What Is an Increasing Death Benefit in Life Insurance?

What Is an Increasing Death Benefit?

When you buy life insurance, you pick the size of the death benefit that would go to your heirs if you pass away. While some policies keep the same amount the entire time, others give you the option to increase the death benefit over time. You build a larger payout for your heirs, usually in exchange for a more expensive premium. Here is what to know about these policies.

Life Insurance With an Increasing Death Benefit

Most permanent life insurance policies provide owners options to automatically increase their death benefit as their cash value grows.

For universal life (UL) insurance, insurance companies offer two primary choices. The level death benefit, sometimes called Option 1, maintains the same death benefit throughout the life of the policy. The increasing death benefit (Option 2) allows the death benefit to rise as the cash value of the policy increases in later years. Most UL policies allow owners to switch between level and increasing death benefits with few restrictions.

Whole life insurance policies produce dividends that can be used to purchase additional coverage, thus increasing the death benefit.

Some term life insurance policies offer increasing death benefits as well. When you sign up, you pick the insurance term for coverage, like five years or 20 years. Over this period, you will see how much the death benefit goes up over time. Your premiums will also increase along with the extra coverage.

How Level Death Benefit Works

In a permanent life policy with a level death benefit, fees and sales charges are deducted from the premium and the remainder is credited to the cash value. Over time, as premiums are paid, the cash value of the policy increases, and the amount of insurance purchased each month gradually decreases. For example, in year two, a $500,000 policy might have a cash value of $1,500. Therefore, only $498,500 of insurance is needed to cover the $500,000 exposure.

Upon the death of the insured, the insurance company pays a death benefit consisting of insurance and a return of the policy's cash value. Assume the owner paid the premium for a $500,000 policy for 15 years, accumulating a cash value of $65,000. The insurance company would pay $435,000 for insurance and return the $65,000 cash value, for a total benefit of $500,000 to the heirs.

In a term policy with a level death benefit, you keep the same coverage amount for the entire term. The premium also stays the same for the entire term.

How Increasing Death Benefit Works

For a universal life policy with an increasing death benefit, the beneficiary receives $500,000 of insurance proceeds plus any accumulated cash value. The more the policy owner pays into the cash value, the larger the death benefit they will leave to their heirs. Universal life policies also earn interest on the cash value, which further increases the account value and the future death benefit. The premiums for an increasing death benefit universal life insurance policy would be more expensive than a level death benefit policy.

Whole life policies differ in that dividends can be used to buy additional insurance. This increases the death benefit by small increments as additional insurance is purchased each year.

When you sign up for a term policy with an increasing death benefit, the insurance company will show you how much the death benefit will go up over time. The insurer will also show how much your premium will go up throughout your coverage.

Level vs. Increasing Benefit

There is a variety of reasons you might want to choose an increasing death benefit over a level death benefit:

• You may temporarily need a higher amount of insurance. This works especially well when you're younger and the cost of insurance is lower. You may later switch back to a less expensive, level death benefit policy.
• You may need a death benefit that will continue to increase. For example, if insurance is being used as part of a business succession plan, level death benefit coverage may not keep up with the value of a growing business.
• You may want to rapidly build cash value by overfunding the policy in the early years after buying coverage. For this strategy, you might need an increasing death benefit policy to avoid turning your life insurance into a modified endowment contract (MEC), which removes the tax benefits of life insurance cash value. A policy becomes an MEC if the amount of premium paid exceeds the seven-pay test without an increasing death benefit.

The Bottom Line

Having determined that you need permanent life insurance, consider your death benefit options closely. There are many ways to tailor coverage to meet your needs. An experienced independent insurance broker is an excellent resource for providing insight and assistance.