The 5 life insurance need-to-knows
There are many different types of life insurance: some protect a mortgage and some protect all your dependants, while others provide a way to mitigate inheritance tax. Yet here we're focusing solely on life insurance taken out to provide money for your family if you or your partner were to die. This is something every parent, partner, or person with any other type of dependant needs to consider.
The key product for doing this is called 'level term' life insurance or assurance. You insure something that MAY happen, while you assure something that WILL happen. Death is of course assured, but as the question is "will you die within a set time?" many call it insurance, and here's what you need to know.
There are many different types of life insurance: some protect a mortgage and some protect all your dependants, while others provide a way to mitigate inheritance tax. Yet here we're focusing solely on life insurance taken out to provide money for your family if you or your partner were to die. This is something every parent, partner, or person with any other type of dependant needs to consider.
The key product for doing this is called 'level term' life insurance or assurance. You insure something that MAY happen, while you assure something that WILL happen. Death is of course assured, but as the question is "will you die within a set time?" many call it insurance, and here's what you need to know.
This is the simplest type of life insurance and the name actually tells you all you need to know...
- Level: The payout you get doesn't vary. It's always at a set amount regardless of when you die during the term, eg, £200,000
- Term: You only get a payout if you die within a fixed term, eg, 18 years
So all in all the cover guarantees a lump sum payout upon death to your dependants within a fixed time, for example, £200,000 if you die within the next 18 years. Obviously, the more cover you get and the longer the term you want, the more it costs.
It's also worth noting that as the policy only pays out on death – there's usually little dispute over whether someone is dead or not – and it pays a fixed amount, then providing the company is reputable...
Don't confuse it with other types of life insurance
This is just one type of life insurance, there are others that do different jobs including:
- Mortgage decreasing term insurance: This pays out to cover your mortgage if you die within a set term. As mortgage debt decreases over time, the amount it pays also decreases (it's often called 'decreasing term assurance' because of this).
- It's cheaper than level term life assurance as the insurer usually has to pay a lot less. See our Mortgage Life Insurance guide for how to get it. However, if you want to leave a lump sum for your dependants to cover other debts and ongoing spending, a level term life insurance policy, while more expensive, is likely to be a better option.
- Whole of life insurance: These are often (but not always) investment-linked life insurance policies mainly used to mitigate inheritance tax. In other words, the payout amount should cover the inheritance tax bill on death, and the policy runs out when you die, instead of after a fixed time.
- Life insurance investment: These are effectively investments operated through life insurers. While there is a life insurance element they're often things like endowments or with-profits policies and are used far more often in the 'investment' zone rather than for protection if someone dies.
2. You don't need life insurance if you don't have dependants
If you have no dependants and are single, then you'd be right to question why you would bother to get this policy. This is all about paying out when you're gone, so if you've no one you want the money to go to, don't bother.
However, if you do have dependants, such as a partner and/or children or anyone else who relies on your income, then ask yourself: what would happen financially to the people around me if I died?
If the answer is there'd be little financial impact, then you may not need a policy. But if paying the bills, the mortgage, bringing up kids, food shopping and more would be a struggle, this is a cheap way to solve that.
3. Roughly cover 10 times the annual income of the highest earner till kids have finished full-time education
The rough rule of thumb is to cover 10 times the main breadwinner's income, yet you don't have to stick with that. It may just be a case of do what you can afford – the budget planner should help. Here are some things you should take into account. It should cover...
While 10 times your income may seem high, it's worth remembering that inflation will mean the value of this payout is less in, say, 10 years' time than it is now, and you're getting cover to last you that long (or longer if you choose a greater term).
Your dependants don't have to pay any income tax on the payout, but it does count as part of your estate so if your total assets are above the inheritance tax (IHT) threshold, they will have to pay 40% (ouch!) IHT on it. This can be avoided by putting the policy into something called a trust, see below for more info.
How long should the term be?
A policy covering children should last until they are no longer reliant on you, so that's generally at least until they finish full-time education. If you're planning on having more children you may want to estimate when that'd be rather than trying to extend or get a new policy later. This is because cover becomes more expensive the older you get.
To cover a partner it should last until the year you expect to reach pensionable age. Don't feel obliged to cover a round number of years, eg, policies can be for 17 years.
