Understanding life insurance

First published 19 October 2017 • Updated 09 April 2019

Life insurance protects your loved ones financially in the event of your death – or alternatively, gives you protection in the event of someone else’s death, if you rely on that person financially.

Here you can find out about the different kinds of life insurance, the various reasons you might want (or need) to have it, and how to choose the right life insurance products for you.

  1. What is life insurance?
  2. Do I need life insurance?
  3. Is life insurance compulsory when getting a mortgage?
  4. What is a term life policy?
  5. What is a whole-of-life policy?
  6. Using life insurance to cover an inheritance tax bill
  7. Can I buy life insurance for a family member?
  8. Can I buy life insurance for an employee?
  9. How much does life insurance cost?
  10. What’s the best way to compare life insurance?

What is life insurance?

Life insurance is an insurance policy that pays out a lump sum on the death of the person insured. Sometimes the insurance will only pay out if the death takes place before a specified age (a term life policy) but you can take out insurance that will pay out whenever the death takes place (whole-of-life policy).

Do I need life insurance?

If your family would struggle financially in the event of your death, a financial adviser may recommend life insurance. The same applies if you depend financially (either partly or wholly) on another family member, such as your spouse. A married or cohabiting couple might take out a joint life insurance policy, to cover the surviving partner if the other one dies.

Is life insurance compulsory when getting a mortgage?

Technically, life insurance is not compulsory when you buy a home with a mortgage, as the lender can recover the mortgage from the sale of the property. However, if you are living with a partner and/or dependants, you will not want them to be made homeless by the enforced sale of the house. For this reason, if you have a family you should consider life insurance essential when you take out a mortgage.

A joint-life policy will ensure that your mortgage is fully paid off if either you or your partner should die.

What is a term life policy?

A term life policy covers you for a set period of time, so will only pay out if you die before a certain age. For example, you may want the cover to last until your children reach adulthood, so are less likely to be dependent on you. Another strategy may be to have insurance that lasts to the end of your working life.

There are various types of term life policies out there, so it’s worth reading up on them before choosing which one to take out.

What is a whole-of-life policy?

Whole-of-life policies pay on your death, whenever that may be. As this means a definite pay-out at some point, premiums will be higher than for a term life policy, and you will need to keep paying them until your death. This means that you might in theory pay more in premiums than would be paid out on your death, if you live a long time. However, one popular use for a whole-of-life policy is to cover an inheritance tax bill.

Using life insurance to cover an inheritance tax bill

You can use a whole-of-life insurance policy to cover any inheritance tax (IHT) that may be payable on your death. One of the common problems of IHT is that it often needs to be paid before the money in the estate is released – and your beneficiaries may not have enough accessible money to spare.

A solution used by some people is to set up a life insurance policy specifically to cover the IHT bill. Please note that the policy has to be set up to pay into a trust that is outside your estate, so that the pay-out itself will not be taxed and can be used to pay HMRC. If the policy does not pay into a trust, then the pay-out itself will be subject to IHT!

Trusts are a specialist area, so be sure to consult a financial adviser first, and a solicitor when setting them up. Find out more about trusts and estate planning.

Can I buy life insurance for a family member?

You can buy life insurance that covers someone else (such as a parent), for example if they don’t feel confident doing it themselves. However, you must of course have that person’s signed consent to be insured in that way.

You must also be able to demonstrate ‘insurable interest’ in that person. This means showing that their death would have a negative impact on your finances. If you don’t depend in any way on that person for your financial security, you won’t be able to get life cover on them. This is to ensure that a person cannot benefit financially from another person’s death.

In short, you can insure your spouse, or a parent / other relative who supports you financially, but you are unlikely to be able to insure your children (unless they earn an income on which you depend, e.g. from acting).

Can I buy life insurance for an employee?

If you run a business, you’ll know that some members of staff are essential to your operations and very hard to replace. These are known as ‘key persons’. Many businesses that recognise these key persons will take out special life insurance to cover them in the case of death or incapacity. Find out more about key person insurance.

How much does life insurance cost?

The cost of life insurance varies significantly based on factors such as your age, state of health and lifestyle (such as whether or not you are a smoker). It will also vary from provider to provider – and of course based on what size of pay-out you want.

However, it is possible to give a rough estimate. For example, if you are a 30 year-old non-smoker, and you want a term-life policy limited to 30 years, paying out £100,000 if you die within that time, your monthly premium would be in the region of £6. Mortgage life insurance would be somewhat cheaper, as the mortgage balance would reduce over time.

Some lifestyle activities, such as smoking, make life insurance much more costly. If you are a smoker, then monthly premiums are typically twice as expensive from age 40 upwards.

What’s the best way to compare life insurance?

Price comparison sites are an increasingly popular way to buy insurance of all kinds. However, with life insurance it is advisable to take a little more care. The loss of a close family member is one of the biggest upheavals a person can face, and is the worst possible time for any financial insecurity or uncertainty. To ensure that your life insurance is fully suited to your needs, it is best to include it as part of your overall financial plan – which your financial adviser can help you to put together.

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About the author
Nick Green
Nick Green
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.