Polly’s Guide to: Life Insurance
Knowing how much life insurance you need (or if you need it at all) can be tricky. That’s why it can sit on people’s to-do lists. This guide can help get you one step closer to protecting what matters – because your death can have a big financial impact on the people you leave behind.
What is life insurance?
In simple terms: life insurance is an insurance policy that can pay out if you die. When you buy it, you agree to pay a monthly amount – known as the life insurance ‘premium’ – in return for a lump sum, paid out after your death. Many life insurance policies can also pay out the lump sum early if you’re diagnosed with a terminal illness and given 12 months of less to live.
Depending on your personal circumstances and wishes, the lump sum can be paid out to either your partner, children, family, or whoever you’ve named as the ‘beneficiary’, (if an insurer has a beneficiary or trust service or you choose to place your life insurance in a trust) – which means: the person or entity (e.g. a charity) you’ve stated should receive it. The main purpose of life insurance is often to help make sure anyone who relies on you financially can be protected in case the worst happens: you die.
How does life insurance work?
When taking out life insurance, you may have to decide on the following: what kind of policy you want (known as the type), how much it covers (the amount), and for how long (the term).
The type determines: how the policy will pay out; the amount determines how much the policy pays out; and the term determines how long you’ll be insured for. Based on these three things, you can be quoted a price for your monthly life insurance premiums.
What does life insurance cover?
Life insurance is usually taken out to support your family’s financial needs after you die, particularly if you have financial commitments like dependents or a mortgage. Life insurance can be a way of providing the money your family would need to cover essential things like keep a roof over their heads and to help with raising the children. If you’re a single parent, meanwhile, life insurance can be a way of making sure essential guardianship costs are covered, so that your children can continue to be provided for until they reach an age at which they can financially support themselves.
This is the minimum you might choose to do with life insurance – but it can also cover even more if you wanted it to. You might use it to help cover future university or private school fees for your children, for example.
Do you have to pay tax on a life insurance payout?
Life insurance is unusual in the sense that although the policy is yours, it can be claimed by someone else after you’ve died. It’s also paid out as a lump sum, so it can be understandable that you might have some questions about whether or not the payout is taxed. Some insurers offer a trust or beneficiary service. Here you can nominate who would receive the lump sum if you die. These are known as your beneficiaries. The benefit of using these services is that the lump sum is not subject to probate or inheritance tax.
If an insurer does not offer this service, it may still be best to place the life insurance into a trust to help ensure the money goes to people you want it to go to. If you do not, then the lump sum may count as part of your estate and, if you have one, be left to the person stated in your will and depending on the amount, tax may have to be paid.
Different types of life insurance
The most common type of life insurance is what’s called ‘term life’ – but there’s also different types of life insurance that could be suitable.
Decreasing term life insurance
In a decreasing term life insurance policy, the lump sum of money paid out if you die during your policy term decreases over time. So, if you die early in your policy term, your family would receive a bigger lump sum than if you died nearer the end of it.
This kind of policy tends to be suitable if the things you’d need the money for also reduce with time – a mortgage being the most obvious example.
Level term life insurance
In a level term life insurance policy, the lump sum of money can be paid out if you die during your policy term. So, if you die early in your policy term, your family would receive the same lump sum as if you died nearer the end of it.
This kind of policy tends to be suitable if you want to leave behind a fixed amount for your loved ones, to help ensure expenses are covered that may not decrease over time. In other words, the amount of money you’d need to pay off debts and/or support your loved ones financially would be the same in 5 years’ time as it would be in 20 years’ time. Or, you might choose this kind of policy simply because you want to leave a set amount of money to your loved ones if you die at any point during your policy term.
Increasing insurance
Increasing (also known as indexed linked) life insurance is typically designed to increase with inflation over the term you have chosen to take the life insurance out for. This means that each year your premiums and cover amount are likely to increase.
This kind of policy tends to be suitable if the things you’d need the money for may increase over time – for instance funeral costs rising with inflation.
