Life insurance can offer vital protection for your family if the worst happens. So how do you work out whether you should have it, what policy to get, and how much cover you need?
The first thing you need to decide is if you need life insurance at all. This should be relatively simple. If you have financial dependants such as children or a partner, then you probably need life insurance. If you are single and without children, you probably don’t need life insurance, as no one is reliant on your income.
Before you take out life insurance, also check what provision your employer makes for the event of your death. Many companies offer their employees a “death-in-service benefit”. This means that if you die while you work for them, they will pay your family a lump sum. Usually this is between double and quadruple your annual salary. To get this payment, you don’t have to die while you are at work; you just have to be employed by the company at the time of your death. If your employer offers this benefit, you need to do the sums to see if the amount will provide sufficiently for your family, or whether you want to take out a life-insurance policy on top of it.
So how much money will your family need? As a rough guideline, aim to cover ten times your salary. You want the payout to cover your outstanding debts – most importantly your remaining mortgage – as well as other essential outgoings and any future expenses you would have intended to pay, such as your children’s university fees.
When you start shopping for life insurance, you’ll discover that there are several types of policy. The two main ones are referred to as “level term” and “whole of life”. If you go with a level-term policy, you will receive a fixed payout regardless of when you die, as long as it is within the “term” of the policy. The term is set by you at the outset. If you choose this type of policy, you need to decide how long you want the term to last. For example, if you are taking out a policy in order to provide for your children, you want the term to last until the youngest one is an adult – or, more specifically, until you think your children will be able to manage financially for themselves. If you want your life insurance to help your partner in the event of your death, then a good idea is to have the term last until you reach pension age, when presumably they would benefit from your pension.
If you choose a whole-of-life policy, you will receive a fixed payout when you die, no matter when that may be, as long as you keep paying the premiums. These policies tend to be more expensive than a level-term policy, but give you the peace of mind of knowing that your dependants will get a payout no matter how long you live. The downside is that if you pay premiums for several decades, you could end up paying in more money than your dependants get out.
A third type of policy, decreasing-term insurance, is often used to make sure your remaining mortgage is paid off on death (for this reason, it’s also known as mortgage-term insurance). This tends to be cheaper, as the potential payout steadily shrinks the longer the policy runs. When choosing a policy, check whether the premiums are guaranteed. This means that your premiums won’t rise during the policy. If you don’t check this, you could end up with reviewable premiums, whereby the insurer can periodically review your situation and potentially put up your premiums.
Finally, consider putting your life-insurance policy in a trust. Otherwise, when you die, the payout is classed as part of your estate, so could be liable for inheritance tax. If the policy is in trust, the payment should go straight to your beneficiaries and avoid the taxman.
In the news this week…
• Some of Britain’s biggest pension firms are still charging huge “exit penalties”, in spite of a new cap imposed by the government, says Sam Brodbeck in The Daily Telegraph. Policies set up in the 1980s and 1990s were commonly subject to exit penalties of up to 40% of the value of the pension if they were cashed in or transferred before a specified age. However, so that people could take advantage of its new “pensions freedom” rules, the government capped the exit penalty at 1% as of April this year – but only for those aged 55 or over. While some firms, including Scottish Widows, have voluntarily capped or scrapped exit charges for all of their customers, regardless of age, others including Old Mutual Wealth and Standard Life have not. As more cases emerge of younger savers losing out while older customers are protected, the government is “coming under pressure to extend the ban” to savers of all ages. Unfortunately, the problems won’t end there. Even taking into account high exit fees, in some cases providers’ ongoing fees are so high that it can still be worth switching to a cheaper alternative. One 43-year-old customer of Old Mutual Wealth was quoted a 4.5% exit fee. But even with this charge, he would have been better off financially after just
• As the housing market slows, lenders are battling it out for borrowers with large deposits or equity in their homes, says Annabelle Williams in The Times. Barclays launched the cheapest five-year fixed-rate mortgage on the market last week, offering a rate of just 1.7% to customers with a 60% loan-to-value mortgage. Their arrangement fee is £1,499. HSBC is close behind, with a 1.79% deal that carries an arrangement fee of £999. In 2011, the average five-year fixed mortgage had a rate of 4.68%. However, there are signs that interest rates are about to rise again. Inflation rose to 2.3% in February, above the Bank of England’s 2% target, announced the Office for National Statistics last week. Historically, higher inflation signals an impending rise in bank interest rates. So if you’re on a variable rate with no penalties, now might be the time to lock in an ultra-cheap deal.