Life assurance guide

There are various types of life assurance to choose from depending on your budget and how much, and when, you would want a lump sum to be paid out to your loved ones. Policies include term assurance, whole of life assurance and family income benefit.

How much life assurance do I need?

You may well have some life cover already under a with profit endowment policy you bought to pay off your mortgage. In addition, you may have a death-in-service benefit with your employer, which is typically worth three or four times your annual salary. This makes it important to check how much insurance you already have before buying additional cover.

Firstly, you should have life assurance to cover the amount of any outstanding debts such as your mortgage, so that if you died, your loved ones could pay it off. Additionally, you could also protect your loved ones’ lifestyle if you are no longer there to support them. As a rule of thumb, financial advisers recommend that you insure a sum equal to 10 times your annual salary. In the event of death, this lump sum can be used to provide an income. While this might not be realistic if you are on a tight budget, you may only need to top-up your existing cover if you already have some level of insurance.

Life insurance vs. life assurance

Life assurance, rather than life ‘insurance’, is the correct term for this type of policy, because it refers to something that is a certainty – most types of insurance deal with possibilities. Whilst the correct name is life assurance, the two terms are generally interchangeable by both providers and consumers.

Types of life assurance

Life assurance falls into two categories- term assurance and whole of life assurance.

Term assurance

Term assurance will pay either a lump sum or an income if you die during the term of the policy, which can be anything from five to 40 years.

Term assurance policies can be arranged to cover just one person (a single life policy) or spouses or partners too (a joint life policy). However, you need to remember that if you die outside the term of the policy, there is no payout.

The level of life assurance you buy will depend on your individual circumstances, but generally speaking it should be enough to pay off major debts, such as your mortgage.

There are four main types of term assurance:

Level term assurance

The amount of cover remains the same throughout the term of the policy. These policies are normally used to cover an interest only mortgage or to provide family protection.

Decreasing term assurance

The sum assured reduces each year, decreasing to nil at the end of the term. The cover can reduce by a fixed amount each year, or in line with the outstanding balance of a repayment mortgage, to match the reducing debt.

Family income benefit

This type of policy is ideally suited to provide your family with a replacement income if you die during the term of the policy. A regular annual income is paid to your dependants for the remainder of the term of the policy.

This can be a useful way of providing a partner or spouse with a monthly income to pay for essential outgoings, such as council tax, utility bills, child care and so on. If you pay school fees, you may wish to factor in this cost as well.

The income is usually paid yearly, although some policies can pay out monthly or quarterly. Some policies provide an income which increases each year at a fixed rate, such as 3 or 5% so that the benefit keeps pace with rising costs.

‘Gifts inter vivos’ policies

These policies are designed to cover the potential inheritance tax liability that can arise if you bequeath assets or gifts to someone from your estate while you are alive.

Such a gift is called a potentially exempt transfer (PET) because the liability for inheritance tax (IHT) tapers off over seven years. A gift inter vivos policy lasts for seven years and is specifically designed to cover the tapering liability should you die during this period so your beneficiaries can pay the inheritance tax due.

Whole of life assurance

This is more expensive than term assurance because it will pay out on death, whenever it occurs. Whole of life assurance can be useful if you have dependants whom you wish to protect, irrespective of when you die.

There are a number of different forms of whole of life assurance:

• Non-profit whole of life – this has fixed life assurance benefits and premiums
• With-profit whole of life - this features an investment element. The payout is the sum assured plus any profits allocated to the policy during the term
• Low cost whole of life - a with-profit contract that calculates profits on the basis of a lower sum assured but on death pays out the greater of the guaranteed death benefit and the value of the policy.

Unit-liked whole of life incorporates a unit linked investment element and the premiums are subject to regular review. If the cost of proving the life cover has risen, you can opt to pay a higher premium, reduce the investment element of the plan or reduce the sum assured. Premiums are typically reviewed at five or ten year intervals and may well increase.

