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Life insurance and protection: A primer (or why you should buy renewable term life cover, most of the time)

Photo of Mark Meldon, IFA

This guest post is by Mark Meldon, an independent financial advisor (and Monevator reader) who we’ve noticed talking a lot of sense over the years.

There remains a great deal of confusion about life insurance, so I thought I’d put together a guide to what life insurance is, who should consider purchasing it, the kinds of policies that are useful in the real world, how such policies are best purchased and set up, and when to review any cover you might have in place.

Too many people:

  • Have no life insurance when they should.
  • Have life insurance when they don’t need it.
  • Have the wrong kinds of policy and likely pay too much in premiums.
  • Have too much life insurance and waste money on unnecessary premiums.
  • Haven’t set policies up correctly.

It’s not actually terribly difficult to get matters right when considering life insurance, especially if you hire a suitably experienced independent financial adviser (IFA), or one of the on-line brokers like Lifesearch with whom I have no connection whatsoever, but who have an excellent reputation.

By using a combination of commonly available policies, you can minimise your costs and maintain flexibility and important long-term guarantees.

I believe:

  • You should buy the right kinds of insurance.
  • You should not waste money on insurance you don’t need.
  • You should take a responsible view on this matter and get on with it if there is a demonstrable need for insurance.
  • You should set up everything in the correct way and then file your papers in your bottom drawer, just taking a peek every now and again.
  • You should do your best to avoid making a claim by maintaining your health and keeping active.

Let’s get back to basics and have a think about this fascinating subject.

(Well, it’s fascinating to me, anyway.)

Life insurance and protection

Families purchase life insurance for protection; that is, they buy financial protection for themselves if the breadwinner – who brings in most or all of the household income – dies before the children have grown up.

Some families also buy financial protection for the years that follow the breadwinner’s retirement.

Even in the 21st century I find the father is usually the main breadwinner in most families, and so most of the life insurance purchased by a family is on the father. Of course, more and more families have two breadwinners, and the loss of income of either one could seriously affect the family’s financial security. Families with two breadwinners, therefore, may need to consider insuring both individuals.

Life insurance is based on the law of large numbers. Many families share the common risk of losing the breadwinner, and pay a small amount of money (called a premium) each year. In the event of the insured life dying during that year, the dependents/beneficiaries receive a much larger amount of money than the annual premiums that were paid.

A life insurance company uses mortality tables to calculate the risk of the insured dying during that year, collects premiums from all the persons sharing the risk, and handles the payment of the sum assured.

The type of financial protection a family needs varies with family income, resources, goals, composition, and stage in the family life cycle.

Used unwisely, life insurance can be an excessive drain on family finances and, indirectly, on family happiness and satisfaction.

Incidentally, many employers set up group life insurance schemes for their employees. This usually costs the members nothing and can be very helpful should disaster strike. I have a group life insurance plan for my small firm and the cost (tax deductible) is very modest. Do check if such a plan is available to you.

Types and uses of life insurance policies

Today, life insurance can be purchased in three basic types – term, whole of life, and endowment. The latter is quite rarely arranged nowadays, but I still come across policies of the so-called low-cost variety which were often arranged alongside interest-only mortgages up until 15 years or so ago.

There are many different names for policies, such as family income benefit, mortgage protection, gift inter-vivos, ‘flexible life’, and so on. They are all just combinations or variations of the three basic types of policy mentioned above.

Term

A term insurance policy protects the policyholder’s beneficiaries so long as the policyholder dies within the ‘term’, or period of time, specified in the policy.

Protection expires at the end of this period unless the policyholder has purchased a renewable policy; an option that allows him or her to renew the cover, regardless of any changes in health or occupation, until the age specified in the policy.

The premium for renewable term insurance rises at the beginning of each new term, or as death becomes more probable.

For the amount of protection it gives, term insurance is less expensive than any other type of protection up to about age 55. Most term policies can be renewed only up to age 65. A few can be renewed up to around age 100, but the premium for a term policy past age 65 will be extremely high.

Term insurance policies are seldom taken out past 65 because most families no longer need to protect against the loss of the breadwinner’s income. By this time, they may have pension or retirement benefits adequate to cover living expenses for the surviving spouse.