Do you need life insurance?
The easiest way to answer this question may be to ask yourself: do you have another person (or people) relying on you financially? Or do you have a big financial commitment? If one (or both) of these applies to you, then it’s likely you have some sort of need for life insurance. This can be because your financial dependents or beneficiaries could be left liable for your outstanding financial commitments if you died. Some common reasons for needing life cover are:
Because you’ve got a partner.
Partners tend to rely on each other financially – with shared financial commitments, or shared debt. If you’ve got a partner, life insurance can be a good way of protecting the future you’ve planned together. It means one partner can be helped to cope financially, covering current shared financial commitments, if the other were to die.
Because you’ve got children.
Naturally, children are usually financially reliant on their parents, so life insurance can be a way of supporting them until they reach an age where they can financially support themselves. If you have a partner, life insurance can help provide money to raise children. If you’re a single parent, on the other hand, it can help cover the amount needed for a legal guardian to raise your children in your absence. In either case, it could also be used to help provide a lump sum which could be used for the cost of education, including private school and university fees.
Because you’ve got a mortgage.
This is often one of the most common reasons for considering whether or not you need life insurance – not only because a mortgage is usually one of the biggest debts you could take on (and one of the biggest asset you’ll ever have). Protecting your mortgage can mean, protecting your home – so that if you have a family, they can pay off the mortgage and continue to live there.
Do you need to use a life insurance calculator?
Buying life insurance can be complicated because of all the math’s and what-ifs. This can be why so many people put it off – or assume they may need the help of a financial adviser before buying it. It can also be why so many people turn to online life insurance calculators in an attempt to get a rough idea of how much life insurance they might need and for how long. The problem with using automated calculators can be that there are lots of contextual variables they may not factor in – like your age, health and lifestyle, plus your household setup and how many financial dependents you have.
When should you get life insurance?
Most people often don’t think about buying life insurance until something changes in their life which might trigger the need for it – like buying a house or becoming a parent. This can be totally understandable. Like any insurance product, you’re unlikely to think about buying it until you actually, generally speaking, need it.
But when it comes to life insurance, it tends to be a case of: the sooner, the better. This can be because life insurance tends to get more expensive as you get older– which generally means that the younger you are when buy it, the cheaper it can be. The (unfortunate!) reason being that the older you are, the more likely you are to die and, therefore, the more risk you tend to pose to the insurer in terms of having to pay the policy out. You may also be more likely to develop a health condition that may affect your life insurance premiums – so it can be best to keep in mind that premiums tend to be cheapest when you’re young, fit and healthy.
Is over 50s life insurance worth it?
Over 50s life insurance usually comes in the form of whole-of-life policies, rather than term life policies. This means a policy that can be guaranteed to pay out when you die, whenever that is, rather than if you die within a pre-agreed period of time. Unlike other life insurance policies, over 50s cover is not usually medically underwritten, so there’s often a limit to how much the policy will pay out. For reference: it’s unlikely to be as big as a term life lump sum.
People usually take out over 50s protection to help cover particular costs that they know may arise after their death. This could mean things like funeral expenses or outstanding debts that members of their family could be left liable for. Others may take it out simply because they want to leave a little extra for their family. Either way, it can be a more affordable, viable option than term life insurance for people at that stage of their lives to help get some extra peace of mind about their family’s financial future.
How much does life insurance cost?
Several factors can affect how much your life insurance policy can cost per month – some relating your health and lifestyle or the policy you choose. This can include your age, individual and family health history, smoking status, and dangerous hobbies. And as for the policy, factors include the amount of cover you choose, what type, for how long – as well as what features may be included in the cover. All of these factors combined can determine how much your monthly premiums could be.
Does life insurance always pay out?
Life insurance can pay out if:
- You die while your insured
- You were honest about your health when you applied
It won’t pay out if:
- You die after your policy ends
- You die after cancelling your policy
- You don’t keep up with your policy payments
- You meet an exclusion (e.g. suicide within the first year of having your policy)
Do you need life insurance to take out a mortgage?
