While most people understand the concept of life assurance, there are a number of different types of insurance available, and they are designed for different purposes.
Term Assurance
As the name suggest, term assurance is a life insurance policy that will only cover you for a certain period of time. It pays out a lump sum if you should die within this term.
Typically, we use term assurance policies to give protection against known liabilities and timeframes
There are two main types of term assurance:
Decreasing Term Assurance has a reducing sum assured, so that in the final months of the policy the payout will be minimal. We typically although not exclusively would see these used to protect repayment mortgages, where the reduction in the life cover amount should reflect the reduction in the mortgage balance outstanding.
Level Term Assurance has a level sum assured. We use this for interest-only mortgages (where the mortgage balance does not decrease over time) and for other identified risks.
For example, if your mortgage runs for 17 years, then you need to insure against death within that period. So we would arrange a life insurance policy where the ‘sum assured’ matches your mortgage balance, and run it over a 17-year term. If you have a repayment mortgage then we would recommend a Decreasing Term Assurance, and if you have an interest-only mortgage we would recommend a Level Term Assurance.
This ensures that if you die within that period, the payout is enough to clear the mortgage. If you die after this time then there is no payout, but there is also no longer a mortgage to repay.
Family Income Benefit
These are really useful policies that we also use for family protection.
Like a standard term assurance policy, these run for a set duration which you choose at outset.
Unlike a traditional term plan, these policies make an annual payout upon death. For example, £50,000 per annum for a 20 year period.
This means that if you die within the first year the intended beneficiary would receive a total of £1,000,000 (£50k x 20 years), and if you died in the last year they’d only get £50,000 (£50k x 1 year).
Typically but not exclusively we see these policies used to replace the lost income that would follow the death of one or both of a couple, particularly where they have children.
We will calculate the sum assured after discussing and understanding the financial consequences of premature death of one or both partners. Nothing will replace a loved one, but these policies mean that financially, at least, the family they leave behind are able to maintain their previous standard of living, and their children still have the same opportunities they would have had.
Whole of Life Assurance
Again, as the name implies, these policies will last for your whole lifetime.
As there is no set term, these policies are guaranteed to pay out at some point (as long as you continue to pay the premiums).
Whereas term assurance is designed to cover known liabilities over a known timeframe, Whole of Life cover is for known (or forecast) liabilities over an unknown timeframe.
This typically includes providing funds to meet the inheritance tax bill due on your estate, and legacy planning where you wish to leave a set amount to your family, regardless of when you die.
As these plans are guaranteed to pay out at some point (again, we will all die one day) the premiums will be higher, both at outset, but particularly when viewed as the lifetime cost of the insurance. If you take a policy out when you’re 45 and pay until you die at age 90, the total premiums paid will be considerable. Some whole of life plans may include pricing reviews at regular intervals which may increase the monthly premium.
Another issue with Whole of Life assurance is the effect of inflation. We’ve often been engaged by new clients who are dealing with the estate of a recently deceased spouse or parent, and part of the estate is a life insurance policy which has paid out a couple of thousand pounds.
That level of life insurance was a lot of money when the policyholder took out the policy in the 1960s, but is a very small sum in 2020. So we usually recommend that Whole of Life assurance rises with inflation each year. This will mean that the both the sum assured and the premium will rise each year, sometimes significantly, and will ensure that the payout is as significant as you thought it would be, especially over very long timeframes.
Life Assurance plans typically have no cash in value at any time and cover will cease at the end of term. If premiums stop, then cover will lapse.
The Financial Conduct Authority does not regulate Estate Planning and we do not give specific advise on property planning