Life Insurance

Level term life insurance pays out a set amount if you die within a fixed term

This is the simplest type of life insurance and the name actually tells you all you need to know...

• Level: The payout you get doesn't vary. It's always at a set amount regardless of when you die during the term, eg, £200,000

• Term: You only get a payout if you die within a fixed term, eg, 18 years

So all in all the cover guarantees a lump sum payout upon death to your dependants within a fixed time, for example, £200,000 if you die within the next 18 years. Obviously, the more cover you get and the longer the term you want, the more it costs.

It's also worth noting that as the policy only pays out on death – there's usually little dispute over whether someone is dead or not – and it pays a fixed amount, then providing the company is reputable...

It's just a case of the cheaper the policy, the better.

Don't confuse it with other types of life insurance

This is just one type of life insurance, there are others that do different jobs including:

• Mortgage decreasing term insurance: This pays out to cover your mortgage if you die within a set term. As mortgage debt decreases over time, the amount it pays also decreases (it's often called 'decreasing term assurance' because of this).
  
  It's cheaper than level term life assurance as the insurer usually has to pay a lot less. See our Mortgage Life Insurance guide for how to get it. However, if you want to leave a lump sum for your dependants to cover other debts and ongoing spending, a level term life insurance policy, while more expensive, is likely to be a better option.


• Whole of life insurance: These are often (but not always) investment-linked life insurance policies mainly used to mitigate inheritance tax. In other words, the payout amount should cover the inheritance tax bill on death, and the policy runs out when you die, instead of after a fixed time.


• Life insurance investment: These are effectively investments operated through life insurers. While there is a life insurance element they're often things like endowments or with-profits policies and are used far more often in the 'investment' zone rather than for protection if someone dies.
  

You don't need life insurance if you don't have dependants

If you have no dependants and are single, then you'd be right to question why you would bother to get this policy. This is all about paying out when you're gone, so if you've no one you want the money to go to, don't bother.

However, if you do have dependants, such as a partner and/or children or anyone else who relies on your income, then ask yourself: what would happen financially to the people around me if I died?

If the answer is there'd be little financial impact, then you may not need a policy. But if paying the bills, the mortgage, bringing up kids, food shopping and more would be a struggle, this is a cheap way to solve that.

Roughly cover 10 times the annual income of the highest earner till kids have finished full-time education

The rough rule of thumb is to cover 10 times the main breadwinner's income, yet you don't have to stick with that. It may just be a case of do what you can afford – the budget planner should help. Here are some things you should take into account. It should cover...

• Any outstanding debts that need to be paid off (including a mortgage if you don't have a separate policy)
• Immediate outgoings your dependants would need to pay
• Future spending you would have wanted to make, eg, university fees for the kids
• Any additional expenses a death may trigger, such as funeral costs

While 10 times your income may seem high, it's worth remembering that inflation will mean the value of this payout is less in, say, 10 years' time than it is now, and you're getting cover to last you that long (or longer if you choose a greater term).

Your dependants don't have to pay any income tax on the payout, but it does count as part of your estate so if your total assets are above the inheritance tax (IHT) threshold, they will have to pay 40% (ouch!) IHT on it. This can be avoided by putting the policy into something called a trust, see below for more info.

How long should the term be?

A policy covering children should last until they are no longer reliant on you, so that's generally at least until they finish full-time education. If you're planning on having more children you may want to estimate when that'd be rather than trying to extend or get a new policy later. This is because cover becomes more expensive the older you get.

To cover a partner it should last until the year you expect to reach pensionable age. Don't feel obliged to cover a round number of years, eg, policies can be for 17 years.

Quick questions:

Two single policies can be better than joint cover

When buying level term life insurance, you can either get a single policy or a joint couples policy. If both you and your partner are getting life cover, a joint policy may be marginally cheaper than getting two single policies, but it will only pay out once, usually on the first death. You used to be able to get a policy paying out on the second death but they have now become incredibly rare.

A joint policy vs two single policies

Joint policy: The pros

...a joint policy is cheaper than two single policies.

...if you are married but have no dependants it's much less hassle to set up a joint policy compared to two single ones.

Joint policy: The cons

...if you have dependants you will only get one payout, usually on the death of the first policyholder. Single policies, however, pay out twice.

...if you split with your partner you may have to cancel the cover (unless you're still on good terms) and buy two single policies, priced on your new age and health, which will be more expensive.

Two single policies: The pros

...each policy will pay out on the death of each person, rather than just on the first death, which is what happens with a joint policy. So you get two payouts rather than just one.

...if you split with your partner you would not have to buy a new policy.

Two single policies: The cons

...two singles policies are typically more expensive than a joint policy.