4. Quit smoking or planning to? You could get cheaper cover
Non-smokers pay a lot less than smokers, because they're a lot less likely to die during the term. To count as a non-smoker, you need to have been genuinely nicotine-free for at least a year and in some cases longer, so always check.
Therefore one year after you quit, it's worth getting a new deal to see if you could save big. But don't be tempted to lie. If you die and it is discovered you had been a smoker, it could invalidate the policy. If you are seriously giving up, it's a good idea to get it noted on your medical records to back up any potential claim. See other savings in the Stop Smoking MoneySaving guide.
It is also worth noting that some insurers have tightened their criteria and their cheapest policies now outline that you need to have been smoke-free for five years to count as a non-smoker.
5. Make sure the cost is fixed each month with 'guaranteed premiums'
When you buy level term cover you will be given two choices of premium (which is the official name for monthly insurance payments). It can be guaranteed or reviewable.
If your premiums are guaranteed, your insurer will never change the price, so you'll know what you'll be paying over the life of the policy. Reviewable premiums, on the other hand, cost less at first, but your insurer can hike costs later on, meaning a cheap deal can potentially become costly as you age.
If you have no dependants and are single, then you'd be right to question why you would bother to get this policy. This is all about paying out when you're gone, so if you've no one you want the money to go to, don't bother.
However, if you do have dependants, such as a partner and/or children or anyone else who relies on your income, then ask yourself: what would happen financially to the people around me if I died?
If the answer is there'd be little financial impact, then you may not need a policy. But if paying the bills, the mortgage, bringing up kids, food shopping and more would be a struggle, this is a cheap way to solve that.
3. Roughly cover 10 times the annual income of the highest earner till kids have finished full-time education
The rough rule of thumb is to cover 10 times the main breadwinner's income, yet you don't have to stick with that. It may just be a case of do what you can afford – the budget planner should help. Here are some things you should take into account. It should cover...
- Any outstanding debts that need to be paid off (including a mortgage if you don't have a separate policy)
- Immediate outgoings your dependants would need to pay
- Future spending you would have wanted to make, eg, university fees for the kids
- Any additional expenses a death may trigger, such as funeral costs
While 10 times your income may seem high, it's worth remembering that inflation will mean the value of this payout is less in, say, 10 years' time than it is now, and you're getting cover to last you that long (or longer if you choose a greater term).
Your dependants don't have to pay any income tax on the payout, but it does count as part of your estate so if your total assets are above the inheritance tax (IHT) threshold, they will have to pay 40% (ouch!) IHT on it. This can be avoided by putting the policy into something called a trust, see below for more info.
How long should the term be?
A policy covering children should last until they are no longer reliant on you, so that's generally at least until they finish full-time education. If you're planning on having more children you may want to estimate when that'd be rather than trying to extend or get a new policy later. This is because cover becomes more expensive the older you get.
To cover a partner it should last until the year you expect to reach pensionable age. Don't feel obliged to cover a round number of years, eg, policies can be for 17 years.
4. Quit smoking or planning to? You could get cheaper cover
Non-smokers pay a lot less than smokers, because they're a lot less likely to die during the term. To count as a non-smoker, you need to have been genuinely nicotine-free for at least a year and in some cases longer, so always check.
Therefore one year after you quit, it's worth getting a new deal to see if you could save big. But don't be tempted to lie. If you die and it is discovered you had been a smoker, it could invalidate the policy. If you are seriously giving up, it's a good idea to get it noted on your medical records to back up any potential claim. See other savings in the Stop Smoking MoneySaving guide.
It is also worth noting that some insurers have tightened their criteria and their cheapest policies now outline that you need to have been smoke-free for five years to count as a non-smoker.
5. Make sure the cost is fixed each month with 'guaranteed premiums'
When you buy level term cover you will be given two choices of premium (which is the official name for monthly insurance payments). It can be guaranteed or reviewable.
If your premiums are guaranteed, your insurer will never change the price, so you'll know what you'll be paying over the life of the policy. Reviewable premiums, on the other hand, cost less at first, but your insurer can hike costs later on, meaning a cheap deal can potentially become costly as you age.
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