We don’t like to spend too much time contemplating our own death, let alone the passing of a partner. But the fact is it's an inevitable part of life - and for some of us it will, unfortunately, come earlier than we expect.

Life insurance is a policy that will pay out a lump sum or a monthly income upon the insured person’s death. If you have a mortgage, a family that relies on your income, or any outstanding debts, it’s one of the simplest and most cost-effective financial decisions you can make to protect your loved ones against financial hardship.

You need your life insurance to provide an adequate safety net for your dependents

Who do I need to protect?

Most people take out life insurance to protect their dependents. If you were to die, your partner, spouse or civil partner would be responsible for covering mortgage repayments or rent, monthly bills, lifestyle costs and children’s school or university fees on their own. As well as keeping on top of the finances, they’d also need to cope with the emotional impact of your death. Without financial help, they’re likely to struggle financially and emotionally.

As well as ensuring your family’s financial wellbeing, a life insurance policy can cover the cost of your funeral – which according to the British Seniors Funeral Report, is an average of £5,600. That could mean there’s one less financial burden for them to deal with at an already difficult time.

Depending on the value of your estate, you might also want to consider a life insurance policy that covers any Inheritance Tax that may be due on your estate. For a single person, inheritance tax is 40% on any inheritance over £325,000. If you leave your estate to your spouse or civil partner, they won’t have to pay the inheritance tax. But an unmarried partner, children and grandchildren could be left with a hefty tax bill without the right tax planning strategies in place.

How much life cover do I need?

You need your life insurance to provide an adequate safety net for your dependents. But at the same time, you don’t want to pay for too much cover.

How much you’ll need will depend on your circumstances. But in general, the key areas to consider are:

  • your mortgage (or mortgages, if you have multiple properties)
  • any other existing debts
  • a lump sum, or a regular income, for your dependents to maintain their standard of living
  • inheritance tax liabilities

Determining the right level of cover is a case of working out how much your family would need to cover their existing financial commitments, and for how long. This is particularly important if you are the primary earner.

Make sure you consider other policies you may already have in place too. Many companies offer a death in service benefit, which pays out a lump sum if you die while employed. You also might have a critical illness policy, which would pay out if you were diagnosed with a critical illness.

All of your other policies should be factored in before deciding exactly how much life insurance cover you need.

How long does the life policy need to last?

Term Life Insurance

If you want to pay off your mortgage or protect your family until they can look after themselves or retire, you would generally choose a Term Life Insurance policy.

A Term Life Insurance policy will pay out either a lump sum when you die or, if you take out a Family Income Benefit policy, provide a monthly income for the term of the policy.

A lump sum policy will pay the entire insured amount up to the very last day of the term. In contrast, if you don’t make a claim until the last 12 months of a 25-year Family Income Benefit policy, you’ll only receive the monthly income for that final year.

Whole of Life Insurance

If you are taking out a policy to pay your funeral expenses or for Inheritance Tax Planning, you would choose a Whole of Life Insurance policy (also known as a Guaranteed Life Insurance policy).

So as long as you keep paying the premiums each month, it will pay out a lump sum no matter when you die. However, these policies are typically a lot more expensive, and if you live longer than you expect, you could end up paying more in premiums than the policy pays out.

If you want to avoid your beneficiaries facing a hefty tax bill, the best way to do this is to place your life insurance in a trust

What type of life insurance do I need?

Single or Joint Insurance Policy?

You need to decide if you want to take out a single or a joint policy. If you take out a joint policy, the chosen amount of cover is paid out if the first person dies during the term of the policy. Once it’s paid out, the policy ends, and the surviving partner will no longer have life cover under that policy.

For a single life insurance policy, the money goes into each of your estates, so you can decide how the money is dispersed. You may choose to do this if, for example, you have children from a previous marriage, and want to ensure they receive a percentage of your life insurance.

Taking out two single policies will cost more. However, having two policies means they will each pay out separately. So, if your partner or spouse dies, you will receive the payout, while your own life insurance policy remains in place and continues to protect your family in the event of your own untimely death.

Level or decreasing?

If your main aim is to ensure your family is financially protected when either you or your partner dies, you would typically choose a Term Life Insurance policy. There are four different types of Term Life policies:

  1. Level – this pays out a lump sum when you die, which stays the same throughout the duration of the policy. For instance, it would pay out the insured sum of, say, £500,000, whether you died 14 days or 14 years into the policy
  2. Decreasing – this level of cover reduces every year and is typically taken out to pay off a long-term, reducing debt, such as a capital and interest mortgage. The amount it would pay out in year one would be significantly more than it would pay in the 20th year of the policy
  3. Increasing – this cover pays out a lump sum, but that sum increases during the policy term (e.g. by a fixed percentage or to keep up with inflation). The size of the payout in year 20 would be greater than in year one, but the premiums will also gradually increase to reflect the annual increases in cover
  4. Family Income Benefit – This cover pays out a monthly income rather than a lump sum – but only pays out for the duration of the policy. The later into the policy it begins paying out, the fewer monthly payments you will receive, but this is reflected in the premiums you pay so it can be a cost-effective solution to cover the living costs of your family (e,g, until your children grow up)

As we mentioned before, if you want a guaranteed policy to cover your funeral or any Inheritance Tax, you should choose a Whole of Life Insurance policy. Once you pass away, the lump sum becomes part of your estate to be distributed in accordance with your will.

If you want to avoid your beneficiaries facing a hefty tax bill, the best way to do this is to place your life insurance in a trust. That way it is the trust that technically owns your policy, not you, which means there’s no inheritance tax to pay when you die.

Because the rules and laws relating to tax are complex, subject to individual circumstances and can change at any time, it’s a good idea to speak to a financial adviser who can help you decide on the right policy for you.

It’s important to be honest about your health and medical history, even if it makes the premiums more expensive

How much does life insurance cost?

Life insurance costs vary depending on the amount of cover you need and for how long, the state of your current health, your lifestyle and whether you have any dangerous hobbies or a risky occupation.

It’s important to be honest about your health and medical history when taking out the policy, even if it makes the premiums more expensive. If you make a claim, the insurer will check this and, if they discover you didn’t answer truthfully or failed to disclose something, they might not pay out.

By and large, Term Life Insurance is considered good value because, for a relatively low monthly cost, you can protect your family with a decent level of financial protection. Although Whole of Life Insurance is more expensive, it is guaranteed to pay out upon your death.

But always read the small print. Each policy provider has varying definitions and exclusions, so don’t get caught out. If in doubt, ask your insurance or financial adviser for help.

Amber River Financial Planning

If you need advice on the type of life insurance or other protections for you and your family, Amber River financial planners can help you determine the level of cover you need and then help you decide which policies are best suited for your particular needs.

Get in touch

To speak to one of our team, arrange an appointment or find out more, call 0800 915 0000, or alternatively use our contact form here.