A Short Guide to Life Insurance

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In financial planning, we often have to prompt our clients to think about worst-case scenarios. This is not always a pleasant exercise, as no one likes to think about their own mortality or the loss of a partner.

But part of any plan involves addressing risks. By making sure that contingencies are covered we can move on to more exciting things, safe in the knowledge that are families have a secure future even if the unthinkable happens.

In this guide, we look at the basics of life insurance and explain why you need it.

How Does Life Insurance Work?

A life insurance policy works as follows:

•          You pay a monthly premium to an insurance company for a specified term, which can range from a few years to the rest of your life.

•          If you die within the term, the company pays out a sum to your family, your estate or a designated trust.

•          Most policies don’t accumulate a value, and will lapse if you stop paying premiums.

•          The premiums are underwritten from a medical and lifestyle point of view. Any health issues or risky pastimes are likely to increase your premiums.

It’s important to complete your application fully and accurately so that the insurance company has all the necessary information to make a decision. Any non-disclosures which later come to light could render your cover invalid.

Why Do You Need It?

Most people take out life cover for the first time when they are arranging their mortgage. This means that if they die, the mortgage will be cleared and the property can pass to their beneficiaries. This may be less important for single people, but will be vital for anyone with a partner or family as it ensures that they won’t lose their home at an already difficult time.

But simply covering the mortgage is unlikely to be enough for most families, particularly if they are reliant on the income of one parent. It’s worth taking out additional cover to ensure that your family can maintain their lifestyle even if you are no longer around.

It’s also important to think about other roles and responsibilities in the household. While one spouse may contribute significantly less in financial terms, perhaps their role in childcare and maintaining the home is more important. Buying in this kind of help can vastly increase the family’s costs.

How Much Cover Should You Have?

This is not a simple question, as everyone’s situation is different. There are a number of factors that can influence this decision:

•          Your debt or other financial obligations

•          Your savings or other assets

•          Your family’s current and future spending requirements

•          Your plans for the children’s education

•          The extent to which your household income is reliant on one person.

A financial plan can help you determine exactly how much cover you need.

 The Different Policy Types

While life cover is a simple concept, the policies available can vary. For example:

•          Level term assurance – pays out a fixed sum on death during the term of the policy.

•          Decreasing term assurance – the policy benefit reduces each year, for example, in line with a repayment mortgage.

•          Family income benefit – this phases the policy benefit over a number of years rather than paying it out as a lump sum 

•          Whole of life cover – this has no end date and will pay out on death whenever it occurs. Premiums are usually reviewable over the term of the policy and generally increase. Level premiums are available, but are usually very expensive. Whole of life cover, placed in trust, can be useful for ring-fencing wealth outside the estate or paying an inheritance tax bill.

Additionally, business owners can opt for either of the following:

•          Key person cover – pays out a sum to the business or other shareholders. This can be used to ensure the business can continue, or to buy the shares from the deceased person’s estate.

•          Relevant life cover – this can be used for the benefit of any employee, including directors. The life cover is paid into trust for the benefit of the employee’s family. The company cannot benefit, however the premiums are a tax-deductible business expense.

Some Options You Can Include

There are various additional options you can add to your life insurance policy:

•          Joint life cover – this can pay out the policy benefits either on first or second death.

•         Critical illness cover – pays out a lump sum on diagnosis of a serious illness. Life and critical illness policies are usually set up on a ‘first event’ basis. This means that if you claim for critical illness, no further benefits will be available if you subsequently die.

•          Waiver of premium – ensures that the cost of the policy can be covered if you are unable to work due to ill-health.

•        Increasing cover – premiums and benefits increase with inflation. Some policies allow you to substantially increase your cover after significant life events, such as the birth of a child or a promotion.

Some insurers offer discounts and perks, or may link your premiums to achieving certain health goals.

Should You Place Your Plan in Trust?

By placing your plan in trust, any policy benefits can be paid outside your estate. This has the following benefits:

•          It can speed up the payment process for your beneficiaries.

•          It avoids inheritance tax on the lump sum.

•          It allows a degree of discretion over who benefits from the lump sum and when. This can protect your beneficiaries’ inheritance if they get divorced, lose capacity or are declared bankrupt.

Of course, a trust should not be used if the policy is required to repay your mortgage.

If a policy includes critical illness benefits, it’s usually possible to set up a split trust. This means that any critical illness benefits would be paid to you, while death benefits would pass into the trust.

Other Options to Protect You and Your Loved Ones

Life cover is an important part of your protection plan. However, there are other steps you can take to address risk and ensure your family’s security:

•          Make sure you have an emergency fund to cover any unexpected bills, periods of illness or redundancy.

•          Set up an income protection plan to replace your salary if you are unable to work for health reasons.

•          Arrange a standalone critical illness policy to ensure that you don’t lose your life cover if you need to claim for a serious medical condition.

•          Take care of your health to ensure that you will be around for your family for as long as possible.

Please do not hesitate to contact a member of the team to find out more about your protection options.

 

The Financial Conduct Authority does not regulate tax advice or Trusts