Due to this reducing death benefit, decreasing term life insurance is often cheaper than a term life insurance policy.
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How does decreasing term life insurance work?
Decreasing term insurance, also known as DTA insurance, is different from a standard term policy, or level term life insurance, in the payout structure. While a level term life insurance policy has a face value that remains constant over the life of the policy, the death benefit decreases either monthly or annually for decreasing term insurance. However, the two policies are similar in that they both have constant premiums and term lengths that typically span five to 30 years.
For example, say you purchased a 25-year decreasing term life insurance policy with a face value of $500,000. If you died during the first year of coverage, your beneficiaries would receive the full $500,000 death benefit. If the policy’s coverage was set to reduce by 4% per year, then the death benefit would be $480,000 during year two (a total reduction of $20,000). This reduction would continue annually until either the policy pays out — if you pass away — or after 25 years when the policy’s term ends.
| 0 | $500,000 | $500,000 |
| 5 | $400,000 | $500,000 |
| 10 | $300,000 | $500,000 |
| 15 | $200,000 | $500,000 |
| 20 | $100,000 | $500,000 |
| 25 | $0 | $500,000 |
Terminal and critical illness riders
Most decreasing term life insurance policies come with or allow you to addon terminal and critical illness riders. A terminal illness rider is usually included at no additional cost and allows you to access your policy's death benefit while still alive if you need the funds to cover expenses such as hospice care, the hiring of a caretaker or residence at a nursing home. The money is generally paid out on an as-needed basis and can reach up to 80% of the death benefit. However, you won't be able to use the rider unless you've been diagnosed with a terminal illness, meaning you have a condition that gives you less than 12 months to live.
A critical illness rider, on the other hand, is optional and often comes at an additional cost when added to a decreasing term insurance policy. This rider similarly allows you to collect a portion of the death benefit for expenses, but the funds often come in a tax-free lump sum. Whether you're critically ill is typically determined by the life insurance company and is only considered a diagnosis if you've had a serious issue, such as a heart attack, ALS, kidney failure, stroke or cancer. Insurers vary on their list of different conditions that fall under the rider, so we recommend researching the providers' critical illness policy.
Why buy decreasing term life insurance?
If you are searching for life insurance to cover debts, loans or financial obligations, then decreasing term life insurance can be a tool to cover obligations like these that are decreasing in size over a fixed period of time. A decreasing term policy can help ensure that your beneficiaries receive enough money to pay the remaining portion of the debt after you pass away. Some debts you might use decreasing term insurance to cover include:
- Mortgage loans
- Auto loans
- Personal loans
- Business loans
For instance, decreasing the term life insurance policy’s death benefit can be structured to match your outstanding mortgage, and as mortgage payments are made periodically, the face value of the policy would decrease. If you passed away, the policy would pay out to your chosen beneficiary, who would then be able to pay off the outstanding mortgage.
In this way, decreasing term insurance policies are similar to credit or mortgage life insurance policies. However, credit life insurance policies name the lender as the beneficiary, which is usually the bank. Decreasing term life insurance policies differ in the fact that they allow anyone to be named a beneficiary. You may want this flexibility to allow your loved ones to decide how to allocate the funds from the death benefit instead of the money going directly to the bank.
For example, your partner may prefer to not carry on with mortgage payments and instead put the funds toward education for your child. This would not be possible with a mortgage life insurance policy where the death benefit goes directly to the repayment of the loan.
Similarly, when small businesses take out loans for operations, the owners may purchase decreasing term life insurance in the event that one of them passes away. This would help ensure any costs would continue to be paid out.
Besides coverage for loan payments, you might want a decreasing term life insurance policy if your financial obligations will decrease over the term of a policy. For example, if your kids are going off to college or starting a first job, you may expect less of a need for life insurance coverage over the next five to 10 years. In this case, a policy like decreasing term life insurance, where the death benefit begins large and then gradually reduces over time, may give you the best assurance.
Cost of decreasing term life insurance
A level term life insurance policy typically costs more than a decreasing term life insurance policy. Since a decreasing term policy's death benefit reduces every period, the insurance company will not require such high premiums from you due to the decreasing risk you present. It is important to remember that both types of policy premiums are constant throughout the term life.
Choosing the best decreasing term insurance
The availability of decreasing term life insurance has declined in recent years but is still available from a few reputable insurance companies. Farmers, Banner Life, Prudential, Protective Life and John Hancock all offer decreasing term insurance policies. Farmers Insurance, for instance, offers a policy with coverage starting at $25,000 available in 15-, 20-, 25- and 30-year term lengths.
When shopping for the best decreasing term insurance for yourself, you want to choose a policy that would cover unpredictable situations. For example, buying coverage that extends slightly longer than the term of your outstanding mortgage can be useful if you have to delay mortgage payments at any point. It can be helpful to think of possible situations like this in advance so that you can choose the best coverage possible.
While shopping for insurance coverage, we also recommend comparing quotes from multiple insurance companies to ensure you are receiving your best rates possible. Life insurance companies evaluate applicants differently so, for example, if you have a pre-existing condition, you may get a significantly cheaper rate with one insurer versus another.
When you should choose level term life insurance
Level term life insurance provides your beneficiaries with additional flexibility to cover unplanned expenses if you pass away. For example, you could purchase a policy that's large enough to cover the mortgage (like decreasing term insurance) and, as your outstanding balance decreases, the excess coverage could be used by your family as they see fit. The money could go to any number of expenses, including education, food, travel and/or unforeseen financial troubles.
Also, level term insurance gives you a steady and higher death benefit throughout the life of the policy. Unless you're confident that your need for life insurance will decrease over a period of time, then we recommend using a more steady policy like level term life insurance.
Once you've purchased life insurance coverage, you won't be able to increase your coverage if your financial needs change without either purchasing a new policy or going through a scheduled reexamination. Furthermore, if you pay off your debt and require less coverage, it is sometimes possible to reduce the face value amount on level term insurance depending on the insurance provider.