Level term vs decreasing term, what’s the difference?

What is the difference between decreasing term and level term?

A level term life insurance policy will offer your beneficiaries a fixed payout if you pass away during the policy term, and the payout will remain unchanged throughout the policy. While a decreasing term life insurance policy also offers your loved ones a payout if you pass away during the policy term, but this time the payout amount will get lower as each year goes by. So, if you pass away within two years of taking out the policy, the amount your loved ones receive will be higher than it would be if you passed away after 20 years.

Decreasing term insurance might be right for you if: 

You have a repayment mortgage

If you have a repayment mortgage (meaning your monthly mortgage payments are made up of capital and interest), decreasing term life insurance can be one of the most affordable ways to protect your family home. Your cover won’t be officially connected to your mortgage, but the payout amount will fall in line with your outstanding balance.

You have another type of fixed-term loan

A decreasing term might also be suitable if you have other types of debt, whether it’s credit cards, car finance or personal loans. As the amount you owe gets lower, the potential payout will fall too.

You want to keep your premiums as low as possible

Decreasing term life insurance tends to be much cheaper than level term life insurance. So if you’re on a tight budget or you want to ensure your monthly premiums stay affordable, this could be a smart way to protect your family from financial uncertainty.

Level term life insurance may be right for you if…

You have an interest-only mortgage

If you have an interest-only mortgage, you’ll be better suited to a level term life insurance policy than a decreasing term one. Since your monthly mortgage payments consist of just the interest and you won’t pay the capital until the end of the term, you need a policy that’ll payout a set amount no matter how much time has passed. 

You want to give your loved ones extra stability

If you want your life insurance payout to do more than just pay off the mortgage, a level term policy can offer extra protection. With a fixed lump sum, your loved ones could pay off outstanding debts, cover bills while they take time off work and even hire help with household tasks and childcare.

If you choose a decreasing term policy, your beneficiaries are under no obligation to use the money to pay off the mortgage. They could use it for other living costs instead. Keep in mind that the cost of goods and services rise over time due to inflation, so not only will the payout get smaller, its spending power will fall too.

You may also want to consider adding critical illness cover or income protection too. Income protection will replace a percentage of your income if you’re ever unable to work due to an illness or injury. Critical illness insurance will provide you with a lump sum payout if you’re diagnosed with a listed illness during the policy term, regardless of whether you’re able to work or not.

Learn more: Is critical illness cover worth it?

You want to reduce your inheritance tax bill

If you have a very large estate, a financial adviser or tax expert may recommend level term life insurance. 

By taking out a level term policy and placing it in a trust, your loved ones can use the payout to cover the inheritance tax bill. This can save them having to sell assets they inherit - particularly useful if most of the estate is made up of properties, antiques and sentimental items. 

It’s important to remember that most people don’t pay inheritance tax. In fact, less than 4% of estates were eligible for the tax in 2020/21. So if you’re hoping your life insurance policy will help to reduce the amount of tax you pay, speak to a financial adviser first. Your estate might not be eligible for inheritance tax in the first place and even if it is, there may be more effective ways to reduce your tax bill.

Learn more: Do beneficiaries pay taxes on life insurance?

You want to leave a legacy

While a decreasing term policy can help your loved ones become debt-free, a level term policy could help them tackle multiple financial goals at once. It could even enable them to make big changes to their lives in your memory. The payout could be used to study abroad, start a business, or travel the world, for example. 

We’d all like our loved ones to receive a million pound payout if something were to happen to us, but you’ll need to consider the affordability of your monthly premiums when deciding how much cover you need. 

If you’re ever out of work due to an illness or injury, you may find it difficult to keep up with your insurance premiums. If you stop making the payments, your policy will end. If you’re concerned this may happen to you, it may be worth exploring life insurance policies that include a waiver of premium. This will protect your policy if you’re ever out of work. 

Learn more: Life insurance for mums

Should I choose a level term or decreasing life insurance?

Whether you should choose a level term or decreasing term life insurance policy depends on your personal circumstances. If you have a repayment mortgage and you’d like to keep your monthly premiums as low as possible, you might want to choose a decreasing term. If, however, you have an interest-only mortgage or you’d like your loved ones to receive a payout that’s big enough to cover more than your outstanding debts you’ll be better suited to a level term policy.

Level term life insurance key points:

• If you pass away within the policy term, your loved ones will receive a lump sum
• The payout will stay the same throughout the term
• Suitable for interest-only mortgages

Decreasing term life insurance key points:

• Can protect the family home and give you peace of mind
• Usually cheaper than level term insurance
• Payout gets smaller over time to reflect outstanding mortgage balance