...if you are married but don't have dependants you will only need one payout – to your partner. So there is no need for a second payout as there would be no one for it to go to.

The less risk you'll die, the cheaper the cover

The cost of the cover increases with the likelihood of death within the term – age, health, having a risky occupation or being a smoker can increase price. So a 98-year-old tobacco chewing racing driver who likes to go cageless shark diving may struggle to get a good deal, even after reading this.

Pricing radically changes depending on who you are so it's important to disclose everything. However, the rules around disclosure are changing and from August 2016 insurers will be unable to unfairly reject customers' claims if they've given the wrong information about a part of their policy that is irrelevant to their claim (see the news story: New insurance laws will stop insurers wriggling out of claims). But until then...

Disclose everything; all past conditions and any risks. If not, your insurer may use 'non-disclosure' as an excuse not to pay out.

When it comes to pre-existing medical condition, every insurer has its own rules. If you've had issues, it's worth speaking to a broker, who will know which insurers will give you the best rates.

At what point you need to disclose all your medical information depends on who you buy the cover from. If you are buying it from a discount broker it's very much like getting home or car cover from a comparison site. The broker will ask you a few basic questions and then you will be sent to the website of the insurer, which will ask you for much more detailed information, such as your medical history.

Advisory brokers, on the other hand, will ask the detailed questions before you speak to the chosen insurer.

Quit smoking or planning to? You could get cheaper cover

Non-smokers pay a lot less than smokers, because they're a lot less likely to die during the term. To count as a non-smoker, you need to have been genuinely nicotine-free for at least a year and in some cases longer, so always check.

Therefore one year after you quit, it's worth getting a new deal to see if you could save big. But don't be tempted to lie. If you die and it is discovered you had been a smoker, it could invalidate the policy. If you are seriously giving up, it's a good idea to get it noted on your medical records to back up any potential claim. See other savings in the Stop Smoking MoneySaving guide.

It is also worth noting that some insurers have tightened their criteria and their cheapest policies now outline that you need to have been smoke-free for five years to count as a non-smoker.

Make sure the cost is fixed each month with 'guaranteed premiums'

When you buy level term cover you will be given two choices of premium (which is the official name for monthly insurance payments). It can be guaranteed or reviewable.

If your premiums are guaranteed, your insurer will never change the price, so you'll know what you'll be paying over the life of the policy. Reviewable premiums, on the other hand, cost less at first, but your insurer can hike costs later on, meaning a cheap deal can potentially become costly as you age.

Write your policy in trust and the money can't be claimed by the taxman

If you die your life insurance forms part of your estate, which could mean it's hit with a huge whack of Inheritance Tax. In many cases it's possible to avoid this by writing the policy in trust, if it's done at the time the policy is taken out.

If you write in trust the insurance pays out directly to your dependants, so it never becomes part of your estate, which avoids inheritance tax and speeds up the payout.

This is relatively easy to do. When you get most insurance policies they include the option (and papers) for writing in trust directly at no extra charge. If you know what you are doing, you can write the policy in trust yourself. If not, get advice from one of our cheapest advisory brokers or see our guide on Independent Financial Advisers.

Switching MAY cut costs

If you already have a level term policy, this guide could help you cut the cost if you decide to switch. If a new quote shows you can save (make sure the cover is at the same level), all you need to do is set up the new cover.

Once it's in force, cancel your existing policy BUT remember to check the T&Cs carefully to make sure the cover is covering the same things your previous policy did. Your current policy could be better value so don't rush out cancelling it before you're sure you can get equal or better cover elsewhere.

However, there's no guarantee you'll save. If your policy was bought years ago, or you've had health problems since then, the savings from buying a cheaper policy may be cancelled out by your increased risk level and/or age.

You are protected if your provider goes bust

As taking out life insurance is usually a long-term decision, many things can happen during the lifespan of the policy, and while your insurance company may be doing well now it could be a different scenario 20 years down the line. If something happens, here's how it would affect you:

• If your insurer went bust. If your provider goes bust, the Financial Services Compensation Scheme (FSCS) will try to find another insurer to take over or issue a substitute policy. However, if you've ongoing claims, or need to claim before a new insurer is found, the FSCS should ensure you're covered (always check new insurers are on its register to make sure they're UK registered). For more see the insurance section of our Savings Safety guide.
  
• If your broker went bust. The only payment you're likely to make to a broker will be the fee for arranging the policy, which is often no more than £25.
  
  In the unlikely event your broker went bust after you paid it but before your insurance was arranged, the chance of you getting your money for the fee back is slim. Saying that, the FSCS would be able to help with any premiums lost as a result of a broker going bust, as these payments are ring-fenced, but this is unlikely to extend to broker fees in this instance.