What is life insurance?
Life insurance is a type of insurance policy that provides a payout upon your death.
In exchange for monthly payments (premiums), the policy will pay a lump sum to your beneficiaries when you pass away or, in some cases, if you are diagnosed with a terminal illness. You have control over how the lump sum is distributed, allowing you to choose the beneficiaries who will receive the funds.
How does life insurance work?
When purchasing life insurance, there are three key elements to consider, which will help determine your monthly premiums:
- Type of policy – This defines the circumstances that would trigger a payout, such as death or a terminal illness diagnosis.
- Amount of cover – The sum of money the policy will pay out to your beneficiaries.
- Term of insurance cover – The length of time you are insured for, whether a set period (term insurance) or for life (whole-of-life insurance).
These factors collectively influence the cost of your policy and the level of protection it provides.
Why do people get life insurance?
The primary reason people opt for life insurance is to provide financial support to their family in the event of their death. During a difficult and stressful time, the assurance that your family will be taken care of financially can offer peace of mind.
You can choose to cover essential expenses such as the mortgage balance, childcare, or educational costs, while also factoring in extras like holidays or home improvements for your loved ones. This flexibility allows you to tailor the coverage to suit your family’s specific needs and future plans.
Is the lump sum subject to tax?
The answer is, it depends.
If your spouse or civil partner is the recipient, the payout is generally not subject to inheritance tax. However, if other beneficiaries are nominated, the payment could be subject to inheritance tax if the total estate, including the life insurance payout, exceeds the inheritance tax threshold. One way to mitigate this is by placing the policy in trust, which can help keep it outside of your estate for tax purposes.
What are the types of life insurance?
There are two basic types of life insurance to consider:
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Term life insurance: The most common type, which provides coverage for a specified period or "term." If you pass away during the term, the policy pays out; if the term expires, the policy ends without a payout.
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Whole-of-life insurance: This type of policy covers you for your entire life, ensuring a payout whenever you pass away, as long as premiums are maintained.
What is decreasing term life insurance?
Decreasing term life insurance is a policy where the coverage amount reduces over time throughout the term.
The idea behind this type of insurance is that as your mortgage balance decreases and your children become financially independent, your need for financial protection lessens. As a result, this type of policy typically comes with lower monthly payments, making it a more affordable option for those whose financial obligations reduce over time.
What is level term life insurance?
With level term life insurance, you choose a term that specifies how long you’ll be covered, and your monthly premiums remain fixed throughout the term.
The key difference is that the payout remains constant for the entire term, providing a consistent level of cover. As a result, premiums are typically higher compared to decreasing term policies, reflecting the steady payout amount.
What is whole of life insurance?
With whole of life insurance, you are covered for your entire lifetime rather than for a fixed term.
This type of policy comes with higher premiums but offers the most peace of mind, as it guarantees a payout whenever you pass away, as long as the premiums are maintained. It provides lifelong financial protection for your loved ones.
Do I need life insurance?
If you have people who are financially dependent on you, such as children or a spouse, it’s worth considering life insurance.
Without it, your dependents could be responsible for handling your financial obligations, including any debt, and may struggle to maintain their current lifestyle in your absence.
A life insurance payout can provide the funds to pay off the mortgage and other debts, helping your family remain financially secure and live debt-free.
How much does life insurance cost?
While life events like buying a house or becoming a parent often prompt people to get life insurance, it's generally better to sign up for a policy when you're younger.
Simply put, as you age, the likelihood of death increases, which leads to higher premiums. By taking out life insurance when you're younger, you can secure lower monthly payments.
You will pay lower monthly premiums when you are young and healthy, as insurers view you as less of a risk. Securing a policy early can lock in more affordable rates.
Many factors influence the calculation of your monthly life insurance premiums, including your age, medical history, smoking status, and even dangerous hobbies.
Online calculators can provide an initial estimate of your premiums, but the final amount will be tailored to your specific circumstances, making it a bespoke calculation.
What about if I'm over 50?
Life insurance for those over 50 is typically a specialist product, with most policies being whole-of-life plans. These policies often have a limit on the payout, as they are not always medically underwritten.
Do I need life insurance when I get a mortgage?
While life insurance is not mandatory when taking out a mortgage, it is highly recommended. It provides financial protection, ensuring your family can pay off the mortgage and maintain their home in the event of your death.
What if I already have life insurance?
Even if you already have life insurance, it’s important to periodically review your policy to ensure it continues to meet your needs. Changes in your life circumstances, such as buying a new home or having children, may require adjustments to your coverage.
If your circumstances change, such as increasing your mortgage borrowing or having another child, you may want to amend the terms of your existing life insurance policy. Updating your coverage ensures that it continues to provide adequate financial protection for your growing responsibilities.