Life insurance is a great way to help protect your family from the financial worries they could face if you were no longer around, such as household bills, child-care costs, university fees and covering mortgage payments.So what is life insurance? In a nutshell, life insurance is a contract between you and an insurer. It aims to pay out a cash sum if you die during the length of the policy.
“I now have a cheaper mortgage than any high street bank would have offered me, full life cover and peace of mind knowing that my property will eventually end up with my children via my trust.”
HOW DOES LIFE INSURANCE WORK?
You decide what type of life insurance best suits your needs, how much you want and how long you need it for. For example, if you want help in protecting your family you may wish to think about the costs they would need to cover and how long they would need to cover them for. If you want your loved ones to be able to pay off the mortgage, think about the size of your mortgage and the number of years left to pay. Most people have two main protection needs that can be covered by life insurance (often known as life assurance): paying off large debts like your mortgage family protection, where you leave behind money for your family to live on after you’ve died. Different types of insurance policy are good for different protection needs.
HOW DOES LIFE INSURANCE WORK?
he most basic type of life insurance is called term insurance. With term insurance you choose the amount you want to be insured for and the period for which you want cover. If you die within the term, the policy pays out to your beneficiaries. If you don’t die during the term, the policy doesn’t pay out and the premiums you’ve paid are not returned to you. There are two main types of term assurance to consider – level-term and decreasing-term insurance. Sometimes a combination of the two is the best answer.
Level-term life insurance policies
A level-term policy pays out a lump sum if you die within the specified term. The amount you’re covered for remains level throughout the term – hence the name. The monthly or annual premiums you pay usually stay the same too.
Level-term policies can be a good option for family protection, where you want to leave a lump sum that your family can invest to live on after you’ve gone. It can also be a good option if you need a specified amount of cover for a certain length of time, for example to cover an interest-only mortgage that’s not covered by an endowment policy.
Decreasing-term life insurance policies
With a decreasing-term policy, the amount for which you are covered decreases over the term of the policy. These policies are often used to cover a debt that reduces over time, such as a repayment mortgages. Premiums are usually significantly cheaper than for level-term cover as the amount insured reduces as time goes on. Decreasing-term insurance policies can also be used for inheritance tax planning purposes.
Family income benefit policies
Family income benefit is a type of decreasing term policy. Instead of a lump sum, though, it pays out a regular income to your beneficiaries until the policy’s expiry date if you die. The upside of family income benefit is that it’s easier to work out how much you need. For example, if your ‘take home’ income is £2,000 a month, you could arrange for the same amount to be paid out to your family if you die. However, there is a downside too. If you die two years into a 20-year family income benefit policy, your family could get £2,000 a month for 18 years. But if you die a year before the policy ends, your family gets £2,000 a month for just one year.
As the name suggests, whole-of-life policies are ongoing policies that pay out when you pass away. Because it’s guaranteed that you’ll die at some point (and therefore that the policy will have to pay out), these policies are more expensive than term assurance policies, which only pay out if you die within a certain timeframe. Whole-of-life policies can be a useful way to cover a future inheritance tax bill.
Life insurance pitfalls to watch out for
A life insurance policy can offer valuable cover and peace of mind. However, pick the wrong type of policy or fail to disclose important information to your insurer and your policy might not pay out, just when your dependents are in most need of financial support. Watch out for ‘low-start’ policies. If you use a price comparison site to find life insurance, you might find these policies come out on top on cost. What you might not realise, though, is that the monthly premium increases throughout the term of the policy. What may seem to be a very cheap quote in the early years could cost you much more over the whole term of the policy than taking out the same cover under a level-term policy, under which your monthly premiums will stay the same.
Two life insurance policies may be better than one
Couples can buy a joint policy that covers both lives or can have one policy each. Joint-life policies pay out on either the first partner’s death or the second. First-death policies are often used to provide a lump sum for your family if you or your partner dies, for example to pay off a mortgage. Second-death policies can be used to cover an anticipated inheritance tax (IHT) bill.
And yet, if you’re looking for cover for you and your spouse, two single-life policies may offer much better value than a joint-life policy. For a start, two individual policies will often be no more expensive than a joint policy. And if both partners die within the period covered by the policies, that’s double the payout to their beneficiaries. Also, as a joint policy ends on the death of one partner, if the surviving spouse wanted to take out a new policy in their own name, they would have to pay more for the cover at that stage as they would be older at the outset of the new policy.
An extra benefit is that single-life policies give more flexibility as the payout goes to your estate and is distributed under the terms of your will. Joint-life policies tend to pay out to the surviving spouse.
Reviewable life insurance policies
If a quote seems unusually low, check if it’s a reviewable policy. Rather than the monthly premium staying the same (as would happen with a regular ‘guaranteed’ policy), the premium is only guaranteed for the first few years (often the first five or 10 years), at which time it is repriced. As prices rise as you get older, you may find that reviewable premiums become unaffordable in later life, leaving you exposed to an expensive product which no longer matches your budget.
Health issues when buying life insurance
If you withhold any information about your health, your policy could be invalid and might not pay out. If you have a pre-existing medical condition you should still be able to get life cover, but it may cost more and be harder to find.