None of us wants to think about a time when we’re no longer around. Life is to be lived so why contemplate its end? There are of course very good reasons to do so. Unless you live an entirely solitary life, there are likely to be people who depend on you or whom you would like to help financially after your death. Very few of us live in a vacuum. If you can’t be around for the ones you love, then at least you can arrange for something good to happen in the midst of the pain of bereavement.
It’s better to think of life insurance as a positive arrangement. There’s nothing morbid about it. In planning for what happens after your death, you’re simply being practical, just as you are when writing your will or simply accumulating wealth to pass on to your children. Think of it as an investment in your family’s future.
There are many other questions to consider on this issue including ‘do you need life insurance to get a mortgage?’ That’s something we’ll look at shortly, along with a summary of the different life insurances available, whether you should consider insurance for life or just for a fixed term. Let’s start with the fundamentals.
Do I Need Life Insurance?
If we’re agreed that life insurance is a good thing which, as a general rule, everyone ought to have in place, we need to consider the circumstances in which rather than just being beneficial, it is actually necessary.
Consider your financial obligations. Firstly, if you have dependents of any age then the money you bring in is crucial to their standard of living. Remove that and they may lose essential support. Even if the effect is not as serious, it will certainly reduce their financial resources. If the outgoings to which your income is committed are not compensated with an employer’s ‘death in service’ policy, investments, savings, a pension plan or saleable assets, then taking out a personal life insurance policy is probably the only viable alternative.
Bear in mind that debts survive the death of the person who owes them, so if you have any loans, credit card bills or an outstanding mortgage balance then someone will have to assume responsibility for repaying them. They don’t become personally liable, but creditors will make a claim on your estate . This instantly transfers a significant financial liability to your loved ones, which is never desirable and is particularly unwelcome at a time of grief.
Even funeral costs can be an unexpected and potentially unaffordable burden. What your family will have to pay varies according to the arrangements, but the average cost in the UK is £4,184 . A good life insurance policy would comfortably cover this, otherwise, it’s a further drain on your estate and, therefore the money that your family will inherit.
There may be other ongoing costs that need to be met, such as school fees or other insurance policies. It’s easy to overlook these but as soon as the funding disappears, your family will notice.
How Much Life Insurance Do I Need?
This is a much more precise question and it’s difficult to give a definitive answer. Insurance companies and comparison sites often carry life insurance calculators although these tend to start from the assumption that you know how much you need and will simply try to give you the most attractive quotes.
Some experts suggest that the minimum you should choose is 10 times your gross annual salary. However, depending on the level of your outgoings and the size of your family, higher multiples of 15 or even 20 might be advisable . Ideally, you should start by calculating the essentials your family will have to cover and if you can afford more, then everything above that figure will be a bonus for them.
Do I Need Life Insurance for Mortgage Loans?
No, in most cases, mortgage lenders won’t require you to take out life insurance in connection with your mortgage. Under the terms of the mortgage, the property is not actually yours until you have paid off the entire mortgage debt. As long as a proportion remains unpaid, the lender has a legal right to your property, which is why in cases of mortgage default, they can repossess it and sell it to recover what you owe. Because this right exists under the mortgage contract, the lender knows their loan is always safe, even if you die with a balance outstanding.
However, ‘do you need life insurance for a mortgage?’ might not be the right question. Many lenders or mortgage brokers will advise you to take out life insurance anyway, precisely because of this risk to your home. Having this protection in place means everyone can feel secure. There was a time when endowment life insurance mortgages became very popular. These enabled borrowers to take out a loan to buy a property, paying only the interest on the loan throughout the term. The idea was that when the fixed-term endowment policy matured, it would be enough to repay the original loan. However, this way of covering mortgages was entirely discredited by the generally poor performance of the investments, which meant that many borrowers reached the end of the mortgage term without sufficient funds to pay back the capital. The property still had to be sold.
Today the vast majority of mortgages are repayment ones, which means you’re paying both the monthly interest and a portion of the capital. The balance of the outstanding loan reduces as time goes on, leaving a balance of zero interest and zero capital at the end. Nevertheless, it is still very sensible to have a life insurance policy in place in case you should die before you reach that zero balance.
