The decision to take out life insurance is often triggered by a life event such as taking out a mortgage on a property or starting a family.
People often turn to life insurance because their mortgage is one of their largest financial commitments, and many worry about what would happen to their debt, family and home if they passed away before they could pay off the loan.
In this article we will discuss the different types of life insurance available to you, and explain how we determine which is most suitable.
The basics
Life insurance will pay out a tax-free lump sum to your family or your beneficiaries if you pass away during the term of your policy.
The monthly premium for your life cover (the cost) will depend on several factors. Some of the factors that can impact the monthly premium are:
- Your personal profile – your age, your occupation, your general health
- How much life cover you need – also known as the ‘sum assured’ – this could be based on how much your mortgage is, or how much you want to leave behind to your family if you pass away
- How long you need the life cover for – also known as the ‘policy term’ – this could be based on your mortgage term, or how many years left until your youngest child becomes financially independent
- Whether you need a decreasing term policy or a level term policy – the type of cover you need is likely to be heavily influenced by what you need the life cover for
You may not know what the right amount of cover is for you, or how many years you will need the policy for which is why it is so important for you to speak to an adviser if you are considering taking out a life insurance.
Our clients often do not know the difference between a decreasing term policy and a level term policy either, which is what we will explore next.
Decreasing term life insurance
This type of life insurance can be used to pay off a capital repayment mortgage if the policyholder passes away during the term of the policy.
The policy term and sum assured are usually aligned with that of the mortgage, and the sum assured decreases in line with said mortgage to ensure the outstanding balance can be cleared in the event of death. There is usually no surplus left once the mortgage is cleared.
Because the amount that you are covered for reduces over time, this type of cover tends to be the most cost-effective option as the monthly premium you are offered is discounted to reflect the diminishing pay-out.
Whilst a decreasing term life insurance can be a good option to cover a capital repayment mortgage, a level term policy may be more suitable if you have children who depend on you financially or you have an interest only mortgage.
Level term life insurance
This type of life insurance does not decrease over the term of the policy, instead the sum assured remains fixed for the entirety of the term.
Level term life insurance can still be used to cover mortgage debt, and it is best suited to an interest-only mortgage, as the balance is not reducing over the term.
That being said, even if you have a capital repayment mortgage, you may still wish to arrange your life cover on a level term basis.
This might be because you see more value in a level term policy, it might be because you want to be in control of exactly how much gets paid out to your estate in the event of your death, or perhaps you want to arrange a level term policy as part of your wider protection planning.
Another fundamental reason for you to arrange a level term policy would be if you wished to leave a lump sum behind to your children/spouse/beneficiaries.
If your motivation for life insurance is to provide your spouse with funds to help raise your children, or provide your children with an inheritance, or even just to provide your estate with enough funds to pay for things like your funeral, then a level term policy would likely be recommended.
Because the sum assured does not reduce over time, this cover tends to cost more on a monthly basis when compared to a decreasing term policy.
How do they work together?
It is often best practice to take out multiple policies if you need cover for different purposes. For example, a decreasing term policy to cover your repayment mortgage on the family home and also a level term policy to provide additional funds for future family living costs or inheritance.
You may also receive a small discount in your monthly premium if you arrange both policies under one plan with the same provider.
What should you do?
If you are thinking about arranging life insurance, it is important to get the right advice involving what type of life cover is most suited based on your circumstances. Feel free to contact me on my mobile 07875 80 1229 or you can email me on Chelsea.Warren@alexanderhall.co.uk to discuss any of the points raised or visit the Alexander Hall website.
Chelsea Warren is protection adviser at Alexander Hall