Term insurance is especially useful to young families that have only a small amount of money to budget for insurance but that need a large amount of protection.

In my experience, when money is tight, insurance can be forgotten. That’s potentially disastrous. If you choose ‘five-year renewable term insurance’, for example, a lot of protection can be arranged for a small outlay.

Longer-term policies cost more, and I’m not convinced that they are the best option for most families.

Decreasing term – often called mortgage protection – is a form of term insurance that is bought for a specific purpose. This policy insures the life of the mortgagor(s) for the amount of the mortgage at the time of the mortgagor(s) death. If the breadwinner(s) dies, the home will be paid for in full. The premium for decreasing term insurance is fixed, and the amount of cover decreases over time.

Always arrange life insurance to pay off a mortgage on your family home! (It’s maybe different for ‘buy-to-let’ mortgages where you might decide not to insure your life, preferring the property to be sold instead.)

There are other advantageous uses for term insurance. For example, a family that depends on current income to keep a child in school, college, or university can take out insurance on the breadwinner’s life for the amount needed to complete the child’s education. Commercial debt and leases can also be covered by life insurance, something many prudent businesses do as a matter of course.

Term insurance is often called ‘pure’ insurance because it does not include a savings element. That is, it provides for no cash build-up, as does, for example, endowment assurance.

A convertible clause gives the policyholder the right to convert a term insurance plan to whole life or some other permanent plan, and sometimes families take this option when they can pay higher premiums.

But this is anachronistic in today’s world of Individual Savings Accounts (ISAs) and pensions. There are nearly always better options for savings than life insurance!

Whole of life

Generally speaking, a whole of life policy furnishes the maximum amount of permanent death protection at the lowest annual premium.

Provided that all premiums due are paid, whole life policies will pay out whenever death occurs, hence their name. They are sometimes known as permanent policies.

Whole of life provides death protection throughout life, with premiums payable continuously until the policyholder dies.

Such policies used to contain a savings element, but this type ceased to be available some years ago. Whole life policies available today are pure insurance, akin to term insurance with no term.

Today, whole life policies are mainly used for specialist applications, such as inheritance tax mitigation planning and for those with long-term dependency issues.

Whole of life is much more expensive to purchase and, generally, of limited use for those wishing to insure the family breadwinner(s).

Endowment

The endowment policy is like a savings fund protected by term insurance. It offers insurance protection against death for a specified period of time. The policyholder decides that he or she wants to build up a certain amount of money by the end of a given number of years.

In a sense, the insurance company establishes a savings fund to which the policyholder contributes regularly and on which interest is compounded, usually annually.

If the policyholder lives to the end of the period, he or she will have accumulated – and can obtain – the face value of the policy.

What is face value? Let’s say a £50 per month endowment has a ‘sum assured’ of £25,000. The latter is the face value. If you pay all the premiums to the end of the agreed term, or die during it, the face value – here £25,000 – will be paid. (Perhaps more, if investment-linked or with profits.)

If the policyholder dies before the end of that period, the beneficiary will again receive the face value of the policy.

The limitations of the endowment policy arise from its incorrect use. The prospect of having a large sum of cash at the end of a relatively short period of time once led many families to purchase this plan, when their real need was for premature death protection.

Mainstream life offices withdrew endowments from the market some years ago – mainly due to the mortgage endowment scandal. Restrictions were placed on premium limits (£3,600 per annum) more recently.

The policies are still available from a handful of Friendly Societies who offer what they call ‘tax-exempt savings plans’ with premiums of £25 per month, such as Healthy Investment and Sheffield Mutual.

I believe endowments are an anachronism, and best avoided.

Special policy features

Regardless of the type of policy or policies your family decides to buy, it is important that you keep your plan flexible. To help keep it flexible, you can add special clauses, what I like to call ‘riders’ in the American fashion, to your policy.

Two of these clauses – the renewable and convertible clauses available with term insurance – were mentioned above.

Two additional clauses – which will add to the cost, but which may help you keep your plan flexible – are the disability clause and the guaranteed insurability clause.

