What type of life insurance policy should I buy?
Most people have two main protection needs that can be covered by life insurance (often known as life assurance):
- paying off large debts like your mortgage
- family protection, where you leave behind money for your family to live on after you've died.
The most basic type of life insurance is called term insurance. With term insurance you choose the amount you want to be insured for and the period for which you want cover. If you die within the term, the policy pays out to your beneficiaries. If you don't die during the term, the policy doesn't pay out and the premiums you've paid are not returned to you.
There are two main types of term assurance to consider; level-term and decreasing-term insurance. Sometimes a combination of the two is most suitable.
Level-term life insurance policies
A level-term policy pays out a lump sum if you die within the specified term. The amount you're covered for remains level throughout the term – hence the name. The monthly or annual premiums you pay usually stay the same, being based on your age and health at the start of the policy.
Level-term policies can be a good option for family protection, where you want to leave a lump sum that your family can invest to live on after you've gone. It can also be a good option if you need a specified amount of cover for a certain length of time, e.g. to cover an interest-only mortgage that's not covered by an endowment policy.
Decreasing-term life insurance policies
With a decreasing-term policy, the amount you're covered for decreases over the term of the policy. These policies are often used to cover a debt that reduces over time, such as a repayment mortgages. When used for mortgages, it is called mortgage protection insurance.
Premiums are usually significantly cheaper than for level-term cover as the amount insured reduces as time goes on. Decreasing-term insurance policies can also be used for inheritance tax planning purposes.
Family income benefit policies
Family income benefit life insurance is a type of decreasing term policy. Instead of a lump sum payment, it pays out a regular income to your beneficiaries until the policy's expiry date if you die.
The advantage of family income benefit is that it's easier to work out how much you need. For example, if you take home £2,000 a month, you can arrange for the same amount to be paid out to your family if you die. This will continue to be paid up to the end date of the policy (the term) chosen at the outset.
As the name suggests, whole-of-life policies are ongoing policies that pay out when you die, whenever that is provided you keep paying the premiums. Because it's guaranteed that you'll die at some point (and therefore that the policy will have to pay out), these policies tend to be a little more expensive than term assurance policies, which only pay out if you die within a certain timeframe.
The premium difference is not always so great when you effect a policy at a younger age as normally there are premium review dates. These policies are also prefixed by flexible as you can make adjustments to the sum insured and there can be an investment element.
Whole-of-life policies have many uses. For instance, they can be an efficient way to cover a future inheritance tax bill.