Working out how much life insurance you need is 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.
What do you need life insurance for?
There can be a number of reasons why people require life cover but generally most of these fall into one of the following categories:
- To clear a mortgage or other debts
- 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 to live on in the event of your death
To keep things simple I’m only going to look at the above scenarios. A good starting point is to make sure your mortgage is paid off in the event of your death. That way your partner and dependents won't face losing the roof over their heads.
How much mortgage life insurance do I need?
To begin, you’ll need to know your outstanding mortgage balance, how many years are left until it is repaid and whether you’re paying interest only or capital and repayment when you make your monthly payments.
Let's assume you have 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 life insurance 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, the insurance provider would pay out £250,000 and the mortgage could 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 and the level of life cover required to clear it also falls. That way you are not paying for life insurance you don't need.
Because of this tapering effect, decreasing term assurance policies are cheaper than level term assurance policies.
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How much life cover do I need to cover my family, debts or inheritance tax?
Now think about what other financial protection may be needed for the people you leave behind and what commitments will need to be met when you pass away.
Will your family need financial support?
Will your family be able to support themselves once you are gone? If you are an earner, there will be an immediate loss of your earnings to consider. If you are a carer, your family may have to consider whether they will have to pay someone to replace the care you provide or change their commitments to support the family which may result in a further loss of income.
Consider the following:
- Will they need a regular amount of money to live on?
If yes, they will probably benefit from a Family income benefit life insurance policy. The amount of cover should reflect how much money will be needed each month to keep the household going until your dependents are self-sufficient.
Or, you can multiply up all the money that will be needed over the period of time that others depend on you and buy a Level term life insurance for this amount.
However, the family income benefit is usually cheaper as the amount it has to pay out reduces with each year that you live because that’s another year they didn’t need the life insurance.
- Will they need funding for one-off events such as weddings, further education or anything else that you may be saving towards funding in the future?
A lump sum level term assurance that covers you until you retire could be helpful so that if you die during your working life, your financial aspirations for your family are still met.
Do you have outstanding debts?
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. You can include the amount of money that would be needed to settle your debts into your life insurance but be careful that you're not covering them for longer than it will take to pay them off. Some life insurance policies will allow you to reduce the amount of cover without having to change it but you should check this.
Will you have a large inheritance tax bill?
If you plan on leaving your estate to someone other than a spouse and the value exceeds the inheritance tax threshold of £325,000, any assets passed on over this amount are liable for 40% inheritance tax (IHT).
A life insurance policy can be used to fund a potential IHT bill but it will have to be set up in a Trust so that it doesn’t end up inflating your estate for inheritance tax instead of helping with the bill. The type of life insurance that is usually appropriate is a Whole of life insurance policy but you should get guidance on buying this type of insurance and setting up the trust. We share how to do this later in the article.
How much life insurance will your partner need?
Don’t forget to consider the impact of your partner dying. Could you cope financially on your own?
You may want to consider buying a joint life insurance policy so that your mortgage is cleared should the worst happen to either of you.
Alternatively buying a life insurance policy individually is often a cost-effective way to double your life cover for almost the same monthly premiums as a joint life insurance policy which will only pay out once. This will provide more financial protection for children or other dependents.
What else do you need to consider for your life insurance?
- Consider placing any life insurance policies under trust. It will ensure the money goes where you want it to and avoid any inheritance tax being applied.
- Think about whether you need income protection. If you are of working age, 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.
How to get help to buy your life insurance
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 and life insurance premiums across the market. They will also recommend the most suitable protection solution to meet your personal circumstances as there's no such thing as average life insurance or an average cost of life insurance – it should give you peace of mind and work for your personal budget.
The specialist life insurance adviser will also be able to guide you to the best life insurance policies and companies if you have health issues; do a risky job or if your lifestyle will affect the cost of life cover. Not all insurance companies treat these aspects of your application the same way and the advisers have knowledge of which insurance companies to apply to in order that you minimise your life insurance costs.
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 up to £100 cashback if you take out a policy with them.
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