The disability waiver clause allows for a waiver of premiums if the policyholder becomes permanently disabled or unable to work through ill-health. This is very useful as it means cover can be maintained should illness strike.

The guaranteed insurability clause (often provided free of any explicit charge) guarantees the policyholder the right to purchase stated amounts of additional insurance at specified times – such as the birth of a child or increasing a mortgage – in the future without providing any heath information. Often forgotten about, this clause can be helpful to those whose health has deteriorated.

Payment of premiums

The premium is the amount of money you pay to keep your policy in force.

The annual premium is almost always less when paid once a year and paying twice or four times a year usually costs less than paying once a month.

However the vast majority of premiums are paid monthly nowadays – as most people never consider the other payment frequencies – by direct debit mandate.

Life insurance needs across the Life Cycle

Life insurance needs of families change as different family members grow older. The amount of protection needed will also vary with the number of members in the family, the current and anticipated income of the family, the earning potential of the family members, other financial resources, and the goals of the various family members.

The single person

In general a single person needn’t bother with life insurance. They may purchase it if they choose to leave any other financial assets, such as their house, to someone else and they don’t want the tab for what are euphemistically called final expenses (funeral and legal bills) to be left to a family member or friends

Sometimes a young single person will be encouraged to buy insurance early in order to get lower premiums.

It is generally true that, the younger the insured, the lower the premiums for a given type of insurance. The younger the person, the lower the risk of death.

However the individual may be paying for protection that he or she does not need, just to get lower premiums throughout life. That’s a waste of money in the majority of circumstances.

Single persons may also want to take out insurance against their own death if they have dependent aged parents. This need for protection could apply during any stage of the life cycle.

Establishment of the family stage (no children)

The insurance needs of a newly settled couple (married or otherwise) with no dependents are likely to be the same as for the single person.

The businessman/woman, the professional person, or the farmer who borrows money to become established – for example, to purchase equipment, supplies or livestock – should cover loans with insurance to protect his or her spouse/partner as well as his or her creditors. Term insurance should be considered to fill these needs.

Decreasing term insurance should be arranged to cover mortgages and something like family income benefit could be considered to protect rent payments.

In this stage of the family life cycle, the couple should try to save for the future. Often both of the couple are working. Building up cash reserves and establishing longer-term investments using tax-efficient things like ISAs and pensions should be a priority, especially if the plan is to have children in due course.

The arrival of children

Without wishing to be accused of gender bias, even today it remains true in my experience that while the children are very young, the death of the father is usually the greatest hazard faced by the family.

Of course if the father is a ‘house husband’ while the mother works, the gender roles and risks I describe here and below are switched.

Though a young mother may be working or may be able to provide income for the family if the father dies, it is more difficult for her to leave home during the preschool and first school stages than at any other time during the family life cycle.

Even if she was working before the death of the father, her income will not be sufficient for the family to maintain the same level of living it did on two incomes. And if she was not working but now goes to work, her income may not be sufficient to maintain the standard of living it had with the husband’s or partner’s income.

Therefore, young families usually need a great deal of income protection from life insurance. At the same time, they typically have relatively little spare cash to provide this protection.

If your family fits into the early life cycle staged, here are some suggestions for getting the major protection you need with minimum expenditures.

What protection should you buy? The most important insurance need for most families is to insure the life of the sole or principal earner. Take care of this need before you buy insurance for any other family member.

The next important consideration, as ghastly as it sounds, should be burial expenses for the mother. If these expenses cannot be met out of current income or savings, consider buying a small whole life policy for, say, £10,000 to cover such ‘final expenses’.

If the mother works, your family might want to consider insuring against the loss of her income as well as against her death. Your family should also consider whether it would be able to meet the cost of caring for the children out of current income if the mother were to die. If you feel you would have difficulty meeting this cost, consider taking out a decreasing term insurance or family income benefit policy on her life. The family’s income needs for child care will decrease as the children mature.

Look ahead to the protection you will want for the possible widow(er) between the time the last child reaches 18 and the time when the widow(er) is eligible for a pension or other retirement benefits. The amount needed will depend on the ability of the non-breadwinner to support him or herself during this period.

