Life insurance policies are designed to provide some financial support to your loved ones in the event of your passing. After making a valid claim on your policy, your dependents will receive a lump sum, helping them cover expenses such as mortgage repayments, funeral costs, or daily living expenses. In the UK, life insurance policies vary, and understanding how they work can help you make an informed decision.
How Life Insurance works
Life insurance involves paying regular premiums to an insurer in exchange for a payout to your beneficiaries when you pass away. The policy remains active as long as your premiums are paid and the terms of your policy are met. The amount your beneficiaries will receive depends on the type of policy and the level of cover you have chosen.
Types of Life Insurance
There are two main types of life insurance in the UK: term life insurance and whole of life insurance. Each serves different purposes and suits different financial needs.
Term Life Insurance
Term life insurance provides coverage for a fixed period, such as 10, 20, or 30 years. If you pass away within this term, the policy pays out to your beneficiaries. However, if you outlive the term, the policy expires, and no payout is made. For this reason, term life insurance often comes with lower premiums, as you’re covered for a shorter amount of time.
Whole of Life Insurance
Whole of life insurance provides lifelong coverage, meaning it pays out whenever you pass away, as long as you keep up with premium payments. Because it guarantees a payout, whole of life insurance is typically more expensive than term insurance.
Benefits of Life Insurance
Life insurance offers several benefits, including:
- Financial security – It provides money to your loved ones to help cover living expenses, debts, and funeral costs
- Mortgage protection – Your benefit amount may be able to help pay off outstanding mortgage loans, ensuring your family can stay in their home
- Future education costs could be taken care of – Knowing that your children’s or grandchildren’s future education could be funded through this payout may bring you some reassurance
- Peace of mind – Knowing your family will be taken care of can relieve some of your worries about their future
How to decide if you need life insurance
Life insurance is not essential for everyone, but it can be particularly beneficial in a number of circumstances. You may benefit from securing life insurance if you:
- Have dependents who rely on your income
- Have outstanding debts, such as a mortgage
- Want to leave a nest egg inheritance for your loved ones
- Want to cover end of life expenses, such as funeral costs
If you have no financial dependents or significant debts, you may not need life insurance, but it can still be useful for covering funeral costs.
When is a good time to take out life insurance?
Taking out life insurance is a personal decision. You may consider taking it out when you have financial responsibilities or dependents. Some key moments include:
- Buying a home – If you have a mortgage, life insurance could help your family repay it if you’re no longer around
- Getting married – Your spouse may rely on your income, and your benefit amount could help to support them if you should pass away
- Growing your family – Life insurance could help to alleviate the costs of raising a child or a grandchild if you were to pass away, or even leave a nest egg for your children as they start their own families
Younger individuals generally pay lower premiums, so taking out a policy earlier can also be more cost-effective.
How much does life insurance cost?
The cost of life insurance varies based on several factors, including:
Age
Typically the younger you are at the beginning of your policy, the lower your premiums.
Health
Pre-existing conditions can sometimes increase costs.
Lifestyle
Smokers and those with risky hobbies may pay more in premiums.
Type of policy
Whole of life insurance is generally more expensive than term insurance.
Coverage amount
A higher benefit amount means a higher premium.
These are some general factors to keep in mind, but overall, premiums can vary, depending on the level of cover and your individual circumstances.
How do claims work?
When a policyholder dies, the beneficiaries must file a claim with the insurer. The process generally involves providing a death certificate, completing the insurer’s claim form, and submitting any other documents that the insurer may ask for. So, it may be a good idea to file all documents away safely. Once a claim is approved, the insurer will pay the agreed benefit amount to the chosen beneficiaries.
Are life insurance payouts tax-free?
In the UK, life insurance payouts are technically tax-free, but may be subject to inheritance tax (IHT) if the policyholder’s estate exceeds the current threshold (currently £325,000). To avoid IHT, many people place their life insurance policy in a trust, ensuring the payout goes directly to beneficiaries rather than being counted as part of the estate.
Conclusion
Life insurance can be a valuable safety net that provides peace of mind and financial security for your loved ones. Understanding the different types of policies, their benefits, and how to choose the right one can help you make an informed decision. If you have dependents or significant financial responsibilities, taking out a policy early can be a smart move, ensuring your family is protected in the event of your passing.