In the UK, it’s not compulsory to buy life insurance when you take out a mortgage – but lots of mortgage brokers tend to recommend life insurance as an effective way of protecting your mortgage.
It’s up to you whether you take it out or not, but taking on a mortgage can be one of the most common triggers for getting covered. This is often because a mortgage is usually the biggest sum of money someone ever borrows in their lives, so naturally it can be a debt people are keen to insure.
Life insurance policy feature
Additional Policy Features/ Add ons
Waiver of premium
You can pause your monthly insurance premiums if you’re unable to work for certain medical reasons. Different insurers will have different requirements to be eligible to use this feature.
Terminal illness benefit
You can claim your lump sum early if you’re diagnosed with a terminal illness. Eligibility for this usually requires a doctor to say you have 12 months or less to live.
Guaranteed insurability
You can have the option to increase your cover after certain life events, like getting married or becoming a parent, without further medical underwriting. The list of included life events tends to vary per insurer.
What if you’ve already got life insurance?
Even if you’ve already got life insurance, it can be good to review the level of your existing cover to check that it’s still appropriate for your needs. If your policy has what’s known as a ‘guaranteed insurability’ feature, you may even have the option of increasing your cover after certain life events without further medical underwriting. This typically includes things like:
- Getting married or entering a civil partnership
- Becoming a parent
- Taking out a new mortgage or increasing your mortgage
- Getting a significant pay rise
Changes in circumstances like these may affect what you need for a number of reasons: you might be gaining financial dependents that you didn’t have when you took out your life insurance; you could be increasing the liabilities that would be left behind if you died; or you could be making significant lifestyle changes that you want to protect.
Can you have two life insurance policies?
Technically, you can have as many life insurance policies as you want, although most insurers will have a maximum sum they’re willing to insure per person, across one or more policies.
But you may be thinking: why would someone need or want to take out more than one policy? A common reason can be if something changes in your life, while you already hold a policy, that alters what you need to protect – like becoming a parent, for example, or increasing your mortgage. If it’s the case that your existing policy leaves you under insured, some people may look to take out another one. It’s can also be simpler from a life admin point of view – both for you to manage while you’re alive, and for your family to claim.
Another common scenario for having multiple policies is if you may have some sort of existing employer insurance – like death-in-service cover, for example. This normally works by your insurer paying an agreed multiple of your salary to your partner or family if you die while you’re still employed by the same employer, but you might still look to buy your own policy if this amount doesn’t meet all of your needs. Also, the sooner you buy your own life insurance cover, the cheaper it can be – so it may still be a good idea to get your own cover if you have death-in-service, particularly as the cover may not follow you if you change jobs.
Is it easy to claim life insurance?
Claiming can be straightforward. If you die while you’re insured, your loved ones simply needs to contact the insurer you’re covered by to inform them of your death and make a claim. There might be some paperwork to fill in and provide (e.g. a death certificate), but once that’s all sorted correctly, the insurer can pay out the lump sum. This process can be quicker if you have named your loved ones in a trust or as a beneficiary.
How can you find lost life insurance policies?
Life insurance can sometimes go unclaimed. This is likely caused by it being such a long-term policy, so family members could be unaware that you even had a policy, or unaware of the policy details required to make a claim. It can be important to make sure this is not the case – by informing the relevant people about your policy and its details, whether that’s your partner, children, or other family members. If this information gets lost, that’s not to say they won’t be able to make a claim – it can be just be a little more difficult and time-consuming, as the executor of your will may need to trace the policy through bank or employment records.
Life insurance: Polly summary
Your death may be difficult for your loved ones. But the good thing about life insurance is that it can lessen any financial burden on top of the potential emotional impact that your death can have on the people closest to you. That burden can be alleviated with life insurance – often for the price of a TV subscription or a couple of coffees per month.
If you have other people who rely on you financially, or a big debt like a mortgage, or any other kind of need to protect – life insurance can be a good way to help financially protect your loved ones
