How Does Life Insurance Work?
Life Insurance is a protection policy designed to pay out a cash lump sum to alleviate financial difficulties your loved ones might face after your death.
This payout can be used for anything, from repaying the outstanding mortgage to generally maintaining their lifestyle.
There are a number of different options to consider with Life Insurance which will have an impact on both what the policy covers and how much it costs.
Level or Decreasing Life Assurance?
Level and Decreasing Life Insurance are the two main types of Term Life Insurance. This means the policies last for a set term, covering you if you die within that period of time, and then end.
Level Life Insurance
Level Life Insurance is the simplest of these life products.
You choose a level of cover (e.g. £100,000) and a length of cover (e.g. 25 years) and should you pass away at any point during those 25 years the policy would pay out that chosen benefit to your loved ones.
Level term life cover is most commonly used to protect an interest-only mortgage or provide a level of family protection.
With an interest-only mortgage, where you are not repaying the capital the outstanding debt remains the same over the life of the mortgage, and therefore so should the amount of life cover.
Other uses include providing a level of family protection, setting up a policy with a level of cover which would help your loved ones through the difficult times to ensure any financial pressures are removed.
Decreasing Life Insurance
Decreasing Life insurance is most commonly used to protect a repayment mortgage. The policy will be taken out for the length of the mortgage and the level of cover will decline over time in line with you repaying your mortgage and reducing this debt to zero.
Decreasing term insurance is the most cost-effective form of life insurance for repayment mortgages as the risk to insurer declines over time as the level of cover falls. As a result the monthly premiums are lower than a Level Life Insurance policy.
What is Whole of Life Insurance?
Whole of Life Insurance is very different from the two types of Life Insurance outlined above.
This is because Whole of Life Insurance doesn’t expire after a set term – it covers you for your whole life, paying out on your eventual death, whenever that may be, providing you keep paying the premiums.
Given that a payout is assured with Whole of Life Cover, it’s sometimes known as Whole of Life Assurance. It also means that premiums are typically more expensive than for a term policy.
Payouts from a Whole of Life Insurance policy are often used to cover funerals or to meet inheritance tax bills as both are liabilities that will definitely arise on death, whenever that may be.
Single or Joint Life Insurance?
A single Life Insurance policy is written on just one life, whereas a joint policy is written on the lives of a couple.
Couples Life Insurance is typically suited to those who share joint liabilities, such as a mortgage and dependents, and would therefore need a Life Insurance payout if one half of the couple were to pass away.
However, getting Joint Life Insurance may not be the best option for all couples. This is because such policies only pay out once, usually (although not exclusively) on the death of the first policyholder.
This would then leave the surviving policyholder without any cover should they later pass away.
It would also only pay out once on the tragic event that the couple both died at the same time, despite both being named on the policy.
Should I Add Critical Illness Cover?
Most Life Insurance plans have the option of including Critical Illness Cover.
Where Life Insurance only pays out on death, a Critical Illness plan pays out the sum assured should you be diagnosed with any one of the critical illnesses as defined by the insurer’s terms.
These conditions include the likes of cancer, heart attack and stroke, which represent the top three claims on all such policies.
Given the risk of suffering a serious illness is a lot higher than that of dying, the monthly premium will increase to include critical illness cover in your policy.
However, should you suffer a serious illness there are often lifestyle changes to make, whether that be reducing working hours, stopping work completely or modifications to your home which can all have a considerably impact on your finances. This is where Critical Illness Cover can step in to help.
Many individuals opt for Critical Illness Cover for the peace of mind it offers should something serious happen.
What About Income Protection?
Income Protection is another form of sickness insurance that you can buy separately from Life Insurance.
While you can’t package it together with Life Insurance as you can Critical Illness Cover, it’s nonetheless a valuable benefit to consider.
Income Protection is designed to pay out for anything that medically prevents you from doing your job – the illness / injury doesn’t have to be critical as defined by the insurer’s terms.
It also pays out what some people may find a more manageable monthly income (a percentage of your pre-tax earnings) as opposed to the lump sum offered by Critical Illness Insurance.
Sometimes Income Protection can be seen as more comprehensive than Critical Illness Cover, although it all depends on your circumstances. Ask your adviser about which is more suited to your needs.
Do I Need to Write My Life Assurance Policy Into Trust?
Writing a Life Insurance policy into trust means at claims stage the benefit is paid from the life insurer directly into the trust to then be distributed to the nominated beneficiaries.
Writing a policy into trust is the best way to ensure your loved ones receive the payout out quickly and the lump sum gets paid to the correct beneficiaries tax free.
A trust means the payout avoids both probate and any inheritance tax so your family receive 100% of the benefit.