If you’re thinking about taking out life insurance, our guest article from award-winning life insurance broker Reassured gives an overview of the different types available, common pitfalls to avoid and top tips to secure the right cover.
What is life insurance and how does it work?
Life insurance is simply financial protection for your loved ones should you no longer be around to provide. It acts as a safety blanket for a worst-case scenario.
The policyholder makes a monthly payment (the premium) for the lifetime of the policy (the term), to benefit from the set cover amount (the sum assured).
People often take out life insurance after a significant life event – such as having children, purchasing a first home, getting married or losing a loved one.
Should the worst happen, the proceeds from a payout can be used as your beneficiaries wish, however they are commonly used to cover:
- Mortgage repayments
- Future family living costs
- Children’s education
- Leaving an inheritance
- Outstanding debt
The cost of your monthly premium is calculated based on the level of risk you pose to the insurer: the greater the chance of a payout, the more you will pay for your cover. The key cost considerations are your age, medical history and smoking status.
Tip: write your policy in trust
If you are taking out any kind of life insurance policy, consider writing it in trust. This is free to do and can help maximise a life insurance pay out by limiting the amount of inheritance tax you pay, whilst also speeding up the release of funds. This is explained in more detail further down the article.
Types of life insurance
There are a number of different policy types, each more suited to protecting different aspects of your life.
Level term cover
Level term cover provides a fixed (or level) payout sum if you pass away within the term of the policy. If you outlive your policy, no payout is issued and your cover expires.
The term length can be up to 40 years and the maximum sum assured is usually up to £1,000,000.
Decreasing term cover
In contrast to level term, decreasing term cover provides a payout sum which decreases over the policy term. As a result, it is commonly used to cover a repayment mortgage debt. All other aspects of the cover are as with level term policies.
As the financial risk to the insurer reduces with each passing month, decreasing term cover is usually the most cost-effective option.
Family income benefit
Unlike life insurance protection which provides a single cash lump sum, family income benefit (or FIB) provides a tax-free monthly income for the remainder of the term.
FIB policies can be a good option for families who require help with long-term family budgeting.
Can I take out life insurance at any age?
Whilst it is still possible to secure term-based cover later in life, such options will a) get more expensive as you age and b) potentially become less relevant. As discussed, term-based life insurance is traditionally taken out to protect a mortgage debt, or family living costs, against the worst-case scenario of your death. Of course if you live beyond the end of the policy term, the policy expires – no payout is made.
With an over 50s / whole of life plan, you pay instalments until you die. This means that upon your death – assuming you’ve met the terms of the policy – your loved ones are guaranteed a payment. Sums assured are lower than term-based insurance and people tend to take out these policies with the intention of leaving an inheritance or making sure that their funeral costs are covered.
Depending on your age, the state of your health, and what you’re looking to leave for your loved ones, it may be worth considering these types of plans.
Tip: do your maths
With whole of life and over 50s plans, it is possible to pay more into your plan than it will pay out. This is because premiums are paid for as long as you live, and no one knows how long this will be. Always work out the point where you will have paid in more than your policy will pay out and consider whether you are likely to live beyond this point.
As with most insurance plans, missing even a single monthly payment can render your policy invalid so consider your financial circumstances carefully before committing.
Over 50s plans
An over 50s plan, also referred to as a guaranteed over 50s plan or simply over 50s life insurance, is generally taken out by people wishing to use the cover to leave an inheritance or cover / contribute to the cost of their funeral. Because a payout is guaranteed (or assured) when you pass away, it is actually a form of life assurance.
The sum assured of an over 50s plan is much lower than term-based life insurance – between £1000 and £25,000, and unlike traditional term-based cover, an over 50s plan guarantees to pay out (as long as you pay your monthly premiums).
It also guarantees acceptance for those living in the UK aged 50 – 85 with no medical questions asked, however your smoking status and more significantly your age are key criteria when calculating the cost of your premium.
What is the ‘waiting period’?
