How much life insurance do I need?
In my previous job I had a generous death in service scheme with life insurance provided for me. Unfortunately my new job doesn't have such a scheme so I am very conscious of the fact that I do not have any life insurance in place, especially as I have a wife and children. I've started looking around but wondered how much life insurance do I need? Is it just to cover the mortgage or do I need more than that? Any insights would be greatly appreciated.
Well, the truth is that it’s one of those ‘how long is a piece of string?’ questions. How much life insurance you need depends largely on your financial circumstances but also, in part, on your own view of what is adequate. Also there are a number of different types of life insurance policies to suit specific needs, be it a requirement for a lump sum payment on death or a regular income stream.
There can be a number of reasons why people require life assurance but generally most of these fall into one of the following categories:
- To clear a mortgage, or other debts or pay funeral expenses
- To pay a potential Inheritance Tax (IHT) bill payable on your estate, so ensuring that your dependents receive more of your assets
- To provide an income or capital sum for your dependents in the event of your death
To keep things simple I’m only going to look at the above scenarios. Obviously I don't know your full financial circumstances but a good starting point is to make sure your mortgage is paid off in the event of your death. That way your wife and children won't face losing the roof over their heads.
Let's assume you had a £250,000 mortgage with 20 years left to run. If it is an interest-only mortgage then a simple level term assurance policy with a term of 20 years is required. With this type of policy the level of life insurance cover stays at £250,000 during the policy term, to match the fact that your mortgage remains at £250,000 as you are only paying the interest on it. So if you died at any point in the next 20 years your mortgage would be cleared.
However, if the mortgage is a repayment mortgage then you might want to consider a decreasing term assurance policy (another term for a decreasing life insurance policy). With this type of policy the sum assured reduces as time goes by at a pre-agreed rate. The idea is that as you repay your mortgage and the outstanding balance falls then the level of life cover required to clear it also falls. A decreasing term assurance policy can be put in place so the amount of life cover falls alongside your outstanding mortgage balance. That way you are not paying for life insurance you don't need. For example after 15 years you don't need £250,000 of life cover to clear your mortgage.
Because of this tapering effect, decreasing term assurance policies are cheaper than level term assurance policies.
But now think about what other financial commitments or requirements are needed after you have passed away.
- Do you also have large debts outstanding? Debts are payable from your estate when you die which may mean that your dependents will inherit less than you might have wanted them to.
- Will you have a large inheritance tax bill? If you plan on leaving your estate to someone other than a spouse then if you have a large estate (over £325,000) any assets passed on over this amount are liable for 40% inheritance tax (IHT). A life insurance policy can be used to offset a potential IHT bill.
- Income requirements - will your family be able to support themselves once you are gone? An additional level life insurance policy could provide a lump sum to help them, or alternatively think about a Family Income Benefit plan, which provides a tax-free income stream in the event of your death.
Other points to consider
- Don’t forget to consider the impact of your spouse dying. Could you cope financially on your own? You may want to consider taking out a joint life insurance policy so that your mortgage is cleared should the worst happen to either of you. Alternatively taking out a policy each, with the same insurer is often a cost-effective way to double your cover and provide more financial protection for the children
- Consider placing any life insurance policies under trust.
- Think about whether you need income protection. If you are young, statistically you are much more likely to have an illness or an accident which prevents you from working rather than dying. Consider taking out an income protection insurance policy.
As you can see there is a lot to consider so I strongly suggest you speak to a specialist protection adviser who can compare policies across the market but also recommend the most suitable protection solution to meet your needs. I've personally vetted their service (which is completely free) and they provide help with everything from getting the initial quote to chasing the insurance company on your behalf. There is no obligation to take things further, however, they will pay you £50 cashback if you take out a policy with them.
I hope that helps,