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Johanna and Tony | Edited by Martin
Updated July 2017
The sobering statistic is around one child in 29 loses a parent before they grow up. Sadly, the grief and misery are often compounded by a loss of income causing financial crisis – but life insurance is one of the cheapest ways to protect your family’s finances if the worst happens.
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The 10 life insurance need-to-knows
There are many different types of life insurance: some protect a mortgage and some protect all your dependants, while others provide a way to mitigate inheritance tax. Yet here we’re focusing solely on life insurance taken out to provide money for your family if you or your partner were to die. This is something every parent, partner, or person with any other type of dependant needs to consider.
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, Ј200,000
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, Ј200,000 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 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).
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.
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.
I’ve heard that Family Income Benefit may be a cheaper option. Is that right?
If you want to provide a regular income for your family, rather than a lump sum, an alternative is to take out an insurance product called Family Income Benefit (FIB). This provides an annual tax-free payment for a set period (and despite it’s unfortunate name it has nothing to do with receiving benefits).
Sometimes FIB can work out cheaper than level term cover and sometimes it’s the other way round – it all depends on when you die so unless you have a crystal ball this will be impossible to tell. But to demonstrate how they compare here’s an example:
- FIB taken out over 10 years paying out Ј10,000 a year will cost Ј7.28 a month – if you died in the first year your dependants would receive Ј10k a year for 10 years, meaning a total income of Ј100,000. But if you died in the last year they would only get Ј10,000.
- Meanwhile, 10-year level term insurance for Ј100,000 will cost Ј11.10 a month but would pay out Ј100,000 regardless of whether you died on the first or the last day of that 10-year period.
Some of the best buy brokers below offer quotes for FIB but if you’re not sure whether it’s for you it’s worth seeking the advice of a broker or financial adviser before you proceed. See our cheapest advisory brokers below for more.
Why is 10 times the salary of the highest earner a good rule of thumb?
Covering 10 times the salary of the highest earner in the household is a good guideline figure because it is likely to leave enough money to cover mortgage repayments and expenses. Take the example of a family where one partner works and the other stays at home to look after the children. If the working partner dies, the partner looking after the children still needs money to pay the mortgage and look after the little ones. If the partner looking after the children dies, the sum that would be paid out would be enough to cover the working partner if they had to leave full-time employment to look after the kids.
What is the best age to buy level term life insurance?
If you want to buy level term life insurance, it is best to get cover while you are as young as possible. Obviously, if you’re an 18-year-old, do not own a home, are single and don’t have any children, the product is not suitable, but you should consider cover as soon as you have people relying on your income.
The reason you should get cover as soon as possible is because it will cost less. Younger people are largely healthier and will have longer to live than their older counterparts and this will be reflected in the prices offered by insurers. Here’s a table to illustrate this point.