The lump sum is usually tax free. It is vital that you take out life assurance if you are the main breadwinner. Be sure, too, that you take out enough cover; otherwise, your dependants will suffer financially after you die.
If you're single, you don't have a real need for life cover unless you have special circumstances, for example you plan to leave your home to a friend or sibling and want the mortgage paid off before they receive it. Life assurance can do this.
When applying for life cover you must complete an application form, giving details of your age, job, and health. Answer these truthfully, no matter how this affects your premiums. If you don't, your policy may not pay out, which could be disastrous for your dependants.
Most life providers can also tack critical illness cover, which pays out on diagnosis of certain illnesses, onto your policy for an extra premium, which is quite expensive. This cover can also be bought separately.
We explain the different types of life assurance in more detail in the following sections.
Begin Term Assurance
Term assurance is the cheapest form of life protection. It's getting cheaper all the time as people live longer and give insurers less risk of having to pay out. Term assurance is available from traditional providers such as insurance companies and banks and building societies to retailers. Because competition is fierce, the cost of cover is reasonable: a 30-year-old non-smoking female buying £100,000 worth of level cover for a term of 20 years could purchase cover for £6.80 a month.
Term assurance works like this: You choose the term - how long the policy runs for, which can be anything between 1 and 30 years. Many people choose a term that coincides with the length of their mortgage so that their payments are covered if they die before they clear this debt. So if you have 20 years before your outstanding mortgage is cleared, you take term assurance for the same period.
How much the insurer pays out if you die during the term depends upon the type of term assurance:
- Level term: Covers you for the same amount throughout the term of the policy (your premiums also remain the same). As it doesn't take into account the effect of inflation, level term assurance can put your beneficiaries at a disadvantage.
- Renewable term: A renewable term is shorter than a level term - usually five years. You can then renew it if you wish, although you can't increase the sum assured and your premiums rise with age.
- Convertible term: Can be converted to whole of life or endowment insurance without giving further medical evidence of the state of your health. The new policy should cost the same as a normal whole of life or endowment policy based on your age when you exercise this option. This may be worth doing if you don't have much cash initially (so can only afford level term) but have a greater income and more responsibilities, such as kids, later on.
- Decreasing term: The payout sum falls by a fixed amount every year, so by the end of the term you get nothing. However, your premiums remain the same throughout the term, although they are set lower than level term to account for the decline in the sum insured. Popular for covering a repayment mortgage.
- Increasing term: The payout sum, and possibly your premium, increases every year by a fixed percentage of the original sum insured or the retail price index. This ensures there's enough to cover the rising cost of living.
- Family income benefit: Instead of paying a lump sum on your death, your family receives an income until the end of the term. This is paid monthly, every three months, or once a year. You can also have this increase by 3 or 5 per cent each year, but your premiums will be higher to accommodate this.
The downside with term assurance is that your family is protected only if you die during the term. If you take out a policy with a 20-year term and live longer than this, your family won't see a penny of your outlay returned. There is no surrender value either, so if you stop paying the premiums the cover ceases and you don't get back the premiums you have paid. Just as it is important to make sure you take out enough cover - ensuring the lump sum is big enough to clear all your debts and provide an income as necessary - you must review your policy on a regular basis to ensure you still have enough cover. Do this at least every two years, and when something significant happens, such as you get married, move house, or have children. An independent financial adviser can help decide how much cover you need. While checking that you have enough cover, ensure your premiums remain competitive as well. There are no penalties for switching policy, so do so if you find the same cover for less money - just make sure the new policy is properly in force before terminating the old one.
Getting Whole of Life Insurance
If you want to ensure your family are covered whenever you die - not just during a set term - opt for whole of life insurance. Premiums are higher than for term assurance because the insurer will definitely pay out. Some insurers require you to pay premiums until death; others require premiums only until you reach a certain age, such as 65 or older, but your beneficiaries still get the sum insured when you die. The size of the payment your family gets depends on how long you pay premiums for and the performance of any investments within that policy.
