< Life insurance

How does life insurance work?

From how much it costs to who gets the money if you die during the policy term, here’s a simple guide to life insurance.

You’ve probably been told you should have life insurance, but do you know how it works? You might know the basics – that it’s insurance in case you die – but there’s more to it than that. What happens if you die doing something risky, like bungee jumping? Will your ex-wife still get the payout if you’re re-married? The point is, there are a lot of questions to ask, whether you’re considering buying your first policy or if you’ve had one for years.

What is life insurance?

Life insurance is cover that pays out a lump sum if you, the policyholder, pass away during the policy term – or if you’re diagnosed with a terminal illness and not expected to live longer than 12 months. It’s there to provide some financial support for your loved ones after you’re gone, whether that means helping to pay off the mortgage or maintaining their standard of living. 

There are three different types of term life insurance: level cover, increasing cover, and decreasing cover. These impact how your cover amount may change over the term of the policy, and therefore how much the cover may cost, and are designed for people with different financial needs. For example, if you’re interested in paying off a mortgage if you die during the policy term, you might opt for decreasing cover: this type of life insurance policy goes down in value over the length of the term, but the premiums remain the same. This is because generally, a mortgage decreases over time as well. That’s why this type of life insurance is also sometimes known as mortgage protection insurance

How much does life insurance cost?

In addition to the type of policy you choose, there are several factors that can influence the cost of your premiums. The price an individual pays usually depends on factors including:

  • Age – Generally, the older you are, the more expensive a policy will be. This is because with age comes an increased risk of developing a medical condition that may affect your life expectancy
  • Lifestyle – Leading an unhealthy lifestyle can increase premiums. For example, drinking too much alcohol or being overweight can shorten life expectancy. Premiums will be typically higher to reflect this
  • Health – Having a pre-existing medical condition can affect the price you pay. Some more serious, chronic medical conditions mean that premiums will be typically higher
  • Family medical history – Insurers may ask if your parents or siblings have a history of a serious medical condition. For some people this may impact your price, as there can be a greater risk of you suffering from the same condition
  • Occupation – If you have a dangerous job, it’s possible that you will have to pay more than someone who works in a lower risk profession - for example, someone who is an office administrator
  • Smoker status - A smoker can expect to pay more for life insurance cover than a non-smoker, because of the health risks associated with smoking. This includes all nicotine replacement products, including vaping
  • Length of cover: Life insurance policies with longer terms can be more expensive than policies with a shorter term
  • Amount of cover: You decide how much you would like to be covered for - generally, the higher this is, the higher the premiums will be

It doesn’t matter if you aren’t a kale-eating marathon runner with a parent or sibling with a medical condition, or if you work in a more dangerous job – or even if you smoke. It just might cost you a little more in premiums. Whether you get cover, and what you’ll pay, is down to your personal circumstances – so it will be different for everyone.

It’s important that you answer any questions your insurer asks you accurately and honestly when applying, because if you don’t, it could have a devastating impact on your loved ones - it can affect whether your insurer is able to pay out a claim on the policy in full.

What does my life insurance cover?

Life insurance is designed to help your family cope financially when you pass away. It won’t pay out if you suffer an illness or disability and are unable to work and provide for your loved ones – if that’s the product you’re looking for, you could consider critical illness cover. What your life insurance will and won’t cover depends on which insurance company you’re with, so check your policy documents, but the basic principles are the same.

But yes, if you die in a bungee jumping accident, we’ll still pay out – no guarantees your left-behind loved ones will ever forgive you, though.

Can I choose who the money goes to when I pass away?

Generally, the answer is yes – but you’ll need to make sure the right arrangements are in place. 

If you have a joint life insurance policy, when you pass away, the money will usually go to the surviving policyholder – that is, the other person you had the policy with – unless you made other arrangements. 

If you have a single life insurance policy, the money will be paid into your estate. Here’s where it’s really important that you make your wishes known. 

If you want to choose a beneficiary (the person who will benefit from the lump sum payout from your life insurance policy) you could consider placing it into a Trust. Here are the potential benefits of doing this:

  • As the policy is being placed in a Trust, it won’t be counted as part of your taxable estate when you pass away. This means the any money passed on to your beneficiaries is usually exempt from Inheritance Tax 1
  • The money can reach your beneficiaries more quickly if you appoint additional trustees who then deal with this after you pass away

You can also make it clear who you’d like to receive the money from your life insurance policy when writing a will - however, this may not be as tax efficient as placing it into Trust.

It's a good idea to seek independent legal and financial advice when thinking about placing a life insurance policy into Trust or writing a will.

Do I need life insurance?

Whether you need life insurance depends on your personal circumstances. Think about whether there are any people who depend on you financially, like a partner or children. If so, life insurance is a way you can help give them a financial safety net if you’re no longer around to provide for them anymore. Payouts from life insurance can be used to help pay off mortgages, cover the costs of raising children, and cover monthly bills. If you haven’t made any provisions for your loved ones in case you were to pass away, you might want to consider life insurance. 

Looking for life insurance?

Visit our Life Insurance page to see full details of the cover we offer.

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