Life insurance will pay a cash sum to your dependants if you die, or are diagnosed with a terminal illness with a life expectancy of less than 12 months, during the term of the policy. Find out how to choose the best life insurance policy for your circumstances.
Life insurance is a simple form of protection that will pay your dependants a cash lump sum, if you die during the term of the policy. This money can be used to support your dependants for a number of years and/or to pay off a large debt, such as your mortgage.
As life insurance policies also often pay out if you are diagnosed with a terminal illness with less than 12 months to live, this can help ease your financial burden at a difficult time.
There are three main types of life insurance policies available:
The simplest is level term insurance (sometimes known as term life insurance).
In this case you simply choose the amount you wish to be insured for and the number of years (the term) you would like the cover to last. You then pay a small premium every month and should you die during the term, the insurance company will pay your beneficiaries the lump sum in cash.
With level term insurance, both the premium and the payout remain the same for the whole of the term, provided you abide by the terms and conditions.
So, if you were insured for £250,000 over a 20-year term, your family would receive this sum whether you died within 6 months or after 19 years.
Unsurprisingly, you’ll pay more if you require more cover over a longer period. If you were to outlive the term of your life insurance policy, it would end, as would your monthly payments.
Decreasing term life insurance, also known as mortgage life insurance will reduce the cash sum paid out upon your death, over the term of the policy. This is typically used to cover a debt that reduces over time, such as a repayment mortgage.
Your monthly payments stay the same, while the payout decreases over time. As the premiums are typically around 20 per cent lower than level term premiums, this is a cheaper option.
However, as the sum paid out is earmarked to pay off a debt such a mortgage, this means your dependants won’t be left with a lump sum to help with other living expenses.
If you would prefer life insurance that covers you until you die, a whole of life insurance policy could fit the bill.
Like the term-based types of life insurance, you pay monthly premiums for your cover, and the insurer will pay a cash lump sum to your dependants when you die. However, whole of life policies do not specify a term and therefore protect you until you die.
Whole of life policies are guaranteed to pay out, which makes them more expensive for insurers to offer. As a result, you can expect costlier monthly premiums.
Some types of whole of life policies invest your premiums. However, should the investment do badly, you may be asked to increase your premiums or accept a smaller lump sum.
Happily, many whole of life policies do not actually require you to pay your premiums until you die. Instead, you pay for a certain number of years, or until you reach a certain age (typically 90). After this point your cover continues, but you make no further payments.
Whole of life policies can suit those who would like lifetime cover, and don’t mind paying for it.
There are also a number of other types of cover available, including joint or single life insurance, mortgage life insurance, Over 60 life insurance, family life insurance and critical illness cover, which are covered in separate articles.
The first thing to point out is that life insurance pays out to your beneficiaries when you die. If you are single, with no one relying on you financially, you probably do not need life insurance.
However, if you have a partner or children who rely on you financially, it is important to plan for the future.
While most of us will live long and happy lives, it is a sad fact that many children will lose a parent before they reach adulthood. According to the Childhood Bereavement Network 23,600 parents died in 2015, leaving behind around 41,000 children aged between 0-17.
A life insurance policy could ensure your family is provided for financially, should the worst happen and they could no longer rely on your income.
Equally, your partner may want to consider whether they should also take out a life insurance policy.
Fortunately, help may come from an unlikely source. Many employers include group life insurance in their benefits packages, which will pay out should you die while employed by the company.
Alternatively, you may have death in service cover, which will pay out a multiple of your salary, should you die while an employee. For example, if you earn £25,000 a year and you have a death in service benefit worth 4 times your salary, you would be covered for £100,000.
It is therefore worth checking to see if you are covered, and if so, for how much. Bear in mind that some firms only offer these benefits to those in the company pension scheme, so it can be worth enrolling if you have not already done so.
The amount to insure yourself for can vary widely according to your needs and indeed disposable income. However, for many people, the aim is to provide enough money to pay off any outstanding debts, such as the mortgage, as well as provide dependants with some money for living expenses. For many, this would equate to 10 times the main earner’s salary.
As for the term, you may choose to insure yourself for the length of your mortgage, until your children have finished full time education, or until your partner reaches pensionable age.
Now, subtract any cover provided by your employer and you will know how much cover you need, and be well on the way to find the best life insurance deals for you.
It is now time to search for the best life insurance cover for you. But where do you start?
You can search for the best life insurance quotes directly from insurance companies, comparison sites, banks, credit card companies and even retailers.
However, there are a number of factors that affect the price of your premium, such as:
Younger policyholders will pay less for their cover as they’re seen as lower risk. Riskier lifestyles equal higher premiums, and smokers will pay more than their non-smoking friends.
It is vital to disclose anything that might be relevant when taking out the policy as insurers will refuse to pay out for any pre-existing issues they weren’t informed about.
Being in good health equals lower premiums and you might be asked to take a medical check-up before an insurer will cover you. Getting in shape, drinking less and giving up smoking before applying could therefore save you money, as well as improve your health.
If you do have any pre-existing conditions, it can be worth speaking to a specialist insurance broker. While they may charge a fee, they will know which is the best life insurance provider to provide a suitable life cover policy for you.
Alternatively, it can be worth paying for advice from an independent financial adviser. Not only are advisers able to assess all of your existing insurance policies to see what exactly is needed, they will often have access to more competitive products.
When you are happy you have found the best life insurance policy that meets your needs, make sure you read the small print carefully. It’s essential to know what is and isn’t covered and to get anything you are unclear about explained by the provider, or your broker/adviser.
Remember, you have the right to change your mind within 30 days, during which time the provider must offer you a full refund.
It’s worth remembering that the taxman can seize our cash, even when we die, in the form of inheritance tax.
If you arrange with your insurer for your life insurance to be paid directly to your spouse/registered civil partner (or a charity), inheritance tax will not normally be charged, provided they live in the UK.
However, if nothing is arranged, your life insurance will form part of your estate. And this is where inheritance tax rears its ugly head: If your estate totals more than £325,000, anything over this threshold is taxed at an eye-watering 40 percent.
So, if you had a life insurance policy worth £500,000 making your total estate worth £800,000, your beneficiaries would pay IHT on £475,000.
40% of £475,000 is £190,000 – which is the amount of inheritance tax your beneficiaries would have to hand over to the taxman.
Thankfully, it is possible to do a little tax planning to reduce that tax bill.
Life insurance policies can be written into trust, which means they are classed as an asset and avoid becoming part of your estate. Not only does this protect them from inheritance tax, it means they are paid out to beneficiaries directly.
Writing a life insurance policy into trust can be as simple as filling out a form with your insurer, but it is prudent to get advice from an expert regarding your situation first.
With most life insurance policies lasting between 10-50 years, you’re bound to have a few lifestyle changes. You may move jobs and be offered better life cover, have another child or move house and increase your mortgage.
All of these factors can influence the amount of cover you need, which makes re-assessing your cover from time to time a good habit to get into.
Finally, with the COVID-19 pandemic causing many companies to struggle or even collapse, you may be concerned about taking out such a long insurance policy. What if the insurer collapses in the next 20 years?
Check the Financial Services Register to ensure your insurer is listed.