What is life insurance?
Life insurance is a financial product that 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 a large debt such as 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 determine how much you pay.
In this guide, find out more about the different types of life insurance, how they work, and how to find cheap life insurance.
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What are the different types of life insurance?
The most basic type of life insurance is called term life insurance, where 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 and the premiums you've paid are not returned to you.
There are three main types of term assurance to consider – level-term, decreasing-term and increasing-term insurance. Sometimes a combination of the two is the best answer.
With level term insurance, the payout that your loved ones will receive remains level throughout the term of the policy. If you pass away during the term of the policy, no matter what year that may be, your loved ones will receive the same payout from your insurer.
For example, you might take out a level term policy for a £100,000 payout over a 40-year term. Whether you die in year one or year 39, your family will receive that £100,000 payout.
As the name suggests, the payout your family would receive with decreasing term insurance gets smaller over the term of the policy.
This tends to be a popular option with those who have a large debt to pay off, such as a mortgage, as the payout falls in line with the money needed to clear the outstanding loan.
With increasing term insurance, the size of the payout increases as the term of your policy continues. In other words, the later into the term that you pass away, the bigger the payout your family will receive.
The idea here is to combat inflation - as the cost of goods becomes more expensive, each pound in cover that you have needs to stretch that little bit further. But with increasing term insurance, you know that the cover your loved ones are entitled to will increase too.
Family income benefit policies
Family income benefit insurance is a type of decreasing term policy. Instead of a lump sum, though, it pays out a regular monthly income to your beneficiaries until the policy's expiry date if you die.
At the outset, figure out what sort of income would be needed your family to be financially stable should you pass away.
If you die after the term of the policy has finished, there will be no monthly payout to your loved ones.
As the name suggests, whole-of-life policies are ongoing policies that pay out when you die, whenever that is.
Because it's guaranteed that you'll die at some point (and therefore that the policy will have to pay out), these policies are more expensive than term assurance policies, which only pay out if you die within a certain timeframe.
Whole-of-life policies broadly come in two main types - balanced cover and maximum cover:
With balanced or standard cover, your premiums will stay the same throughout your policy. Even when you get older, and your health may deteriorate, you will still pay the same amount for your cover. As a result, your premiums are guaranteed.
You will also have a fixed cash sum agreed upon which the insurer will pay out when you die.
With a maximum cover policy, your cover is linked to an investment fund. The insurer invests the money you pay each month, in the hope that the returns generated from that investment will be sufficient to cover the cost of the eventual payout.
Your premiums will then be reviewed on a periodic basis. If the investments are not performing to the level that the insurer wanted, your cover may be changed. The insurer may increase your monthly premiums, or reduce the size of the payout your loved ones will receive after you die.
While these policies are likely to be cheaper initially, premium increases are likely and can, in some cases, be substantial.
Do you need life insurance?
Having some form of life insurance in place is really important if you have people who are financially dependent on you, such as children or a partner with whom you own a property, who would be left worse off if you passed away.
If you are the main breadwinner of the family, would your loved ones be able to meet your monthly mortgage repayment pay the mortgage and the other household bills without your income?
Furthermore, the loss of a parent can create additional costs, such as a greater need for childcare.
These costs may be less relevant with older or adult children, or a mortgage that's been paid off, hence the attraction of term life insurance.
Some whole-of-life insurance policies will allow you to cash them in, and get some level of payout before you actually die.
If you are tempted to do this, be sure to check the terms of your policy as the surrender value of your policy may work out as significantly less than what you have paid in premiums over the years.
- Find out more: income protection and critical illness cover explained
How do I buy cheap life insurance?
It's not just banks, building societies and insurers that sell life insurance nowadays. High street retailers and supermarkets are also worth considering.
Quite often, one company sells another's life insurance policies. 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.
A word of warning here - getting cheap life insurance doesn't necessarily mean you'll be getting good cover that's properly tailored to your circumstances. Look out for the following:
- Low start life insurance policies - these will appear cheap on comparison sites, but the monthly premium increases throughout the term of the policy
- Reviewable policies - the premium is only guaranteed for the first few years (often the first five or 10 years), at which time it is repriced
- Pre-existing health conditions - you should still be able to get life cover, but it may be harder to find and cost more. Relevant charities should have information on specialist life insurance providers
Speaking to a financial adviser about your life insurance needs can help ensure you find the right policy and the right level of cover.
