There’s no such thing as one-size-fits-all when shopping for life insurance
Some types of insurance require more thought than others. For example, when people are looking to insure a car, they mostly want the same thing; to ensure that they are protected financially in the event of an accident and can get back on the road as quickly as possible.
Life insurance works in exactly the same way but, because the impact of losing a loved one can be much more far reaching, there is more to consider. People’s lives do not fall into easy one-size-fits-all categories, so different types of life insurance have evolved to ensure that policies are available to those with different needs.
What is life insurance?
Life insurance is designed to pay out either a lump sum or an income when you die. You might want it to provide your family with money to live on or to cover specific regular expenses such as monthly mortgage payments or school fees. The right type of insurance for you will depend both on your family circumstances and the amount you are prepared to pay.
Different types of life insurance
Here are some of the decisions you need to make when thinking about which kind of life insurance is for you.
Do I want a single or joint policy?
It is possible to get insurance that covers one person (a single-life policy) or a joint-life policy for a couple. With a joint-life policy, you can decide if you want it to pay out on the first death (useful for paying off a mortgage or protecting dependants) or the second death (which can help with inheritance planning).
It is tempting, if only one of you earns an income, to decide to insure just that one life, but you should consider the financial implications of a caregiver passing away as well. The financial burden of providing for childcare or care of an elderly relative could be high, so this should be taken into consideration.
If different levels of cover are required – if one partner earns a lot more than the other, for example – it may be more sensible to take out two single-life policies. A broker or financial adviser may be able to help you find the best solution.
Term insurance or whole-of-life?
Term insurance will cover your life for the length of the policy, while you make your monthly payouts. Whole-of-life cover, on the other hand, will pay out whenever you die. Whole-of-life cover is more expensive, particularly if you are in poor health or have a family history of medical problems, and is usually only available through a specialist broker or financial adviser. For some families, it is used as an inheritance-tax planning tool. Inheritance tax (or IHT) is payable at 40 per cent on estates worth more than £325,000. Although there are ways to decrease the IHT bill, including passing everything to a spouse and giving away your home to a directly related family member, some families know they will still be left with a bill to pay and find it comforting to know that the insurance payout will cover it.
Term, or level, insurance is good when you have a time-limited expense to cover, such as a repayment mortgage or school fees, since you can take out life insurance that would pay off that debt in the event of your death. There’s more information on this in our guide to life insurance.
Which type of term insurance do I need?
If you decide you would like a term insurance policy, there are further decisions to make. You can opt for level, increasing or decreasing cover, which means that the amount your family would receive on your death either stays the same, goes down or goes up. The most suitable type for you will depend on your expected expenditure during the period of cover. You could also consider a renewable policy, which would allow you to extend the term of the original policy if you need to at its end.
Most life insurance policies pay out a tax-free lump sum, but you could also opt for family income benefit if you wanted your nearest and dearest to receive a regular income instead.
Should the policy be written ‘in trust’?
Life insurance policies can also be written 'in trust'. This means the benefits can be paid direct to whoever you want to receive the payout without it becoming part of your estate. This is useful because your survivors receive the payout more quickly and it is not subject to inheritance tax.
How much life insurance do I need?
If you have a particular debt in mind that you think your family will need to cover if you are not around, then you should insure yourself for this amount. If it is a mortgage, you could consider mortgage protection insurance, which exists for this very purpose, as well as life insurance.
Otherwise, consider your family’s budget and future outgoings, as well as your current income when deciding how much might be sensible. You might want to factor in inflation as well. It is easy to forget how rising prices over time can have an impact on family income needs, but shopping bills, school fees, house prices and rent are all likely to rise in future, so your family may need more to live on.