Life insurance: what is it and why is it important?
How to protect your family should the worst happen
Contemplating on your own demise isn’t the cheeriest way to spend your time, but arranging life insurance might just be the single most important thing you ever do for your loved ones – so it’s worth a morbid minute or two.
Choosing the right life insurance product for your circumstances might take a bit of time and research. It’s not as straightforward as, say, car insurance. Here’s what you need to consider in order to protect your nearest and dearest from the unexpected.
Do I need it, really?
Not everyone needs life insurance, but most people do. Perhaps if you have no dependants or if your employer offers death-in-service benefits, then you might decide you don’t need cover.
Some employers pay out a multiple of your annual salary if you die while you’re employed by them. It’s often four times your pay, but it can be as much as ten times depending on the company.
That may well be more than enough especially if you’re a single person with no dependants. However if you have children or share financial responsibilities like a mortgage with another person, you may want to look for the extra security offered by additional life and critical illness cover.
Even if your partner works and you have no dependants, it’s worth considering whether they could manage the shared household expenses on just one income. Even a small policy could be a big help at a difficult time.
One really important group to mention is stay-at-home parents. These mums and dads often assume they don’t need cover because they are not bringing in an income. But just stop and think about how much childcare your partner would need to pay for if you weren’t there for the school runs and daily care. Plus most people would need to take some time off work to help their children cope and grieve themselves. Life insurance isn’t always about income, it’s about giving your family options.
What kind of cover is there?
There are a few different kinds of life insurance policy and the right one for you depends on your circumstances. Here’s a quick rundown:
Level term insurance
Probably the most straightforward is level term insurance. It simply pays out a fixed, pre-agreed amount in the event that you die during the term of the policy, which you also agree in advance. During the lifetime of the policy the premiums stay the same, which is great news if you start one while you are young and fit.
Whenever the policy is claimed, be it month three or year thirty, the pay-out is the same. At the end of the pre-agreed term the policy lapses and you need to apply for a new one if you still want cover.
Quite a few people take out this kind of policy to make sure their mortgage is cleared if they die or to leave their family a lump sum. It’s a good, straightforward kind of insurance, but there is a risk you’ll be over insured. After all, as children grow up and your mortgage is paid down the amount of money your loved ones would need may reduce. That’s why some people choose to go for decreasing cover instead.
Decreasing term insurance
As with level term life insurance this is a policy where you buy cover for a fixed period, usually somewhere between 10 and 25 years.
With decreasing term insurance, however, the amount the policy would pay out falls over the term. People taking out this kind of insurance usually do so because they want it to protect their repayment mortgage or other outstanding debt.
Because policies like this are less of a risk for the insurer they are usually cheaper than level term as the amount covered falls over time.
Increasing term insurance
This is a much less common kind of term insurance in which the amount of cover rises year on year, usually to keep pace with inflation.
It’s a good option if you need a certain amount to be paid out in the event that a claim is made, and if it is important to you that the value is not eaten away by inflation.
This kind of policy is usually more expensive than both level and decreasing term insurance.
If term insurance isn’t right for you then another option is whole-of-life cover. Unlike cheaper, more limited policies this cover will pay out in the event of your death which, unless you know something we don’t, will inevitably happen at some point.
Keep paying the premiums and the policy will keep covering you. Some policies agree to fix the costs for a set period.
This kind of insurance is usually more complicated than the more common alternatives above as it is more like an investment vehicle; indeed most are linked to an investment fund.
The fund’s performance can affect the price of your premiums or even your pay-out, meaning there’s a risk the cover will become unaffordable. If whole-of-life cover sounds appealing then you almost certainly need some advice to find the right type.
Joint or single?
All these life insurance types can be purchased as a single policy or as a joint policy if you’re part of a couple. It’s often cheaper to buy cover together, but you need to remember that if one of you dies and a claim is made then the policy will close, leaving the other partner without insurance.
You should consider whether you both have the same insurance needs when making a decision. Also, bear in mind that if you have a joint policy and then split up then your insurer might not be able to separate your cover.
How much insurance do I need?
The bigger the pay-out the more expensive the insurance policy so it’s really important you don’t just pluck a big-sounding figure out of the air and put it on your policy. It’s important to work out how much cover you really need.
Think seriously about how much your partner and children, if you have either, would need a year to maintain their lifestyle if you weren’t around – and for how many years.
Add onto that any outstanding debts and obligations, take away any death-in-service benefit offered by your employer, and you should have a pretty clear idea of what amount you need to insure yourself for.
And do remember that if you are relying on death-in-service benefit to top up your insurance policy then you need to check you still have it if you change jobs.
Once you have that figure your insurer will be able to provide you with a monthly or annual premium.
I can’t afford that!
Okay, I hear you. Comprehensive life insurance can feel like an unaffordable extra bill, especially if your budget is already stretched. Even if you can’t afford a policy that exactly meets your needs, then it is still worth taking out some cover. It’s possible to get some insurance for under £10 a month – less than the cost of a posh coffee once a week.
A smaller pay-out might not provide for your loved ones forever, but it would help ease a difficult time. If your partner needed extra time off work, for example, then a life insurance payment could be a big help.
What if I got sick?
Cheerier and cheerier, I know, but another concern for many people is the risk of falling ill and being unable to work and bring in an income. Many life insurance policies pay out if the policyholder is diagnosed with a terminal illness, but usually only if their life expectancy is less than a year.
That’s why many people choose to take out critical illness cover at the same time as life insurance. Those policies pay out if you are diagnosed with one of a set list of conditions, giving you real peace of mind.
Can I go now?
If any of the above rings true then take action. Once you’ve sorted your life insurance, you can get on with the important part: living.
Before making financial decisions always do research, or talk to a financial adviser. Views are those of our mentors and customers and do not constitute financial advice.