What is life insurance in the UK?

What is life insurance?

A life insurance policy pays out on the death of the person who is insured, with either a lump sum or regular payments to the people named in the policy. Different types of policies suit different circumstances, but the principle is the same.

The purpose of a life insurance policy is to provide financial protection for loved ones and dependants should the policyholder pass away. It also gives peace of mind: to the policyholder because they know they’ve made sure the people they leave behind will be looked after; to their loved ones who have the comfort of financial security. Not only can a life insurance payout take care of immediate financial burdens like funeral costs and outstanding debts, it also provides for the living expenses of those left behind.

Types of life insurance

Life insurance policies come in many forms, of which the most popular are these:

Term life

This covers the insured for a specified period, which could be a few years or a few decades. It will pay out if the insured dies within that period.

Pros:

• Relatively low premiums
• Straightforward policies
• Flexibility to suit your needs
• Suitable for time-limited financial aims

Cons:

• No cash value, investment or borrowing element
• Cover has a fixed end date
• Premiums rise if you renew

Whole life insurance

As the name suggests, whole life insurance covers the insured for their entire life, paying out on their death at any age.

Pros:

• Covers you for life
• Builds up a cash value
• Premiums are fixed
• Helps with estate planning

Cons:

• Premiums are higher than term life
• Policies are more complex
• There may be charges for early termination

Joint life insurance

Commonly used by partners and spouses, this insures two lives in one policy and pays the survivor when the other insured dies, at which point the policy ends.

Pros:

• Lower premiums than two separate policies
• Helps with estate planning and inheritance tax
• Single application process
• Equal cover for both partners
• Shared responsibility in financial planning

Cons:

• Some policies leave the surviving partner without cover
• May complicate divorce or separation
• Can lead to higher premiums if one partner has health issues
• Less flexibility than individual policies

Critical illness insurance

This type of policy pays out if the insured is diagnosed with an illness that’s serious (as described in the policy) or terminal. Although this isn’t life insurance, because it can pay out while the insured is still alive, it is often bought as a complement to a life insurance policy.

Pros:

• Lump sum payment if an insured illness is diagnosed
• Covers a wide range of serious illnesses
• Supplements health and disability insurance
• Helps with debt repayment and rehabilitation costs
• Reduces financial stress

Cons:

• Only covers specified illnesses
• Strict criteria must be met when claiming
• Can be expensive, particularly for older people or those with pre-existing conditions
• Usually offers a one-time-only payout
• May exclude pre-existing conditions

How does life insurance work?

It’s a contract between the policy-holder and an insurance company. Between them they agree how much the policy will cost and how much it will pay out. The policy-holder pays regular premiums and in return the insurance company promises to pay an agreed sum of money if the person insured dies and the terms of the policy are met. It’s possible for someone to insure another person’s life but in the vast majority of cases the policy-holder and the insured are the same person.

Who does the money go to after I pass away?

When you take out life insurance you choose your beneficiaries – that is, the person who will receive the pay-out, or the people who will share it. Their names will be listed in your policy documents and when you pass away, they will be able to make a claim from the insurance company. It’s important to keep your list of beneficiaries up to date so you can be sure your wishes are carried out.

It’s worth bearing in mind that life insurance payouts are usually free from tax, but if the value of a policy is considered part of the insured’s estate then the beneficiaries may have to pay inheritance tax.. The easiest way to avoid this is to place the policy into a trust, which keeps it out of the estate so that inheritance tax does not apply.

Do I need life insurance?

Life insurance can be valuable to practically everyone. The most obvious example is someone who is the main or only breadwinner in their family, because it can pay off debts and cover the family’s living expenses, but it can also be useful for people without dependants. For example, if you have adult children you might want to give them a lump sum when you die and the money from an insurance policy isn’t delayed by the probate procedure, nor is it subject to tax. It also has a role in business, where it can be used to provide funds for the continuation of a business if a key member of the team dies.

How to choose the right life insurance

Getting life insurance can seem overwhelming. It can be a long process with providers whose policies have to be set up over the phone and  it can take a heavy emotional toll.. After all, it isn’t easy to face your own mortality, but we think it's an important insurance to have in place.

There are many things to consider before taking out a life insurance policy, but once you’ve made the decision, here are some tips to help you make the best choice of policy.

How much do you want your policy to pay out on your death?

Obviously, this depends entirely on your circumstances. You might have debts that would be left unpaid without insurance. On top of that you may want to work out a sum of money that would help your dependants maintain their lifestyle and for how long you’d like this to last.

How much are you able to pay each month?

Life insurance policies are not as expensive as you might think, but it’s a regular financial commitment like a direct debit for Netflix or the gym. You need to budget for this because if you find yourself unable to keep up the payments, your policy may end and you’ll no longer be covered.

Is the option of withdrawing cash from your policy important to you?

Most whole life policies have a cash value, meaning you can borrow money against them or even cancel the policy and take the money out. This isn’t the case with all life insurance policies.