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What Type of Life Insurance Do I Need?

Life insurance is a way to provide financial support for your loved ones after you die. There are several different types of life insurance, but in broad brushstrokes they all work the same way. You buy a life insurance policy and pay for it every month. For as long as you keep paying those monthly premiums your life is insured.

If you die with an active policy then your insurer will pay out a pre-agreed sum of money – known as a death benefit, lump sum or life insurance payout – to your beneficiaries. There are some tax considerations that do come with this.

As said, there are many different kinds of life insurance; different policies exist to insure different people in different circumstances with different budgets. So by understanding what’s out there, you can protect your loved ones in the most appropriate way to match your needs, lifestyle and what’s going on at home.

What Type of Life Insurance Do I Need?

The short answer is that life insurance pays a lump sum if and/or when you die. In that sense it can cover the costs associated with death, and the costs of life after death.

In the U.K. in 2022, the average cost of dying – funerals and admin – was £9,200. But you probably don’t want to leave your loved ones on the hook for your mortgage and debts. Also, your household’s running costs won’t go anywhere and, if you die, your loved ones will have to go on minus your income. In an emotionally devastating situation, life insurance funds can at least limit the financial devastation.

The more your life is insured for, the more funds will be available for your loved ones. Beyond covering big ticket debts and running costs, many parents factor things like university fees and house deposits into their life insurance should they die before their kids reach adulthood. In this sense, it’s almost like leaving an inheritance.

Life insurance itself doesn’t deal with things like sickness and injury. Other products in the category do that. Critical illness cover, for example, pays a lump sum to the policyholder should they ever be diagnosed with a specific, life-changing illness, while income protection pays the policyholder a high percentage of their wage should they ever have to take significant sick-leave from work.

The terms of a life insurance policy will differ, person to person, and it’s very possible you’ll have what are called exclusions applied to your policy. An exclusion is an instance where both sides – you and the insurer – agree that a policy will not pay out. For example, if you have a dangerous hobby, let’s say rock climbing, your life insurer may be happy to cover you for all eventualities except death via rock climbing. You’ll have to agree that if you die in a rock climbing accident your policy will not pay out.

According to the Association for British Insurers, 98% of U.K. life insurance claims were successfully made and paid in 2022. This 98% has been consistent over the past few years but, fairly obviously, it means that not all claims are paid.

In the small minority of cases where claims are not paid, it’s typically because the policyholder lied, misled or failed to mention something crucial in their application. Let’s say the policyholder never mentioned that they smoke but went on to die of lung cancer. Had the policyholder admitted to smoking at application stage it would have made a material difference to the way they were assessed; hence the insurer may determine that the policy was created on a false premise.

For the record, in cases where the insurer refuses to pay out, the family can appeal. It’s also reasonably common in cases where a claim isn’t paid for the insurer to return the sum total of what the deceased paid in premiums. It’s not the agreed lump sum, but at least it’s something.

The answer to this question is that it depends on several factors, including your budget, needs and circumstances. Here’s a little more on the key types of life insurance available in the  market:

Level Term Life Insurance 

Term life insurance is probably the best-known type of life insurance, and usually they will be referring to level policies. Basically, you pick a term (say 15, 20, 25 or more years), during which your life will be insured. You then pick the payout amount your loved ones will receive if you die.

What you pay in premiums each month won’t change and, should you die while the policy’s active, your loved ones will receive the payout amount as agreed.

Family Income Benefit

Sometimes called family life insurance, this is life insurance that, if you die, pays your death benefit not as a big lump sum but in installments. Some like the idea of their family having regular wages and not a potentially overwhelming lump sum.

Decreasing Term Life Insurance

Sometimes called mortgage life insurance, this product is typically cheaper than others. It’s designed to cover the outstanding balance of a repayment mortgage if you die before it’s paid.

The balance of a mortgage reduces as you make payments. You might owe £250,000 in year two but £100,000 by year 10. Decreasing term life insurance matches your death benefit – the lump sum – to what’s outstanding on your mortgage at a given moment.

Whole of Life Insurance

As the name suggests, whole of life insurance is permanent. It lasts as long as you do, provided you keep making payments. Most life insurance policies expire at some point, but whole of life keeps going.

Because whole of life insurance will definitely pay out, it’s typically more expensive. There are several options in whole of life insurance: you can link your policy to inflation so your lump sum keeps its buying power. You can opt for ‘guaranteed acceptance’ over 50s life insurance. And you can select a whole of life policy with an investment dimension so, in theory, you can increase your lump sum.

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