How life insurance works, what to consider and where to get it from
It’s an unpleasant conversation, but life insurance is a key consideration for anyone with a family – as it’s important to think are your finances protected should the worst happen. Our Money Saving Expert Martin Lewis is here with his guide to how it works, what to consider and where to get it from…
Sadly, around one child in 29 loses a parent before they grow up. And the grief and misery are often compounded by a loss of income causing financial crisis. Yet life insurance is one of the cheapest ways to protect against this. To read about how it works in detail see Martin’s full ‘Life Insurance guide’, but in brief…
What is life insurance?
Life insurance is an insurance policy you take out, that’s designed to pay out a lump sum when you die. This could be to a partner or to children who are financially dependent on you. There are three main types of life insurance policies (as well as investment type life assurance plans).
1) Level term life insurance – here the policy pays out an agreed set amount if you die during a set time.
2) Mortgage decreasing-term life insurance – here the policy pays out the remaining amount on your mortgage. So the amount decreases with time.
3) Whole of life insurance – the policy is mainly about mitigating inheritance tax costs.
What I’m going to concentrate on today is level term life insurance.
With this you pay a monthly premium, and it then pays out a set amount of money if you die within a set period of time. For example, you can cover yourself to pay out £200,000 if you die within the next 20 years. The more cover you get and the longer the term you want, the more your monthly cost will be.
And as the policy only pays out on death (or terminal illness) – and there's usually little dispute over whether someone is dead or not – and it pays a fixed amount, then providing the company is reputable, in most cases it’s just a case of the cheaper the policy, the better.
How much should I cover myself for?
If you’re single and have no children you don’t need life insurance. The whole point of the insurance is to pay a lump sum to those that rely on your income once you’re gone. So if you’ve no partner or children who need the money then there’s not much point getting it.
For couples and families it’s about considering what your financial situation would be if one of you died – what would you do? A 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. And generally you’d get cover for children until they finish full time education.
Ideally your policy should cover any outstanding debts that need to be paid off (including a mortgage if you don't have a separate policy), outgoings your dependants would need to pay, future spending you would have wanted to make, eg, university help for the kids, any additional expenses a death may trigger, such as funeral costs.
If I have a medical condition can I still get cover?
Yes you can, and you must disclose this. It may mean your premiums are more expensive, as you may have a higher risk of dying soon. Similarly, your premiums may be more expensive if you’re a smoker or have a dangerous career. To count as a non-smoker you usually have to have been nicotine-free for at least a year (though some insurers can ask for five years), so if you got a policy and have given up since then, it could be worth requoting.
Do my dependents have to pay tax on the insurance pay out?
No they don’t have to pay any income tax, but they may have to pay inheritance tax, as the pay out does count towards your estates value. Putting a policy into a trust, which you do at the same time the policy is taken out means the insurance pays out directly to your dependants, so it never becomes part of your estate, which avoids inheritance tax and speeds up the pay out.
It’s easy to do and most insurance policies include the option (and papers) for writing in trust directly at no extra charge. If you know what you are doing, you can write the policy in trust yourself. If not, get advice from one of our cheapest advisory brokers (more on that below).
Ok, so where do I get a policy from?
Don’t go straight to an insurer – as you’ll pay full price and it's not the cheapest on the market. Even using a comparison site – while better than going direct to an insurer – isn’t the cheapest way, as they find you the cheapest option generally at full commission and that can be huge.
If you don’t need advice, then best is to go to a discount broker. They usually charge a £25 fee, but they rebate all the commission they get from the insurer into your policy (so you basically get a discount hence the name discount broker). So, while the fee is a one-off £25, you can save £1,000s over the life of policy. It's an easy win. The top discount brokers are Cavendish Online,Moneyworld and Money Minder.
Alternatively, if you're confused or unsure of what you're doing and want advice, then use an advisory broker or Independent Financial Advisor. They will find you the cheapest policy but take commission from it – so it costs more than a discount broker, yet getting it right is important. You can find an IFA atUnbiased.co.uk and VouchedFor or big advisory brokers include LifeSearch,Money Minder, and LifeAssure Online.