Online life insurance brokers
Online insurance brokers may be able to offer cheaper prices as they pay back to you some or all of the commission they receive from insurers.
In the latter case, the company rebates you all the commission throughout the term, reducing the ongoing premium. It's worth checking the overall cost of both options.
However, you'll only get this commission rebate if you choose to buy life insurance without financial advice.
Price comparison sites
One way to compare different life insurance providers is to use a price comparison website like Moneysupermarket.com, Comparethemarket.com or Confused.com.
Make sure you visit a selection of sites as no individual site covers the whole market, and the same insurer may offer a better deal through one comparison site compared with the others.
Remember, the prices you see on a comparison site may not be the price you get when you finally apply for life insurance, after a medical questionnaire has been completed.
Cash back websites
If you buy life insurance online, cashback sites, such as Quidco and TopCashback, may help you get an even better deal. You're not buying the insurance policy from the cashback site but rather accessing the insurer's own website through the cashback site.
The cashback site rebates to you some of the commission it receives from the company selling the insurance.
Can I get life insurance from a friendly society?
Most friendly society tax-exempt savings plans include life insurance cover. This means that if you die during the term of the plan, your estate will receive the guaranteed sum assured stated in your personal illustration, plus any bonuses.
As the sums involved are relatively small, it's common for friendly societies to offer life insurance without prior underwriting. In effect, a friendly society tax-exempt savings plan is a type of endowment.
Some of your monthly premium is used to buy life cover, which will pay out if you die before the end of the term. The rest of the premium is invested.
- Find out more: are you ready to invest?
Can I have two life insurance policies?
It's entirely possible to have multiple life insurance policies, and this is a crucial decision to make if you're in a couple.
Couples can buy a joint policy that covers both lives or can have one policy each. Joint-life policies pay out on either the first partner's death or the second.
First-death policies are often used to provide a lump sum for your family if you or your partner dies – to cover mortgage repayments, for example.
Second-death policies can be used to cover an anticipated inheritance tax bill.
And yet, if you're looking for cover for you and your spouse, two single-life policies may offer much better value than a joint-life one.
Life insurance and inheritance tax
If you take life insurance to make a one-off payment or regular income to your dependents when you pass away there is usually no income tax or capital gains tax to pay on the proceeds, but inheritance tax (IHT) may be charged at 40%.
Whether you'll have to pay IHT depends on the value of your estate - work out yours using our calculator.
One way to avoid this is to have your life insurance policy written ‘in trust’.
When assets are placed within a trust, you effectively give up ownership of them. They are now under the management of the trustees, not you, and are no longer classed as being part of your estate.
This is a really important distinction. It means that should you die, the insurance policy will be handled separately to your actual estate, and so won’t be subject to inheritance tax if your estate is valued above the tax threshold.
Writing life insurance into trust also means that your family will not need to go through the probate process - which is where your estate is divided up according to your wishes - in order to receive the insurance money.
How do I put life insurance in trust?
Most insurers will offer it as an option when you initially take out the policy, and there should not be any extra charge for doing so.
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.
Transferring an existing life insurance policy into trust may involve the assistance of a financial adviser or solicitor, and so could incur some costs.
Can I change my life insurance policy after it has been written in trust?
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.
As a result, you need to make sure that your life insurance policy offers sufficient cover and that you are unlikely to need to change the policy in any way before you write it in trust.
What are the different types of trust?
There are two main forms of trust: a bare trust and a discretionary trust.
In a bare trust, the money is held by a trustee, and all of the proceeds should go to the person or people you nominate, when they turn 18 (or 16 in Scotland).
A discretionary trust gives the trustee greater power to decide how much the beneficiaries get and how frequently they get the money, as well as any other conditions you put on it (such as when they are able to receive the money).
There are more options - such as a gift trust, split trusts and more. What you use will depend on the types of life insurance products you hold and what you want to use the trust for. It's best to seek professional advice if you have complex needs.
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