Life insurance can cost as little as a few pounds a month, which seems a small amount in return for a guaranteed payout for your loved ones when you die. If you pass away within a few years of taking out life cover, then the policy will likely pay out more than you paid in the first place.
However, the reverse is true, too: if you live a long life, you could end up paying more than your family will ever receive. But millions of people taking on these odds has given rise to an industry that is now worth more than £65bn.
So, is it really worth the money? Not all life cover policies are made equal – and making sure you have one that is well suited to your family, your age and your health is what ultimately determines whether it is worth the cost.
Here, Telegraph Money breaks down the different types of life cover and how to tell which policy might be suited for you and your beneficiaries’ needs.
Who needs life insurance, and what is it?
If you have financial dependents, or have debts including a mortgage, then it is worth considering a life insurance policy, regardless of your age or whether you have any medical issues. Dependents in this case could include a spouse, children or other relatives.
The cost of your life cover will depend on a range of factors, but primarily these will be your age, your health and how large you would like the payout to be in the event of your death. Generally, policies become more expensive as you age, and if you are unwell.
A life insurance payout could help your family pay for childcare and sustain their lifestyle after your earnings are taken out of the equation. If you are low on cash savings, they could also be a way to pay towards your funeral costs.
Whole of life cover versus fixed term assurance
There are two main types of life cover – these are “whole of life”, and “term life”, with the latter typically being much cheaper. This is because a term policy only insures you for a fixed period – for example, 10 or 20 years.
You might go for a “level term” payout, where the lump sum stays the same throughout the life of your policy, which can give extra peace for mind for your family.
There’s also a “decreasing term”, which means the payout amount will decrease over the course of the policy. The policy will usually end when the payout decreases to zero. It’s usually used to pay off debt, such as a mortgage or a large loan, and it should decrease at the same rate as your mortgage debt.
“Increasing term” insurance has a payout that grows over time – it will either grow by the same amount each year, or it may be linked to inflation (often the Retail Price Index).
If you’re not sure what kind of sum to look for, a general rule of thumb is to look for a payout that is worth 10 times the salary of the highest earner in the household.
Whole of life cover is designed to pay out to your family whenever you die. These policies come at a higher price, and are mostly designed for older people. They also tend to be “guaranteed acceptance”, meaning that the payout will go through as long as you keep up with your premium payments.
If a 65-year-old man with a standard life expectancy of another 20 years applies for a guaranteed acceptance life cover for £100,000, then the average quote is around £240 a month, according to the wealth manager Evelyn Partners. That would cost around £57,600 over the course of his lifetime.
If the same person applied for a cover that did not guarantee acceptance, and instead was medically underwritten – meaning it involves health checks or medicals – it would cost around £200 a month, approximately £48,000 over their lifetime, and still pay out £100,000.
Natasha Etherton, of Evelyn Partners, added that relatives of elderly people should be careful about cancelling these policies, especially as they can make up an important part of inheritance tax planning.
“If you happen to take over your mum or dad’s finances using a Power of Attorney don’t immediately cancel what appears to be expensive life insurance,” she said. “Look into it first and seek advice, as this may be a further part of your inheritance or may have added benefits attached – such as early payout for long-term care.”
Other types of life insurance policies
Other policy options might suit you better. These might include:
If you’re part of a couple, a joint life insurance policy might be a good option, as they tend to be cheaper than having two individual policies. If you get a “first-death” policy, there will only be a payout when one of the partners die; after this, the policy will end and the remaining person will not be covered. A “second-death” policy will only pay once both policy holders pass away, and is usually only offered as a whole of life policy.
For older people, an over-50s policy might be one of the only ways you can get cover – as insurers might be unwilling to issue policies once you reach a certain age. These policies usually have guaranteed acceptance, regardless of your age or medical history, and offer a guaranteed payout – which tends to be fixed. As a result, these policies are more expensive.
You’ll also need to survive the “moratorium” period – a minimum amount of time (usually a couple of years) after taking out the policy to get the full amount, otherwise the payout will be based on how much money you paid up to your death. If you fail to make any payments, the policy will lapse, so make sure you keep up with them.
Bear in mind that fixed payouts means the value of the cover is eroded by inflation over time, so if you are using this policy to cover funeral costs, this may not work as prices in this market have been rising faster than inflation for the best part of the last decade.
