Life Insurance is one of the most important types of financial protection that people ever buy, yet many don’t do it. For those that do working out the type of policy and amount of cover you need is not straightforward.
It is therefore vitally important to get as much information as possible, and preferably by speaking to a regulated professional, before making your decision.
Do I need life insurance?
If you are unfortunate enough to die unexpectedly, whilst you won’t see the benefit of the policy (for obvious reasons), it can help to take care of the financial needs of the dependants that you leave behind.
It can be used to help clear a mortgage and any other outstanding debts. It can also be set up to provide a lump sum or regular income to help cover your loved one’s day to day living costs. Knowing that they are going to be taken care of financially, should anything happen to you, does offer great peace of mind.
However, its not quite as simple as whether you need life insurance or not. There are other considerations such as how much cover do you need and how long do you need it for.
How do I decide on the right type of policy?
Working out which life insurance policy is right for you depends on many different factors.
A good starting point is working out how much life cover you think you will need (easier said than done so speak with a professional). Consider if you already have any cover in place through policies you have set up yourself or through your employer. This is known as death in service benefit and is generally around 3 – 4 times your annual salary.
The next thing to consider is what type of cover you need, and this is generally determined by what you need the cover for. For example, if you need cover to protect a repayment mortgage, then the best type of policy for you would be decreasing term cover. This would normally be set up over the term of your mortgage and the amount of cover will reduce over time as your mortgage balance reduces. However, you may have an interest only mortgage and so a level term policy would be much more suitable.
It might however be the case that you want a policy that runs until you die (at whatever age that may be) and ay out a tax-free lump sum to your family. For this you would consider whole of life cover.
You should also consider critical illness cover at the same time. This type of insurance is more expensive, but it provides you with financial protection even if you don’t die. If you are diagnosed with a critical illness or suffer a life changing accident this policy pays out a lump sum which can give you some financial peace f mind, at what is likely to be a very stressful and worrying time.
There are also other types of policy available such as over 50’s life cover, which is a more specialist policy that normally offers guaranteed acceptance. However, cover can get expensive as the older you get the more expensive the premium.
How much life cover do I need?
Just like deciding what cover to have, there are also things o consider when thinking about how much cover you need.
As professional advisers, we suggest that a good starting point is enough to pay off your mortgage and any other outstanding debts you may have. This obviously takes a large financial burden and worry away from your family.
The next thing to consider, is your dependants. You may wish to leave an excess of funds to pay for things like living costs, education and childcare. You may even wish to leave some funds for your own funeral.
What else should I consider?
The most important thing when taking out a life insurance policy, is to make sure its suitable and that you are covered for what you think you are. Check for exclusions.
As an example of the above, whilst the policy will cover you for death from an accident or unexpected illness, if you didn’t disclose things properly at your application and you have drug or alcohol dependency or even undisclosed health conditions, you may not be covered. The moral is be honest. If you are a smoker you are also likely to find that your premiums will be significantly higher.
As we have said in another post, do not put off taking out a policy. The older you get, the more the premiums increase. The younger you are when you take out your policy, the lower the premiums, and as you can fix your premiums, this guarantees lower monthly outgoings.
If you are buying cover with a partner, you may be offered individual policies rather than a joint one. This does have benefits, which your adviser can explain, but it could also be slightly more expensive, so always consider joint, if cost is the issue. However, with a joint policy, if one of you dies, the policy pays out and then ends, whereas with single policies, the other policy will continue to provide cover for the surviving partner.
You should also talk to your adviser about trusts. If you put your policy into trust, when the policy pays out, the proceeds will avoid your estate and therefore not attract inheritance tax.
Questions to ask yourself when considering protection:
Would your dependants be financially secure? – Life insurance pays out a lump sum or regular payment, providing financial security for your family
What are the different types of policy available? – The most popular types of cover are level term insurance or decreasing term insurance. They both pay out a lump sum when you die.
Single or joint policy? – If you are a couple then a joint policy may be better but seek advice. Whilst it could be cheaper it does have limitations as on the first death the policy pays out and ends, leaving the surviving partner uninsured.
How much cover? – This is the ‘sum insured’. It should be determined (with the help of your adviser) and cover at least your outstanding credit commitments, including your mortgage. Your budget should also be considered when determining the level of cover.
Are you the main breadwinner? – If you died or suffered a critical illness/ life changing accident that means you can no longer work, how would your family and you cope? If anyone relies on your income, you should consider life insurance.
Are you a full-time parent? – Just because you don’t earn an income, it does not mean your contribution is any less valuable. Your death would have a significant impact on the family dynamic meaning there may be a need to pay for childcare and house-keeping assistance.
Do you need critical illness cover? – This is one of the most popular add ons to life cover. As previously explained, it pays out a lump sum if you are diagnosed with a serious condition or illness, including strokes, certain types of cancer, and life changing injuries. Conditions and cover vary from provider to provider.
Other add-ons you should consider?– There are other options available to provide extra security under certain circumstances. For example, ‘waiver of premium’. This ensures that your policy premiums will continue to be paid in the event that you no longer earn because of an accident or illness.
Should you put your policy in trust? – Generally speaking the answer to this is YES. However, you should seek professional advice.
Life insurance itself is not taxed, but the resulting pay-out could be. In the event of your death, your family will be liable to pay IHT at 40% on the value of your estate above £325,000 (or £650,000 if you are married or in a civil partnership). Considering the values of properties nowadays (especially in the south of England), when you add in life insurance pay-outs, this number is very quickly reached.
If your policy is written in trust, this means it won’t form part of your estate on your death. This means the money goes straight to your beneficiaries, and so the tax man cannot touch any of it.