Whilst acceptance is guaranteed, over 50s plans do enforce a waiting period, (sometimes referred to as the qualifying period). This is a period of time at the beginning of the policy, usually either 12 or 24 months, where a policyholder cannot claim. Although a payout cannot be secured within the defined waiting period, premiums paid will generally be refunded to your loved ones.
If you’re later in life with a pre-existing medical condition which would mean securing term cover would either be not cost-effective or simply not possible, an over 50s plan can be a good option.
Funeral benefit option
Many over 50s plans now come with the option to select a funeral benefit option with a contribution towards your funeral – typically around £250. This means you can choose for the payout to go directly to a funeral director (generally specified by the insurer with whom you arrange your plan), who will then work with your loved ones to plan the ceremony.
Usually, if the sum assured is not sufficient to cover the full cost of the funeral, the remaining balance will be requested from your family. Similarly, any excess will be gifted back to them.
What about free gift card incentives?
Many over 50 plan providers now offer a free gift card incentive to encourage you to buy a policy direct from them as opposed to through an intermediary or a comparison website. While a free gift card can be appealing perk, its value is often minimal compared to the combined total of your monthly premiums. The number one priority should always be to secure the most cost-effective and appropriate policy to meet your long-term needs.
Whole of life insurance
If you’re later in life, closer to the age of 50 and still in relatively good health, then it may be better to look at term-based cover or whole of life insurance.
As with an over 50s plan a payout is guaranteed when (and not if) you pass away, however here you will be asked medical questions during the application. As a result of the insurer having a better understanding of your health, it is possible to secure a much larger sum assured compared with an over 50s plan.
What if I just want to cover the cost of my funeral?
If you’re predominantly looking to make sure your funeral costs are covered then a pre-paid funeral plan locks in a price at today’s rates and protects against rising costs. You can take out a prepaid funeral plan at any age and you’re guaranteed to be accepted, and a pre-paid plan also allows you to plan the ceremony you want. Please note that a prepaid funeral plan can only ever be used to cover or contribute to the cost of a funeral.
Whatever your plan, write your life insurance in trust to avoid or minimise 40% inheritance tax
There is a way of maximising a life insurance payout by limiting the amount of inheritance tax you pay, whilst also speeding up the releasing of funds. The answer is by writing your life insurance in trust (and it is completely free).
By writing your life insurance in trust the proceeds avoid forming part of your estate and therefore are not subject to inheritance tax, (which is charged at 40% on anything over £325,000).
As a result of not being part of your estate your loved ones also do not have to wait for probate to be granted before funds can be released, meaning a faster payout.
A trust could also give you greater control. For example, you may want to leave some money to your children and/or grandchildren but want to specify to the trustee/s that you only want them to receive the funds after they turn 21.
When you write your life insurance in trust you are signing the rights of your policy over to a trustee/s to administer on your behalf, much like an executor of a Will. Therefore, obviously you need to choose a trusted individual/s to carry out your wishes.
Despite these significant benefits it is estimated that only 6% of policyholders utilise a trust¹ .
10 top tips to make the most of your selfless investment
When thinking about any form of life insurance, follow these top tips to securing the right cover:
- Compare multiple quotes to lock in the best price available, this can be done quickly and easily by using an FCA-regulated broker
- Take your time to consider the different policy types to ensure you choose the one which best meets your needs and current / projected financial circumstances
- Consider writing your policy in trust to avoid 40% inheritance tax and access funds without having to apply for probate
- Always be open and honest on your application to ensure your policy is 100% valid
- Premiums rise as we age, if you are looking to take out cover, it’s advisable to do this sooner rather than later
- If you are in employment, factor in any death in service benefit you are entitled to through your employer
- Take the time to calculate the exact level of life cover you need: consider your mortgage, living costs, funeral expenses, childcare costs, the age of your dependants etc.
- Do not take out more cover than you need or an overly long term as this will unnecessarily inflate your monthly premiums
- Switch to a healthy lifestyle before applying for cover, for example, quitting smoking can secure you a lower premium
- Inform your loved ones of your life insurance policy so that they can contact the relevant insurer after your passing
This is a guest article from award-winning UK life insurance broker Reassured.