Life insurance may feel both baffling and daunting, but it’s a key step towards financial security for many people. These are the things to know when deciding whether it’s right for you and which policy to choose.
The most important question is what you want the life insurance to achieve. With most forms of insurance, it’s simply a case of covering costs or replacing something that’s lost, stolen or damaged. With life insurance, you’re commonly looking to replace your income.
That means it matters whether you are the sole ‘breadwinner’ in your household, you share financial responsibilities, or you have no dependents (in which case life insurance usually makes little sense). You also need to consider whether you simply want to maintain an income for your family after you die or if you are concerned with specific expenses, such as a mortgage or university costs for your children.
WHOLE-OF-LIFE OR TERM?
Those factors will help you make the biggest decision: whether to get a whole-of-life policy or a term policy. The former means that, as long as you keep up the payments, the policy pays out when you die. (Sometimes you’ll hear the term life assurance because the covered event – your death – is guaranteed to happen eventually.)
These policies tend to work out more expensive, both through higher payments and because you’ll be paying in for longer. It’s usually taken out by people who want to be sure to cover funeral costs, or want their heirs to be able to pay an inheritance tax bill without having to sell the family home.
Some whole-of-life policies let you ‘cash in’ by ending the policy while you are still alive and then getting a cash payout. This often carries a significant fee and the payout may well be much less than you’ve paid in premiums.
With term policies you pay premiums and are eligible for payouts during a fixed period. Depending on your financial goals, this could be a set number of years, the remaining term of your mortgage or until your planned retirement date. These policies are usually cheaper that whole-of-life policies. Once the term ends, you stop making payments and the policy will never pay out.
If you go for a term policy, you need to decide how the payout level changes over time. The most basic option is a ‘level’ policy that simply pays a fixed lump sum on your death. A variation of this means the payout amount goes up each year during the term, in line with inflation.
In contrast, a decreasing policy means the payout amount falls each year during the term. That makes premiums lower and is most suitable when you want the life insurance to clear your mortgage if you die. The falling payout reflects the fact your outstanding mortgage debt will also fall over time.
Another variation is called family income benefit. This doesn’t pay a single lump sum. Instead, it pays a fixed amount each year after you die until the term ends. The idea is to replace some or all of your income.
SINGLE OR JOINT
Next you need to decide whether to get a single or joint policy. A single policy is straightforward: the payout goes into your estate and is distributed in line with your will.
With a joint policy, the default set-up is that when (or if) one of the two policyholders dies, the payout goes to the other policyholder. The policy then ends with no further premiums or payouts.
Both whole-of-life and term policies may include terminal illness cover or offer it as an extra option that means higher premiums. With this option, the policy pays out when you are diagnosed with a terminal condition that means you aren’t expected to live for more than twelve more months. You get the ‘normal’ payout straight away, meaning no payout when you die.
The good news with all policies is that you are still covered even if your insurer goes out of business. The Financial Services Compensation Scheme will find a replacement insurer to take over the policy on the same terms. It will also normally fund a payout if you die before the replacement policy is in place.