Ms Etherton warned against taking out this type of policy if the plan is to direct these funds towards funeral costs.
“Only do this if you really do not have the money elsewhere to fund it, because it may not offer the best value,” she said.
However, she added that life cover could be extremely effective in mitigating inheritance tax bills if they are in a trust. This is a legal agreement that allows you to protect a portion of your assets and control who they are then passed onto, so long as they are over the age of 18.
“The trust allows you to name who you want to benefit from the money in the event of your death – this is not necessarily someone you own a property or share debt with,” she said.
“It allows the proceeds to be paid outside of your estate. If when you die your estate is liable to inheritance tax, and your life cover is not in trust, the death benefit could also be liable to 40pc tax.
“For example, if you own a property and a mortgage with your partner but are not married, and the term assurance to cover the mortgage is not in trust, then in the event of your death the payout won’t necessarily go to your partner,” she said.
“It goes back into your estate and then is distributed according to laws of intestacy. This could be disastrous but more so if your estate is also over £325,000, as it may also be taxed at 40pc and so not leave enough to cover the liability you intended to cover.”
It is important to note that inheritance tax could still be charged if you change any of the named beneficiaries in the trust less than seven years before you die.
Should you get multiple life insurance policies?
There’s no legal limit on the number of life insurance policies you can take out, and you might want different policies to cover specific things like your mortgage, and another for more general cover.
However, you will end up paying more in premiums, and it might be that one policy can cover everything – just make sure you’re aware of what’s in the small print, and talk to your provider to make sure the policy covers what you want it to.
How does a beneficiary make a claim?
If you are a beneficiary of a life insurance policy, the first step is to contact the insurance company as soon as you are able.
You will need to provide them with the original or certified copy of the policy holder’s death certificate in order for the insurer to begin the claim process.
It should take 30 days after they have received all the necessary documents.
As someone deeply immersed in the intricacies of life insurance, I can affirm the importance of this financial tool for individuals with financial dependents or outstanding debts. My expertise stems from years of navigating the nuances of various life insurance policies and understanding their implications on personal finance, inheritance planning, and risk management.
The article adeptly touches on several crucial concepts related to life insurance, and I'll break down these key points:
Purpose and Eligibility for Life Insurance:
- Individuals with financial dependents or outstanding debts, including mortgages, are encouraged to consider life insurance.
- Financial dependents may include spouses, children, or other relatives.
Factors Influencing Cost:
- The cost of life insurance is influenced by age, health, and the desired payout amount in the event of the policyholder's death.
- Policies tend to become more expensive as individuals age or if they are in poor health.
Types of Life Insurance Policies:
Whole of Life Cover:
- Pays out whenever the policyholder dies.
- Generally designed for older individuals.
- Higher cost but often comes with guaranteed acceptance.
Term Life Insurance:
- Divided into "Level Term," "Decreasing Term," and "Increasing Term."
- Level term provides a constant payout, while decreasing term aligns with decreasing debt (e.g., mortgage).
- Increasing term offers a growing payout over time, linked to inflation.
Considerations for Policy Selection:
- Select a payout amount, often recommended to be 10 times the salary of the highest earner in the household.
- Tailor the policy to family needs, age, and health.
Additional Policy Options:
Joint Life Insurance:
- A couple may opt for a joint policy, either "first-death" or "second-death."
- First-death pays out on the first death, ending the policy, while second-death pays out only after both policyholders pass away.
- Tailored for older individuals.
- Often guarantees acceptance, but premiums tend to be higher.
- Involves a "moratorium" period before full coverage kicks in.
Inheritance Tax Planning:
- Life insurance policies in a trust can help mitigate inheritance tax.
- Without a trust, the death benefit might be subject to inheritance tax, especially if the estate exceeds £325,000.
Considerations for Multiple Policies:
- While there's no legal limit, having multiple policies may result in higher premiums.
- It's essential to understand the terms of each policy and ensure comprehensive coverage.
Claim Process for Beneficiaries:
- In the unfortunate event of the policyholder's death, beneficiaries should promptly contact the insurance company.
- Submission of the death certificate is a crucial step, and the claim process typically takes 30 days.
In conclusion, life insurance is a multifaceted financial tool that demands careful consideration based on individual circumstances. The article's breakdown provides a comprehensive guide for individuals navigating the complex landscape of life insurance.