While they are more expensive than term assurance, whole of life policies can be useful in certain circumstances and are often used as part of inheritance tax planning so that your beneficiaries can receive a lump sum to pay a potential inheritance tax bill. More information on inheritance tax can be found on our inheritance tax guide.

The key thing to remember when buying life assurance is that cheapest is not necessarily best - it is more important to buy cover that is appropriate to your needs.

Many firms sell guaranteed acceptance plans direct to those over 50. There is no underwriting and the policy pays out on death whenever it occurs, other than in the first two years. People typically buy these plans to fund funeral expenses or to leave a legacy to their children or grandchildren. You should be aware that you could pay in more than your loved ones stand to receive if you live for a long time after taking out the policy.

Additional life assurance benefits

Some term assurance policies offer other options at an additional cost, which can provide added protection for you and your family.

Inflation protection

If you do not arrange for your cover to rise in line with inflation, the cover will decrease in real terms over time. Many term assurance and family income benefit policies include the option for your cover to increase automatically in line with inflation each year, however, this may result in higher premiums.

Waiver of premium

Some life assurance policies include ‘waiver of premium’ as an optional extra. This option ensures that your premiums continue to be paid if you are unable to work due to long term sickness or disability.

Conversion options

A small number of policies allow you to convert your policy into a different type of life policy (whole of life, for example) without the need for you to provide fresh evidence of your state of health.

Guaranteed insurability options

Marriage, birth of a child, divorce and moving home may increase your financial liabilities, in which event you can take out a top-up policy. Policies that include 'guaranteed insurability options' allow you to increase cover within a set period following major life events without fresh medical evidence. Otherwise, if your health deteriorates, cover may be more expensive or difficult to buy.

Renewal options

Some term assurance policies can be arranged on a renewable basis, which means that at the end of the policy term – typically five or ten years – you have the right to take out a further policy for the same term as the original policy, without the need to provide further information about your health.

Buying a renewable policy is cheaper at the outset because the period of insurance is shorter, making these policies attractive to people on a limited budget when they are young.

However, you should bear in mind that the cost of the cover when you come to renew the term will be based on your age at the time of renewal, so the long term cost will be higher than a standard term assurance policy bought at the outset.

Critical illness cover

Some life assurance policies allow you to buy critical illness cover as an added extra, in return for an increased premium. Critical illness cover pays a lump sum if you are diagnosed with one of a number of pre-defined life threatening illnesses or conditions, such as certain cancers, a heart attack or stroke and survive a certain amount of time thereafter (typically 30 days). If you are considering adding critical illness cover to your policy, then it is worth reading our critical illness cover guide for more information.

Critical illness is a complex product and policies vary considerably, so it may be advisable to take independent financial advice.

Life assurance premiums

Premiums for all types of life assurance are based on a number of factors such as your gender, health, lifestyle (smoker or non smoker), age and occupation. The lower the likelihood of you dying during the term of insurance, the cheaper the premium will be. Under most term assurance policies, the premium is guaranteed to remain the same for the term of the policy.

Prices vary from insurer to insurer, but the term assurance market is often extremely reasonable because of rapidly rising longevity and a highly competitive market.

Life assurance advice

• If you withhold any 'material facts' about your medical history or lifestyle, you could invalidate your policy, and the insurer would not be obliged to pay out in the event of a claim.
• Placing a policy in trust means that the proceeds can be paid directly to your beneficiaries, rather than having to go through probate and being taxed when you die. This can be complicated, so seek advice from a suitably qualified financial adviser to ensure you have covered every eventuality.
• Before consulting a financial adviser or provider, consider what options you want and how much you can budget for.
• Look at what life assurance benefits you may already have, such as cover included with your mortgage or from your employer.

Taking out a life assurance policy should be treated as an investment, rather than an expense. Once you have taken it out, you and your loved ones can relax in the knowledge that if the worst happens, at least their financial future is secure. Our life assurance guide is a good start to learning about assurance, but you may want to seek professional advice before taking the next step.