What forms or types to buy? To keep the cost of your insurance at a minimum, buy term insurance with a renewable clause. Renewable term insurance should serve your family quite well during this period, particularly if the need for income protection is quite large in relation to what you can pay. If you qualify for group life insurance at work, be sure to join the scheme at the earliest opportunity.

Five-year renewable term price comparison
£250,000 lump-sum cover for a male accountant, non-smoker, born 12/01/1986

Insurer Monthly premium
Royal London £10.87
Zurich £11.35
Aviva £12.42

Source: Source: iress/The Exchange 12 June 2018.

Sixth Form/College and university stages

The years when the children are in sixth form or college or off at university are a good time to re-examine your family’s needs for life insurance. Since the children will not be dependent for many more years, you may want to change the kind or amount of protection you are carrying.

By the time the children are in sixth form or college, the former primary caregiver will probably be back working outside the house. He or she may be in a better position to provide income for the family if the main breadwinner should die unexpectedly.

Any family’s life insurance programme should be re-examined whenever there is an employment change in order to keep the family’s economic security programme up to date.

Recovery stage

The recovery stage of the family life cycle is characterised by the financial independence of the children. The non-main breadwinner is usually the only dependent during this stage, and he or she is probably in the work force, too. If not, be sure that he or she is provided for in the period between the possible death of their partner and the time that he or she is eligible for pension or other retirement benefits.

Your family should make a special effort to build up savings for retirement during the recovery period. Put aside regular amounts for saving.

Retirement stage

When you reach retirement, your family’s need for life insurance is usually much less than in former stages, especially if the couple are nearly the same age.

The widow or widower may be eligible for limited state benefits or other retirement benefits if his or her spouse or partner were to die. He or she may also have money from an ISA or pension plan, or some other form of retirement savings.

During this period, some families purchase annuities. Annuities are the opposite of life insurance – they are used to insure against dying too late and thus outliving your savings.

One time life insurance might be used in the retirement stage is to help set up a fund to help pay for any inheritance tax on the estate. This is a specialist area requiring detailed advice.

Setting up life insurance and using trusts

Apart from the application process – which an IFA can certainly help with – you need to consider the way in which you arrange your life insurance policies.

In most cases, you buy a life insurance policy for someone else: your spouse, partner, children or creditor. It’s best to ensure this plan comes to fruition by arranging the policy correctly.

Sometimes, a life of another policy is arranged. A good example is a wife owning a policy written on her husband’s life. But this is less common nowadays as trusts have become easier to arrange thanks to on-line functionality and simplified documentation.

Simply put, placing a policy into a suitable trust means that the life insured (the ‘settlor’) fills in a form appointing trustees (often a spouse or partner) who would control the sum insured should he or she die whilst the policy is in force. The trustees then deal with the money, following the wide range of potential beneficiaries set out on the trust form. (Most trust forms have a box for specified beneficiaries.)

The big advantage here is that the life insurance payout is not part of the deceased’s estate and won’t be counted as part of his or her estate for inheritance tax purposes. The trustees can usually obtain payment quickly, too, and not wait for the estate to be dealt with in the usual legal way.

Most life insurers offer very good trust forms, which are free to use. It’s unusual to find a situation where a trust shouldn’t be used but, again, an IFA will be able to help.

The bottom line on life insurance.

  • Buy life insurance if someone relies on your income to maintain their lifestyle; protect your dependants.
  • Buy life insurance to pay off loans, such as mortgages and car finance should you die.
  • Don’t buy life insurance if the financial consequences of your untimely demise is zero!
  • Consider renewable term life insurance.
  • Consider, too, ‘family income benefit’ if you think your dependant(s) would find it hard to deal with investing a big lump sum to produce an income; ideally, a combination of these two life insurance types should be arranged.
  • Buy on-line or hire an IFA to help you through this process, as you feel best.
  • Set the policy up correctly; consider using a trust form.
  • Review your life insurance needs periodically. Things change!

Mark Meldon is an Independent Financial Advisor based in Cheddar, Somerset. You can find out more at his company website. You can also read his other articles on Monevator. Let us know in the comments if there’s a topic you’d like Mark to cover.

