Everything you need to know about life insurance

·6-min read

In June this year, research from the insurer Canada Life found that eight million UK adults had either thought about, or taken out life insurance since the start of the pandemic.

The figure, while impressive, was dwarfed by the 33 million Brits that, according to the insurer, had neither thought about, nor taken out, life cover.

Life insurance can offer financial protection to the family and loved ones of a person that’s passed away. Here’s how it works and what to consider when taking out cover.

What is life insurance?

In essence, it’s an insurance policy often set to run for a specific length of time, for example 25 years. This period is also known as the ‘term’.

The insurance is taken out by individuals, such as a household’s main breadwinner, for example.

On his or her death, the policy pays out a tax-free cash lump sum. The cash is paid to beneficiaries named on the policy in question, usually a spouse, partner, or other close family relation.

Financial peace of mind

Dependants are free to do what they like with the money they receive. But it’s often used to provide financial peace of mind by clearing large outstanding debts, such as the mortgage on a property.

Alternatively, the cash could be used to pay bills, or meet costs associated with bringing up children where a parent has died.

Main earners aside, there’s also a case for stay-at-home parents to take out life insurance. If a stay-at-home parent were to die, a payout could be used to pay for childcare or domestic help, enabling the surviving partner to carry on working.

How much life insurance do I need?

Life insurance policies include a ‘sum assured’, reflecting the amount of cover that would be paid out should a policyholder die. Calculating the necessary sum assured can be tricky because there are various factors to take into account.

For many households, the mortgage is the biggest financial commitment. Cover equating to what’s left to pay on a home loan is therefore a good starting point.

To cover the debt from a repayment mortgage, two types of life insurance policy can be considered. ‘Level term’, or ‘term’, insurance pays out if you die during a given timeframe, typically matching the period that your home loan is left to run.

With this type of cover, the payout amount would be the same regardless of when you died during the policy term.

In contrast, ‘decreasing term’ life insurance is a cheaper version of cover. This is because the benefit payable on death reduces each year, as the outstanding mortgage amount falls over time.

A more comprehensive (and expensive) type of life insurance is whole-of-life cover. This type of policy means the sum assured will be paid on the policyholder’s death whenever this occurs.

What affects premiums?

When you buy life insurance, the insurer will calculate the amount you have to pay every month. This is called the ‘premium’. These depend on a number of factors including:

  • Your age

  • The sum assured and policy term

  • Whether you choose term insurance or whole-of-life

  • Your occupation

  • Your health and any pre-existing medical conditions

  • Whether or not you smoke

As an example, a 30-year old non-smoker wanting £300,000 worth of cover for 25 years would pay about £13.84 a month for cover with Aviva.

Premiums can be either guaranteed or reviewable. Guaranteed premiums stay the same all the time you are paying them. With reviewable premiums, you agree that the insurer can review your policy (and increase your premiums) at set intervals.

Initially, reviewable premiums can work out cheaper. But they are likely to be increased over time meaning the overall cost will end up being more than it would be with guaranteed premiums.

Am I already covered?

Before you buy life insurance, if you’re an employee it’s worth checking whether you’re already entitled to a workplace benefit known as ‘death-in-service’. This is paid out by your company in the event you pass away during your employment (not necessarily while doing your job). It normally pays out about four times your salary.

With this type of cover, you might decide either that you don’t need life insurance at all, or a policy with a lower sum assured.

In this situation, it’s important to remember that if you change jobs, you’ll lose your existing benefits and your new employer may not offer the same scheme. Bear in mind also that, the older you get, the dearer your life insurance premiums will become.

How can I buy life insurance?

Various financial institutions sell life insurance including insurance companies, banks, as well as well-known high street retailers.

Premiums and policy terms vary, so it’s best to shop around for the best policy for your needs. You can do this via an online price comparison website, or calling on the services of an insurance broker or independent financial adviser

What should I look out for?

When you take out life insurance you’ll go through medical screening. It’s important to answer all the questions honestly. If you lie or omit important details, this is known as ‘non-disclosure’ and can lead to claims being rejected and your policy voided.

Make sure you know exactly what is and isn’t covered on your life insurance policy. Each policy will have certain ‘exclusions’ – things that aren’t covered. These might include death due to mis-use of alcohol or drugs. Suicide is often excluded in the first year only of a policy only.

Make sure you tell your family you have taken out life insurance. Your family will need to know the name of the insurer and the policy number to make a claim after your death.

Other forms of cover

It always makes sense to protect your finances if you can, but bear in mind not everyone needs life insurance.

Other types of insurance, such as critical illness cover or income protection, may be more suitable if, for example, you’re single and don’t have children.

Critical illness cover pays out a lump sum of money if you are diagnosed with certain illnesses. Income protection, meanwhile, pays out a certain proportion of your income each month should you fall ill or get injured and are unable to do your job.

Before signing up for any sort of cover, it’s worth thinking hard about the sort of insurance that best suits your needs as well as those of your loved ones.

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