Not everyone needs a life insurance policy but if you have young children (or older ones who are financially dependent on you) or have joint debts with someone else — such as a mortgage — you should take out life insurance. Find out why.
Do you need life insurance?
If you’re single and don’t have any dependent children and don’t have joint loans, you may not need life insurance. However, there may be circumstances when it’s still useful to have even if you do not need it.
Here are the typical situations in where life insurance may be worth having:
1. You have a joint mortgage or other large loan. If you have a joint mortgage the other person(s) would be responsible for paying off the entire outstanding balance if you were to die. A life insurance policy can pay out the amount you owe on your mortgage.
2. You have dependent children. If you have children who rely on you financially you should think about who would support them financially if you were to die.
3. You receive child support or maintenance. What would be the financial consequences of your ex dying? If they don’t have life insurance that will pay out to you it may be worth taking out a life policy on your ex.
SAVVY TIP: You can take out a life insurance policy on someone else’s life but you have to be able to show an ‘insurable interest’, that means you have to demonstrate that you’d be worse off financially if they were to die.
4. You pay child support or maintenance. You may not feel much goodwill towards your ex but it’s worth thinking about the consequences for your children of you not being around to pay child support.
5. You rely on your partner. Even if you don’t have a joint mortgage there may be other costs (such as school fees) that you regularly pay or rely on your partner to pay. Alternatively, your husband/partner may look after your children while you work. How would you be able to continue working if your husband or partner were to die?
6. You have a potential inheritance tax bill. If your estate is worth more than the inheritance tax threshold those you leave money and property to may have to pay inheritance tax. You can take out a life insurance policy to pay your inheritance tax bill.
Different types of life insurance
There are several different types of life insurance. Some are quite cheap and others are more expensive.
- Whole of life insurance: This policy will pay out no matter when you die. It’s more expensive than term assurance but it’s useful if you want to take out life insurance to pay an inheritance tax bill.
- Term life insurance: Term insurance does what it says on the tin and lasts for a specific term, normally something like 20 or 25 years (especially if it’s to cover a mortgage). There are two types of life insurance policies that run for a set term:
- Level term assurance: This policy will pay out the same amount no matter when you die within the term. It’s useful if you have an interest-only mortgage where the amount you owe will not change until the end of the mortgage term.
- Decreasing term assurance: This is designed to fall in line with your mortgage balance if you have a repayment mortgage. Although it’s cheaper at the outset than level term assurance your premiums won’t fall as your mortgage is repaid.
- Convertible term assurance: These policies let you convert your term life insurance policy to a whole of life policy at any time before the end of the term. Importantly, you won’t be asked any questions about your health so if you’ve suffered health problems since you took out the original policy that won’t be reflected in the price.
SAVVY TIP: Convertible term insurance policies are far less common these days, partly because they can be expensive. If you live beyond the length of the term of the original policy and it’s not been converted, there’s no payout. Also, if you stop paying your premiums there’s no ‘surrender value’ which means you won’t get anything back.
- Family income benefit: Family income benefit pays out a tax-free income to your husband, partner and/or children every month. These policies last for a specific term. Family income benefit policies are not very well known but they can be a good option if you have dependants. Because these policies pay a specific amount every month rather than a lump sum, they are much cheaper than other forms of life insurance.
SAVVY TIP: Family income benefit is useful if you want to insure your salary or provide enough money to pay for childcare etc. should one parent die. If you make a claim at the start of the term they can pay out more than a lump sum policy. Obviously, if you make a claim towards the end of the term they will only pay out a fraction of the amount of a lump sum policy.
Joint life insurance policy or two policies for couples?
Many couples who take out a joint mortgage also take out a joint life insurance policy. However, it’s often better to take out two separate policies. For a start, if you were to divorce or break up you cannot divide a joint life insurance policy in two so one of you would need to take out a new policy. Secondly, a joint policy only pays out once, so if your husband or partner was to die during the term of the policy you’d be left with no life insurance.
How much life insurance do you need?
Financial advisers sometimes come up with a rule of thumb saying you need ten times your annual income but it’s not that straightforward. You need to work out what would need to be paid if you were to die; childcare costs, mortgage and so on.
1. Your starting point should be your workplace, if you’re employed. They will probably provide you with life insurance if you die while you’re employed. That’s often four times your salary but it may be more or less.
2. Next, work out what debts and expenses you have and how they would be paid. The mortgage is the obvious debt but many people miss out other ongoing expenses.
Using life insurance to save inheritance tax
If you have a life insurance policy, you should make sure it is written ‘in trust’. The jargon is not user-friendly but it’s a very straightforward process. By writing your life insurance in trust, the life insurance company can pay out the proceeds without you having to go through probate. Probate can take some time so this means payments will be made quicker. It also means that the life insurance policy will not form part of your estate for inheritance tax purposes. Writing a life insurance policy in trust may be something that the company will do free of charge.
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