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Many of us hold insurance policies for our homes, cars and holidays, but what about the most valuable thing of all – our lives?
Life insurance pays a sum of money on the death of the policy-holder and can help provide valuable financial support to your family. But, according to research by Direct Line, only 35% of people in the UK hold a life insurance policy, despite 60% of people agreeing their family would benefit if the worst was to happen.
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Here’s a round up of the key benefits of taking out a life insurance policy – more on how life insurance works, below.
What are the benefits of life insurance?
These are some of the main benefits of holding a life insurance policy:
1. Peace of mind
One of the main benefits is having peace of mind that your family has a financial safety net if you die. This may be particularly important if your partner or children are financially dependent on you.
A critical illness policy may also provide peace of mind by helping you meet your financial obligations if you are unable to work due to serious illness or injury.
2. Cover financial commitments
A life insurance policy can cover financial commitments such as everyday living costs, mortgage and loan repayments and one-off expenses such as replacing a car. This support may help your dependents to maintain a similar standard of living if they suffer a fall in household income.
3. Pay off a mortgage and other debts
Life insurance can also help to repay any debts on your death. According to the Institute for Fiscal Studies, over 14 million people in the UK currently have a mortgage and life insurance may ensure that your family can stay in their house.
Mortgage debts have increased with the boom in property prices over the last decade.
The latest Bank of England figures reveal that over 60% of joint mortgage holders have a mortgage of at least three times their salary, while over a quarter of single mortgage holders have a mortgage that’s four times or more their salary.
The life insurance policy can also be tailored to the type of mortgage. Homeowners with a traditional repayment mortgage (where both capital and interest is repaid each month) may consider a decreasing term policy which reduces as the outstanding mortgage debt decreases over time.
However, homeowners with an interest-only mortgage (where the capital debt does not reduce) might look at level cover where the amount remains the same throughout the life of the mortgage.
4. Cover funeral expenses
The average cost of a basic funeral is just under £4,000, according to research by Sun Life, rising to £4,800 if it’s a burial. Add in professional fees, catering, flowers and a wake, and the average cost rockets to £9,200.
That’s why, according to a survey by Direct Line, one of the primary reasons for taking out life insurance is to pay for funeral expenses.
5. Supplement savings
With the rise in the cost of living over the last few years, it has become increasingly challenging to put money aside for a rainy day.
A survey by the Office for National Statistics (ONS) revealed that more than 40% of households forecast that they will not be able to save money in the next year. And the average value of savings accounts in the UK stands at just over £5,000.
A life insurance policy can provide an alternative way of leaving money to your dependents to money built up in savings accounts. Contributing regular monthly premiums to a life insurance policy may also be easier to budget for than ad-hoc contributions to savings.
6. Inheritance tax planning
A life policy can be used to pay inheritance due on your estate after death. For example, you could take out a £100,000 whole of life cover that could be used to pay for inheritance tax obligations.
Life insurance policies may also be ‘written in trust’ to remove them from your estate for inheritance tax purposes. A trust passes legal ownership of the policy to the beneficiaries you nominate and it is not therefore counted in your estate.
This can mean a considerable tax saving. For example, you’d typically pay 40% on the value of your estate above £325,000 in the current tax year (excluding an additional allowance for property in certain circumstances).
The beneficiaries of the trust will often receive the money more quickly than through the probate process after a death. Although setting up a life insurance policy in trust is usually straightforward, there are legal and tax consequences so you should take financial and legal advice.
What are the disadvantages of life insurance?
While there are many benefits of life insurance, it may not be appropriate in all circumstances. For example, if you do not have any financial dependents, or your partner is able to maintain the same standard of living, it may not be a worthwhile investment.
Similarly, any death-in-service benefit provided by your employer may be sufficient to meet any financial obligations.
There is also no cash value to a life insurance policy unless you die during the term of the policy. If you die after the term has ended, there will be no pay-out.
Some life insurance policies can be expensive, particularly if you suffer from certain health conditions that increase your premiums. If you want cover to remain in place, you should also ensure that you can continue to afford the premiums.
In addition, you may end up paying more in premiums than the value of the payout on death, particularly for longer policies.
How do life insurance policies work?
In their simplest form, life insurance policies pay out a lump-sum on the death of the policy-holder.
There are different types of life insurance policies, including:
- Term life insurance: this runs for a fixed term, such as 25 years, and pays out a specified lump sum if the policy-holder dies within this period
- Joint life insurance: this pays out a lump sum on the first death within the term
- Critical illness cover: this pays out a tax-free lump sum (or a monthly income) if the policy-holder is diagnosed with a critical illness or a life-changing injury
- Whole of life cover: this pays out a lump sum on the policy-holder’s death, meaning that cover applies for the whole of their life, not a set term
- Death-in-service benefit: if an individual dies while employed, this pays out a lump sum based on a multiple of their salary.
In addition, there is the option of cover for children, family income benefit and over 50s life cover. Find out more with our guide to the different types of life insurance policy.
