How much life insurance do you need?

In this article I will help you work out how much life insurance you need, what it will cost, where is best to buy it and how to get up to £100 cashback*.

Quickly calculate how much life insurance you need

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. 

Why do you need life insurance?

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 provide an income or capital sum for your dependents in the event of your death
• To pay a potential Inheritance Tax (IHT) bill payable on your estate, so ensuring that your dependents receive more of your assets

So I’m only going to look at the above scenarios while assuming that in each instance the need is to be met by the receipt of a tax-free cash lump sum. That means I’m going to consider term life insurance policies here, which pay out a tax-free cash lump sum in the event of death, within a given period of time – called the term. Term life insurance is the most common type of life insurance that is usually bought by those who want their life insurance to pay out in case they die while they have financial responsibilities. Term assurance contracts are used to cover most people’s post-death requirements in a versatile way. Term assurance contracts do not have an investment element to them as they are pure protection contracts.

So going back to the original question – how much life insurance do you need? Well, a good starting point is to look at the financial requirements immediately after you die. So let’s crunch some numbers. 

Life insurance calculator

STEP 1 - Mortgage

Write down the amount of your mortgage that is outstanding.

• I’ll use the figure of £250,000 as an example.

STEP 2 – Other debts

Write down any additional debts you may have.

• I’ll assume the figure of £20,000

STEP 3 – Inheritance tax bill (IHT)

Now calculate your rough inheritance tax (IHT) bill in the event of your death. If you are young and have a relatively modest estate (i.e. the total sum of your assets) you can skip this step.

Take the value of your worldly assets which you plan to pass on to your beneficiaries. Now deduct any IHT exemptions (i.e. you don’t pay any IHT on money left to a spouse) and your IHT allowance of £325,000 (for the tax year 2024/25).

Take 40% of this figure and you have a rough estimate of the likely IHT bill upon your death.

So let’s assume you have an estate of £1,000,000 (ignoring your house which is jointly owned with your spouse – as they will assume full ownership) and you are leaving half of the estate to your spouse and half to children or your friends and relatives.

• Then £1,000,000 - £500,000 (left to your spouse) - £325,000 (your unused IHT allowance) = £175,000 is liable to IHT. Now take 40% of this figure which gives you £70,000.

To find out more about inheritance tax, read our article 'Inheritance tax explained'.

STEP 4 – Dependents’ income shortfall

Now you need to work out the income requirements of your dependents – over and above their own earnings plus any income their inheritance will provide. I’ll assume your partner will need an additional £50,000 a year tax-free (ignoring inflation) for 10 years after you die.

I'm going to use the cumulative lump sum of £500,000 for this example but you can buy life insurance that is designed to pay an income and can cost less. You can read more about it in our article, "What is family income benefit life insurance and should I get it?"

• So we'll use the lump sum of £500,000 when you die.

STEP 5  - Existing policies

Note down details of any life insurance policies you already have, including those offered by your employer if applicable.

• I’ll assume a death-in-service sum assured of £200,000

Solution

Now carry out the following calculation.

Step 1 + Step 2 + Step 3 + Step 4 – Step 5

In my example that equals £250,000 + £20,000 +£70,000 + £500,000 - £200,000 = £640,000.

So this is the figure that you would need to insure in order to meet all of the above requirements if you were to die today. So you would be underinsured by this amount.

The most important step of all

If you've worked out that you are underinsured the most important thing to do for your family's sake is to take action. But most people don't realise how cheap life insurance is. For example, a healthy 30-year-old man could get £100,000 for around £5 a month!

After researching the market, the best way to place to buy life insurance is through our recommended life insurance specialist*. I've personally vetted their service, having used them to buy life insurance to protect my own family and I am confident that their knowledge and expertise will help you choose the best life insurance policy and level of cover for you. They are fully independent, which means that they compare life insurance policies from every major insurance company and if you take out a policy with them you will qualify for up to £100 cashback. So if you are underinsured then find out how little it costs to put it right - it will only take a few minutes.

How to reduce the cost of your life insurance needs

To insure yourself for the figure needed at the date of death you don't have to buy just one term assurance policy with a sum assured of £640,000 (using the figures from the above example). This would be the most expensive way of insuring yourself, albeit it would be the simplest.

Multiple life insurance policies can cost less than one life insurance policy

Looking at the above example the needs are varied and each will change differently over time. If you choose one life insurance policy that will cover you for all of your needs and pay out the same amount regardless of when you die, you may find that as time goes on, you have more life cover than you need.

This is because your dependents will usually become less financially reliant on you as they grow older and as you get closer to retirement age. If your mortgage is on a repayment basis then the amount needed to repay it will also reduce over time.

The answer would be to take out a number of term life insurance policies that cover each need specifically so that you are not over-insured as time goes by.

Also, a Decreasing term life insurance contract could be taken out with an initial sum assured of £250,000 and a term matching that of your mortgage. This will be cheaper than a level term life insurance.

A Family Income Benefit plan could be taken out to satisfy your dependents’ income requirements which, again, will cheaper than a level term life insurance policy. It also has the advantage of providing your dependents with a manageable sum of money for living costs.

This would save you money and has the additional benefit that each policy can be assigned or placed in trust for different people.

Also 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.

This may sound a bit complicated but the good news is that you can speak to an independent life insurance specialist* who will be able to help you with every aspect of this and tailor each policy to ensure it meets your exact needs. They will even help you complete the application forms, chase the insurance company and they will be there for you and your family if you ever need to make a claim.

 

If a link has an * beside it this means that it is an affiliated link. If you go via the link, Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. The following links can be used if you do not wish to help Money to the Masses and do not wish to qualify for any cashback referred to in the article - LifeSearch