Life assurance helps your dependants to cope financially in the event of your premature death. When you take out life assurance you set the amount you want the policy to pay out should you die, this is called the ‘sum assured.’ Even if you consider that currently you have sufficient life assurance, you’ll probably need more later on if your circumstances change. If you don’t update your policy as key events happen throughout your life, you may risk being seriously under-insured.
As you reach different stages in your life, the need for protection will inevitably change. These are some events when you should review your life assurance requirements:
Buy your first home with a partner
Have other debts and dependents
Get married or enter into a civil partnership
Start a family
Become a stay-at-home parent
Have more children
Move to a bigger property
Change your job
Rely on someone else to support you
Personal guarantee for business loans
Your life assurance premiums will vary according to a number of different factors, including the sum assured and the length of your policy (its ‘term’), plus individual lifestyle factors such as your age, occupation, gender, state of health and whether you smoke.
If you have a spouse, partner or children, you should have sufficient protection to pay off your mortgage and any other liabilities. After that, you may need life assurance to replace at least some of your income. How much money a family needs will vary from household to household so, ultimately, it’s up to you to decide how much money you would like to leave your family that would enable them to maintain their current standard of living.
There are two basic types of life assurance, ‘term’ and ‘whole-of-life,’ but within those categories there are different variations.
Term assurance in its simplest form pays out a specified amount of life cover if you die within a selected period of years. If you survive, it pays out nothing. It is a cost-effective way of buying the cover you need.
Whole-of-life assurance provides cover for as long as you live. Since the policy must eventually pay out, it may build up an investment element that you can cash in by surrendering the policy. However, it could take many years for a surrender value to build up. A variation called a ‘maximum protection policy’ enables you to buy a higher level of cover at a premium that is initially lower. Whole-of-life insurance is also available without an investment element and with guaranteed premiums from some providers.
It makes sense to cover yourself until your normal retirement age, usually 60 or 65. However, if you have young children, you should cover yourself until they are financially independent, which usually comes after they have left school or university and are earning their own money.
Although the proceeds from a life assurance policy are tax-free, it could form part of your estate and become liable to Inheritance Tax (IHT). The simple way to avoid IHT on the proceeds is to place your policy into an appropriate trust, which enables any payout to be made directly to your dependants. Certain kinds of trusts allow you to control what happens to your payout after death and this could speed up a payment. However, they cannot be used for life assurance policies that are assigned to (earmarked for) your mortgage lender.
Generally speaking the amount of life assurance you may need should provide a lump sum which is sufficient to remove the burden of any debts and, ideally, leave enough left over to invest to provide an income to support your dependants for the required period of time.
The first consideration is to clarify what you want the life assurance to protect. If you simply want to cover your mortgage then an amount equal to the outstanding mortgage debt can achieve that.
However, if you want to prevent your family from being financially disadvantaged by your premature death and provide enough financial support to maintain their current lifestyle, there are a few more variables you should consider.
What are your family expenses and how would they change if you died?
How much would the family expenditure increase on things like childcare if you were to die?
How much would your family income drop if you were to die?
How much cover do you receive from your employer or company pension scheme and for how long?
What existing policies do you have already and how far do they go to meeting your needs?
How long would your existing savings last?
What state benefits are there that could provide extra support to meet your family’s needs?
How would the return of inflation to the economy affect the amount of your cover over time?