There are a few different kinds of life insurance. We’ll explain what they are and help you navigate the jargon.
What exactly is life insurance?
Life insurance enables you to leave behind money for your family when you die. This can be used to support them for a number of years, to replace lost income, or to pay off your mortgage.
You pay a monthly premium for life insurance. Your age, health, lifestyle and how much cover you need, as well as the type of policy you have, will all be factors in how much you pay.
The most basic type of life insurance is called term life insurance, with term cover you choose the amount you want to be insured for and the period for which you want cover. If you die within the term, the policy pays out to your beneficiaries. If you don’t die during the term, the policy doesn’t pay out, you aren’t entitled to a refund in premiums.
There are three main types of term assurance to consider:
Decreasing term
Often referred to simply as ‘DTA’, with this cover the amount you’re insured for decreases over the term of the policy. These policies are often used to cover a repayment mortgage as the payout falls in line with the money needed to clear the outstanding loan. For example, if you took out a £200,000 decreasing term insurance policy over 25 years, and you died 15 years into the cover, your loved ones would likely receive around £122,000. (This example is based on an 8% decreasing term plan) This is the cheapest way to protect a repayment mortgage.
Level term
This pays out a lump sum if you die within the selected term. The amount you’re covered for remains level throughout the term – hence the name. If you pass away during the term of the policy, no matter what year that may be, your loved ones will receive the same amount from your insurer.
Increasing term
This is effectively an inflation proof policy. The later into the term that you pass away, the bigger value of the policy. As the cost of goods becomes more expensive, each pound in cover that you have needs to stretch that little bit further. With increasing term insurance, you know that the cover your loved ones are entitled to will increase. You can set the cover to increase by a set amount each year or by the retail prices index (RPI) measure of inflation. But because you have the guarantee that your pay-out will increase over the term, your premiums will increase as your cover rises.
The price you’ll pay will vary depending on where you buy it, even where the underlying product is identical and provided by the same insurer. Cheap life insurance doesn’t necessarily mean you’ll be getting good cover that’s properly tailored to your circumstances.
Remember, the prices you see on a comparison site may not be the price you get when you finally apply for life insurance, after the underwriting process has been completed.
The term ‘over-insured’ isn’t officially recognised when it comes to life insurance, because of this we often find our clients are paying for cover they don’t need. We can either save these clients money with a suitable plan or reallocate their budget so that their protection plan covers them for more perils.
Whole of Life insurance
Whole-of-life insurance is a type of life insurance policy that, no matter when you die, your chosen beneficiaries (beneficiaries are the people you want to benefit from your cover) will receive a lump sum pay-out from your insurer.
Whole-of-life insurance is generally a more expensive form of life cover than term life insurance, for the simple reason that insurers know they will definitely have to pay out some money at some point.
You must ensure that you can afford the premiums, not only during your working life but also once you retire. If you fail to keep up with your premiums, the cover will be cancelled.
Most insurers will only require you to pay premiums up to a certain age, typically to age 90.
The actual cost of your whole-of-life insurance policy will be come down to a host of factors about you, such as how much cover you want, your age, your health and your lifestyle.
One of the big advantages for whole-of-life insurance is that it can help your family deal with an inheritance tax bill. If your estate is worth more than £325,000, (2021/2022 Tax year) inheritance tax will be charged at 40% on the value of the estate above that threshold. However, the tax will need to be paid before your loved ones will be given access to the estate.
You can put your family in a difficult position – they need to pay a tax bill, running into the thousands of pounds, but they cannot use the money in your estate to do so. As a result, many are forced to take out a loan just to cover this bill. This can be an added source of stress at an already upsetting time.
A whole-of-life insurance policy can help avoid this issue.
Inheritance tax planning is not regulated by the Financial Conduct Authority.
TRUSTS
Writing a life insurance policy in trust can help your family avoid a big tax bill on the pay-out they receive.
This money from a life insurance policy is not subject to income tax or capital gains tax, so in most cases, your family will receive the money in its entirety. However, if you fail to set up your policy in a certain way, your family could lose as much as 40% of it to inheritance tax.
If your family gain a large life insurance pay-out on top of inheriting your other assets in your ‘estate’, there’s a risk they could end up paying tax on some or all of it at 40%.
For example, a £200,000 insurance pay-out could amount to just £120,000 after tax.
One way to avoid this is to have your life insurance policy written ‘in trust’.
A trust is essentially a legal arrangement, where the trust takes ownership of certain assets. You appoint a trustee or trustees to oversee the trust. These could be family members, friends or perhaps a solicitor. The job of the trustees is to ensure that the assets contained within the trust go to the named beneficiaries. In other words, the money goes where it is supposed to, rather than into the hands of the taxman.
The named beneficiaries would likely be your partner or your children – the people you want to benefit from the life insurance pay-out.
For most people, the real benefit of writing life insurance into trust means that your family will not need to go through the probate or intestacy process which can be lengthy.
A life insurance policy can be put into trust at any time – you can do it when the policy is first written, or at a later date, it’s entirely up to you.
It’s important to think carefully about what you want from your life insurance policy before having it written in trust. That’s because once it has been written in trust, it is no longer under your control – it has been handed over to the trustee or trustees. This is classed as an ‘irrevocable act’, and cannot be undone.
Trust planning is not regulated by the Financial Conduct Authority.
