Life Insurance

Life insurance could prove to be the most important financial product you ever buy.

If you die while you still have dependents, being able to claim on a life insurance policy could mean the difference between your loved ones struggling to make ends meet, and their being financially secure.

Despite this, many of us simply don’t have any life insurance cover in place – which is sometimes hard to fathom when you think of how vulnerable we all are to accidents and serious ill-health.

But it’s also not hard to see why so many of us put it off. After all, most of us have enough money worries in our everyday lives without also having to think about what will happen in the event of our death.

And who wants to think about death anyway!

However, if you don’t consider what your dependants would do without your income, you could end up leaving them high and dry financially at what is already likely to be a very stressful and emotional time.

Even if you don’t work – you might be a stay-at-home parent, for example – the cover could still prove invaluable, as the chances are childcare and other housekeeping costs would need to be paid for if you were no longer around.

There are several different kinds of life insurance policy to choose from, so it’s important to understand exactly what’s available before buying. Here we explain how the various kinds of plan work, so you can decide which policy might be right for you.

Term insurance

‘Term’ insurance pays out when the policyholder dies within a set period of time. Most policies run for between 10 or 25 years, but you specify how long you want the term to be.

If you die during the term, the policy will pay out the amount agreed at the start, which is known as the ‘sum assured.’ Some policies will also pay out if you are diagnosed with a terminal illness.

If you die within a relatively short time of taking out cover, the policy might not pay out, so always read the small print carefully before buying.

If you live beyond the term of the policy, the cover simply terminates – there is no investment element or any return of premiums.

Variations on the term insurance theme

There are three main kinds of term insurance policy.

With level term insurance, the amount of cover – the ‘sum assured’ – is the same in the final year of your policy as it is in the first.

If you have decreasing term insurance, the potential pay-out will reduce over the term.
This sort of cover is often taken out by people to back a repayment mortgage, with the sum assured shrinking along with the outstanding mortgage debt. The cost is less than for level term cover.

Mortgage providers will often try to sell you life cover at the same time you apply for your mortgage, but always get quotes from other providers before buying to ensure you find the best possible deal.

The third type is increasing term insurance, where any pay-out increases over time to keep pace with the rising cost of living.

The pay-out either increases by a fixed amount each year, typically 5%, or is pegged to the Retail Prices Index (RPI) measure of inflation.

As the amount of cover increases over time, premiums for this sort of policy will be more expensive than for level or decreasing cover.

How long will I need life cover for?

When working out how long you need life cover for, there are several factors to take into consideration.

First, you should think about any debts you have, such as your mortgage, credit card and any personal loans. These will need to be paid off when you die, so look at your current repayment terms.

For example, if you have a mortgage and it has 18 years left to run, you may want to only take out cover for this 18-year period, so you can be certain that it will be paid off when you die.

Alternatively, you might want to take out cover for longer than this, so that you leave a lump sum when you die once your mortgage is paid off.

It’s also vital to think about how any dependents will be provided for if you are no longer there. If you have young children, for example, it’s a good idea to take out cover that will last until they become financially independent.

How much cover do I need?

When deciding how much life cover you need, you will need to add up any debts that need repaying, as well as how much your partner and any children would need to maintain their lifestyle each year if you died.

Once you’ve established what sort of financial support they would need if you were no longer there, you should look at whether you already have any life cover in place.

Many employers include what is known as ‘death-in-service’ benefit, which will pay out a lump sum if you die. Typically this is worth around four times’ your salary, but it’s worth checking your contract so you know exactly how much cover you have in place.

If you have limited debts, or few dependants, this may provide you with enough cover, but if not, you may want to supplement it with further cover.

Bear in mind, too, that if you change jobs, your new employer may not offer the same level of cover, so you may prefer to arrange your own life policy so that you have continuous protection in place.

Remember that the older you are when you take out cover, the more expensive it will be, so don’t leave sorting out cover until later on in life, when premiums could be unaffordable for the amount of cover you require.
What does life insurance cost?

The price of life insurance has fallen considerably over the past few years, so premiums shouldn’t break the bank.
If you have a policy which you took out several years ago, you might be able to find cover at a cheaper price, even though you are now older. It’s certainly worth running a comparison quote to see if a better deal is available.

Don’t, however, cancel your existing policy until you’ve definitely got other cover in place.

Previously, women could expect to pay lower premiums than men for life cover, as they have a longer life expectancy. However, under European legislation, introduced in December 2012, insurers can no longer take gender into account when determining premiums, so this differential between women and men has disappeared.

Although your gender will no longer have a bearing on your premium, several other factors will influence how much you will have to pay.

Insurers will look at your age, health and occupation. For example, if your work is very physical or dangerous, premiums will be higher than if you sit behind a desk all day.

Similarly, if you have always been in the peak of health, your premiums will be much lower than if you have suffered from a serious medical condition at any point, as your life expectancy will be considered longer.

You will also pay less for cover if you are a non-smoker. However, don’t assume you can kick the habit and then take out cover as a non-smoker. You will need to have given up nicotine products, including e-cigarettes, for at least 12 months, and not be using any nicotine replacement products to qualify as a non-smoker.

If you already have life cover in place and stop smoking, let your insurer know, as they might be able to reduce your premiums.

Voucher terms and conditions

Guaranteed or reviewable premiums?

When buying cover, find out whether your premiums are ‘reviewable’ or ‘guaranteed’.
If they are guaranteed, this means they won’t change over time, giving you certainty when budgeting. However, if you opt for reviewable premiums, then these could change over time, and might rise if your circumstances change.