Do I Need Insurance for Life?
We’ve already answered this question in part. It depends on what you want the policy to do. If it is to cover the cost of a time-limited commitment like school fees or a mortgage then no, a fixed-term policy can do the job. It’s really only if you want to prepare for things like funeral costs or inheritance tax – issues that don’t arise until after your death – that you would need to insure yourself for life. The other reason for doing it is to add to the estate you eventually pass on. In fact, a life insurance policy can be written in trust for the beneficiaries which means it never becomes part of your estate, so is not subject to inheritance tax and can be paid out to your loved ones without much delay.
The Different Life Insurances
There are essentially two types of policy, term and whole-of-life. They work in distinctly different ways and we’ll summarise them here.
Term Life Policies
As the name suggests, these are put in place for a fixed period, possibly as short as five years or as long as 25 years. If you die during the term of the policy, then the insurer pays out the sum insured. If you outlive the policy, then it comes to an end and you’ll need to consider if you want to take out a new one or continue without this provision.
There are three types of term policy.
Level term policy. This is set up to pay out a guaranteed, defined figure should you die while the policy is in force. The figure insured does not increase or decrease over time: if you die in the first couple of years or the last couple, the pay-out is the same. This is the most straightforward option and usually the cheapest.
Decreasing term policy. Under this policy, the amount which will be paid out reduces over the life of the policy. You might wonder how this is beneficial and the answer is that it is most commonly used to support repayment mortgages. As we mentioned above, these are mortgage loans which require you to pay back monthly interest as well as a small amount of the capital loan each month. The amount borrowed reduces so the policy is designed to mirror this gradual reduction. It is suitable for people who simply want their repayment mortgage obligations covered and won’t generally yield any extra funds.
Increasing term policy. Where the level term policy promises an unchanging fixed sum however long the policy lasts, the increasing term policy is designed so that the pay-out increases over time. This is mainly to keep it in step with inflation. If you set a figure which won’t pay out for 20 years, it will by that time have decreased in value because inflation means the sum is worth less in real terms. In the UK, we have enjoyed record low inflation for many years but even a small inflation level negatively impacts the value of a fixed sum. The higher the inflation, the less the pay-out is worth. An increasing term policy guards against this so that the eventual pay-out reflects the current value of money.
Whole of Life Policies
These are policies that remain in force, provided you keep up the premium payments, for the rest of your life. There’s no need to worry about them expiring and needing to be replaced. They are frequently used to cover funeral expenses and also to minimise the inheritance tax (IHT) liabilities of the beneficiaries of your will. They are particularly helpful in dealing with IHT because tax on the estate of the deceased usually falls due some considerable time before the grant of probate and the distribution of bequests. This leaves your beneficiaries with a tax bill but no money from the estate to pay it.
Because the policy can be written in trust, it can be paid to the beneficiaries almost immediately after your death, solving the IHT dilemma.
Whole of life policies tend to be more expensive than the shorter-term options and may not be suitable for everyone, but a financial adviser will be able to assess your situation and requirements then suggest the most appropriate solution.
We’ve been talking about single policies so far, but it is also perfectly feasible to have joint insurance. A single policy, unless written in trust, will go to your estate. If you and your spouse or partner choose to take out a joint policy, then when one of you dies, the money will automatically go to the surviving policyholder.
Bear in mind that in this kind of joint insurance life cover ends when the first of the insured dies. When the survivor dies, there will be no further pay-out. One of the advantages of a joint policy is that it will usually be cheaper than taking out two separate policies, but always remember that although both are covered, only the first death will trigger the pay-out and effectively terminate the policy.
How is the Cost of a Policy Calculated?
It’s virtually impossible to give even an average policy cost as everyone’s circumstances are different. However, the kinds of factors that an insurance company will take into account are:
whether you smoke
your family’s medical history
the length of the policy
the level of cover required
Whatever policy you decide on, make sure you understand it fully. You need to know what’s in the small print, the details of any exclusions and any events or facts that might invalidate it. If in doubt, ask. And remember, you have 30 days from the date when you buy the policy to change your mind and receive a full refund of everything you’ve paid so far.
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