Think of a mortgage. When you apply for one, there are all sorts of factors in the price you pay. There are decisions that you will make: how much you want to spend on a house, whether you want a fixed or variable rate (or something even more fancy pants), and how long you want the mortgage to last. And then, there are the decisions that the lender will make: how much they think you can afford each month, the likelihood of whether you will miss payments, and assessing the property to make sure it’s worth what you say it’s worth.
Well, buying Life Insurance is pretty much the same. Both sides of the table have decisions to make, and today we’re going to look at one of the things you’re going to have to decide on, which is the type of cover that you actually want. Let’s take a look at the main options:
Term life cover
This can go by a few different names, but broadly means the same thing. In essence, you’re insured for a specific period, let’s say 15 or 20 years. Then, if you die within that period, the policy pays out an agreed lump sum as defined in your terms and conditions. And if you live for longer? Well, the policy has expired, so you’ll get nothing.
So why would you want to insure yourself for just a specific period? The most likely reason is that the size of the policy is linked to your mortgage. After 20 years, the mortgage is paid off, so you don’t need the life insurance to cover that outgoing for your family when you’re gone. And this is where we get into a few subcategories:
Level term cover
This one is simple enough. The amount you pay and the level of insurance that you have remains consistent throughout the life of the policy. Let’s say that you’ve agreed a policy term of 20 years and the amount of cover at £150,000. If you die at any point in the next 20 years, the payout would be £150,000. Simple! The advantage to this kind of term, apart from the simplicity, is that your dependents will get a guaranteed amount. If the balance on your mortgage is £12,500 when you die, then your family will have a big security blanket to help them. And if you were to die young and your debts were £150,000, then the slate would be wiped clean to give your family a great level of protection.
Decreasing term cover (also referred to as mortgage life insurance, or mortgage decreasing term insurance)
This type of term cover is commonly arranged to cover whatever balance is remaining on your mortgage in the event of your death. The main difference here with level term is that the payout that you’ll receive goes down over time. That’s because as you make more repayments to your mortgage over the years, the outstanding balance decreases, which means you’ll need less from your insurer to pay it off. That means it’s a cheaper form of life insurance than level term as the insurer is likely to pay a lot less. However, unlike our example above, this also means that there is no lump sum left for your dependents to cover any other debts that you might have, or any spending. If you would like your family to have extra, a level term policy is likely to be better.
Increasing term cover
Yep, exactly the opposite as decreasing term. In this instance, the payout from your insurance upon your death actually increases over time. Why would you want this? Essentially, £100 now will not be worth the same as £100 twenty years from now, due to rising inflation and an increased cost of living. So, increased term cover will increase by either a fixed amount each year (most likely around 5%), or in line with inflation. Of course, as the amount of the payout increases over time, your premiums for this kind of policy will be more expensive than for level or decreasing arrangements.
Family income benefit
The next option we’re going to cover is slightly different to the other three, as rather than a lump sum, Family Income Benefit provides an annual tax-free payment for a set period. Why would you want this? Well, sometimes this type of arrangement can work out cheaper than a level term policy (although it depends on when you die), and it can provide your family with certainty over how much income they will have on a monthly or annual basis. There are, as always, different options within this cover, such as the length of the term and whether or not the benefits will remain level or decrease.
One way of looking at whether or not this might be better for you is this: If you have a 20-year term on your Family Income Benefit policy and you die in the second year, your family would receive benefits for 17 years. If you died in the 19th year, they would only receive a single year’s money. Compare this to a level term policy (let’s imagine a 20-year policy paying out £100,000), where if you died in the second year your family would receive £100,000, and if you died in the 19th year, your family would still receive £100,000. When you die really matters in this case, but unless you’re Alice from Twilight (she could see into the future, if you’re not a Twihard), it will be impossible for you to know which one would be better.
Whole life cover
Our final type of cover, Whole Life Cover, is a different beast, because whenever you die, your family can make a claim – the policy is guaranteed to pay out one day. The impact of that? Well, it’s a lot more expensive overall because a claim is inevitable – you don’t have to get Mr Statistics involved as much to know that you’re going to die one day. Yes, the insurance company are still hoping that you live long enough to pay enough into the fund to cover their outlay, but in this instance, they know at some stage they have to pay, so they treat the whole deal slightly differently.
One thing that plays a part in the cost of whole-life is that most of the plans are linked to an investment fund. This normally means that your premiums and the payout are fixed for 10 years, but from then on, they’re regularly reviewed. Investment fund not performing well? You might find that the insurance company bumps up your premium to cover the shortfall or reduce the amount you’ll receive on payout. Either way, you might end up in a situation where you can’t afford the ongoing monthly payments, or the payout that you’ll get at the end won’t be enough. That means you’re going to have to be a lot more on the ball where whole-life cover is concerned, monitoring it like you would any other investment.
So what’s right for you?
Well, there are far too many choices for us to answer that for you. Just like with a mortgage, there is a lot of research that you can do yourself as you narrow down the type of cover that you think would be right for you, and you could use a comparison site to find a good deal. But, if you want someone to help you understand the different options, expertly analyse your own financial position and then come up with several recommendations tailored to your needs, then you’re probably going to want some independent advice. If that’s the case, we’re ready to help.
This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.
GreenSky Wealth Limited is authorised and regulated by the Financial Conduct Authority. FCA No. 629624. Registered Office as above. Registered in England and Wales, Company No. 07103441.