Level Death Benefit

What Is a Level Death Benefit?

A level death benefit is a payout from a life insurance policy that is the same regardless of whether the insured person dies shortly after purchasing the policy or many years later. It can be contrasted with an increasing death benefit, which rises in value over time as the policyholder ages.

Generally speaking, life insurance policies with level death benefits will carry lower premiums than those with an increasing death benefit. However, this does not necessarily mean that level death benefits offer superior value, since inflation can reduce the level death benefit’s real value.

How Level Death Benefits Work

Many people purchase life insurance policies in order to provide their families with peace of mind. In exchange for paying a series of monthly insurance premiums, the policyholder can rest assured that if they die during their coverage period their beneficiaries will receive a death benefit. This can be especially important for policyholders with families, who might struggle to replace the income generated by the policyholder during their life.

When selecting life insurance policies, there are many different factors to weigh up. If the policyholder wishes to minimize their monthly insurance premium, for example, they can consider opting for a policy with a level death benefit. In that case, the amount paid to the beneficiaries upon the policyholder’s death will be set ahead of time once the life insurance policy is initiated.

If, for example, a healthy 30-year old purchases a life insurance policy with a level death benefit of $500,000, the beneficiaries will receive that $500,000 benefit regardless of whether the policyholder dies the very next day or 30 years into the future.

From the perspective of the insurance company, level death benefits are relatively low risk because they allow the insurer to know with certainty what their maximum potential liability will be. Moreover, because of inflation, the real value of the death benefit actually declines each year, meaning that the insurance company’s liability effectively reduces over time. For these reasons, level death benefits are generally less expensive than increasing death benefits

Real World Example of a Level Death Benefit

The decision of whether to opt for a level death benefit or an increasing death benefit will depend on several factors, including the policyholder’s personal budget and their expectations of alternative investment returns.

To illustrate, consider the case of John, a hypothetical insurance shopper. At 30 years of age, John is in perfect health and has an annual income of $70,000. After paying for his expenses, John is able to save $500 per month and is eager to purchase life insurance to help provide for his young family in case he passes away.

If John opts for a level death benefit of $500,000, then his insurance premium will be $100 per month, leaving him $400 to invest separately. John plans to leave the proceeds from his investments to his family, so that when he dies his family will receive both the $500,000 death benefit and the value of his investments at that time.

The effects of compound interest over time should not be underestimated — even relatively modest investment returns can lead to very large sums when allowed to compound over the long-term.

John calculates that if he lives for 50 more years and inflation averages 3% per year during that time frame, the real value of the $500,000 benefit at that time, after adjusting for inflation, would only be about $114,000. However, he also notes that, given his long investment horizon, he should be able to average more than a 3% annual return on the $400 he can invest each month.

If John was able to obtain an average annual return of 6%, then his monthly investments of $400 would be worth over $1.5 million in 50 years’ time. With these observations in mind, John decides to proceed with the level death benefit, with the intention of investing an additional $400 per month on his family’s behalf for the remainder of his life.