Guaranteed premiums are likely to be more expensive at the outset, but this kind of policy could prove more cost-efficient in the long-term, as premiums cannot rise over time.

Honesty is the best policy

Don’t be tempted to be economical with the truth when applying for life cover in a bid to reduce the cost of your premiums.

If, for example, you have been seriously ill in the past, or are currently receiving medical treatment, or you are a smoker, you should declare this when applying.

Even though your premiums will be higher, if you aren’t honest and your insurer discovers after your death that you didn’t tell the truth, your policy will be invalidated and won’t pay out.

Joint or single life cover – which is better?

It’s natural for couples to think it’s better to take out a joint policy, but this might not be the case.

For a start, a joint policy is not significantly cheaper than two separate single life policies. But more importantly, a joint policy only pays out once on the first death, leaving the second person without cover.

Since they are likely to be older by this time, it will be more costly for them to buy insurance for themselves at that later date.

By buying two single life policies you have more flexibility. You might want to insure yourselves for different amounts, depending on your income, and you may want to buy cover for different lengths of time.

What other types of life insurance are there?

Although term insurance is by far the most popular form of life cover, there are other types of cover which can provide financial protection for your dependents should the worst happen.

Family Income Benefit

Standard term insurance pays out a lump sum – all very welcome in a time of financial crisis. But it also brings with it decisions about how the money should be managed once immediate debts and other obligations have been settled.

Some families especially might prefer a regular income after the death of the breadwinner, in which case a family income benefit policy could be worth considering.

This sort of policy will provide a monthly tax-free income which will be paid until the end of the agreed policy term.

You can even opt to have the payment increase over the term to mimic would-be pay rises and increases in the cost of living.

The biggest disadvantage of this type of cover is that, once the policy term finishes, the income will stop. For example, if you take out a 25-year policy, but die two years before this policy expires, your dependents will only receive an income for the final two years.

Whole of life cover

If you don’t want to take out life insurance for a set term, but want it to last a lifetime, one option is to take out whole of life assurance.

(Insurers tend to use the word ‘insurance’ is there is a risk that something might happen within a given time frame, and use ‘assurance’ when something is certain to happen.)
This type of policy doesn’t have an end date, so you keep on paying premiums until you die at which point the policy will pay out (some policies require premiums to be paid only until you achieve an advanced age – perhaps 85).

As a pay-out is certain, this type of cover is much more expensive than term insurance.
The way this cover works is more complicated too, as some of your premiums will go into investment funds and some towards buying life cover. This means that the amount your dependants will receive when you die will be vary depending on how the underlying investment has performed.

Because of the way it is designed, whole of life insurance is not intended to provide for the unexpected and premature loss of an individual. It is often used for complex financial and tax planning needs.

Some term insurance policies can be converted to whole of life policies, known as convertible term insurance. Premiums for this type of policy are higher than for conventional term insurance policies, and once the policy converts, they are likely to increase.

Over 50s life insurance

The main appeal of over-50s life insurance is that anyone over the age of 50 will be accepted, without the need for a medical, even if you’ve had medical problems in the past or are currently suffering from ill-health.

However, policies usually have a maximum age limit, which is typically 75, or in some cases 80 or 85. And the policy might have to run for a certain length of time before a claim will be considered, such as 12 or 24 months.

If you die within this period, your premiums may be refunded to your estate.

Cover works in a similar way to whole of life insurance, as there is no end date, so the policy will pay out whenever you die. Premiums are usually relatively inexpensive, but the level of cover offered is also relatively low, and is usually just a couple of thousand pounds.

Many people therefore take out this sort of cover specifically to cover their funeral expenses.

The biggest drawback of this type of plan is that you could end up paying premiums for a very long time. If you take out a policy when you are relatively young, the chances are you will end up paying much more into the plan than will be paid out when you die.

Some providers will allow you to stop paying premiums when you reach a certain age, often 90 or 95, but if you cease paying before this time, the policy will lapse and you won’t receive anything.

Protect your life policy from the taxman

No-one wants to hand over money to HMRC if they can possibly avoid it, so make sure you ask your life insurer to write your policy ‘in trus’t when you take it out.

If the plan is written ‘in trust’ then this money will not be added to your estate, and therefore any pay-out won’t be liable for inheritance tax (IHT).

Under current tax rules (2014/15 tax year), the IHT threshold is £325,000 for a single person or £650,000 for married couples and registered civil partners. IHT is charged at 40% on anything you leave over this threshold when you die, which means millions of homeowners risk leaving a tax bill for loved ones when they die.

Putting your life insurance ‘in trust’ not only means any pay-out is excluded from your estate for IHT purposes, but also that your dependents will receive the money faster. If the policy isn’t written ‘in trust’, the executors of your will must apply for a grant of probate, which can take several months.

Can I insure against falling critically ill?

Many people opt to take out critical illness insurance at the same time they take out life cover.

Critical illness cover pays out a tax-free lump sum in the event you are diagnosed with a serious illness such as cancer, stroke or heart attack or if you are incapacitated following an accident.

You can use the pay-out for whatever you want, perhaps to pay off your mortgage, or to cover the cost of private medical treatment, refurbish and adapt your house, or pay for a convalescent holiday.

In other words, you don’t have to account for how the money is spent.

According to statistics, one in five men and one in six women will suffer a serious illness at some stage in their life.

Although all critical illness policies will cover a range of core conditions, some are more comprehensive than overs. For example, the average policy typically pays out for 30 to 40 illnesses, while others list 160 conditions.