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{ 48 comments… add one }
  • 1 Dartmouth June 13, 2018, 10:31 am

    A very enjoyable read, thank you! Any recommendations for a soon to become expat in terms of finding appropriate life cover before setting off?

  • 2 Factor June 13, 2018, 12:02 pm

    Error alert – “by THE INVESTOR” at the head of the article.

  • 3 The Investor June 13, 2018, 12:31 pm

    @Factor — Thanks! 🙂 Fixed. I was sure I caught it this time! Maybe I missed a ‘save’ somewhere.

  • 4 YoungFiGuy June 13, 2018, 12:57 pm

    Fantastic article as ever Mark. Greatly appreciated!

  • 5 John B June 13, 2018, 3:08 pm

    My elderly mother has a series of bonds that have a life assurance element, from Prudential, Family Assurance/One Family etc. A typical one had £400 invested in the 1980s, and is currently worth £15k, apparently invested in some equity fund.

    Am I right in presumes they are just investment vehicles, and will be paid out at current valuation when she dies. Will they be part of her estate for IHT purposes?

  • 6 Mark Meldon June 13, 2018, 4:13 pm

    @John B.
    These sound very like ‘single premium bonds’, a kind of lump-sum investment allowed and set up under life insurance legislation. Nowadays, they are be suited to higher-rate taxpayers, after other investment ‘wrappers’ like pensions and ISAs have been used up. Without going into too much detail, they will form part of your Mum’s estate on death (unless they are in trust, which I doubt) and will then be subject to ‘chargeable event’ rules (as death is a ‘chargeable event’). In brief, there might be a taxable gain, but this seems unlikely bearing in mind the size of the bond(s) and the number of years held (as there is a kind of tax credit given for each year they have been around).

    Unless something complicated is going on, it might be easier to consider cashing-in the bonds in order to hold the money in capital secure things like good old Premium Bonds, but you should take appropriate advice from the provider(s) or an IFA.

  • 7 Matthew June 13, 2018, 4:14 pm

    Side note I think topcashback and quid co usually give something for buying insurance through them

  • 8 Mark Meldon June 13, 2018, 4:22 pm

    @ Dartmouth,
    This is a specialist area – your employer (if you have one, that is!) might have a benefits provider which can help.

  • 9 Mark Meldon June 13, 2018, 4:46 pm

    @ Matthew

    Ah, but you are paying for that through the premiums! That’s why ‘discount brokers’ prefer long-term policies (and they certainly have a role).

    Here is why.

    Most IFA’s still take commission for arranging life insurance – the FCA endorse this as many who need life cover don’t have the money to pay fees – and this can be attractive. 80% of IFA’s take so-called ‘indemnified’ commission in the form of an up-front payment instead of a ‘non-indemnified’ payment over, say 48 months ( I’m in the 20%, excepting for small short-term policies). Back in the old days then then life office regulator (LAUTRO) published a commission table that for a short time everyone stuck to. This was known as ‘100% of LAUTRO’. When fixed commissions were abolished as being anti-competitive, you guessed it, they went up.

    Today, ‘150% of LAUTRO’ is about the average; what does that mean in pounds and pence?

    Take a 12-year policy with a premium of £100 a month. the ‘indemnity’ commission would be the premium (£100 x 12 = £1,200) @ 111.83% (that’s ‘100% of LAUTRO’) = £1,341.96 x 150% (167.75%) = £2,012.94. Plus, after 48 months, 3.75% (roughly) of each premium is paid in ‘renewal commission’ for the rest of the term.

    So, if you ‘earn’ £2,000, you can afford to ‘rebate’ £500 to the consumer (subject to a ‘clawback clause’ of course, if you cancel the policy) – you are giving them back their premiums, in effect.

    Non-indemnity commission works in the same way, but is paid ‘on the drip’ and isn’t, therefore, a ‘loan’ to the intermediary. the commission would be about 52.5% of each premium paid for 48 months using the example above. It adds up to more (£2,520) as there is no ‘loan’ element involved.

    A few years ago, I arranged some very substantial policies for a client and agreed to be paid by a fee. The sums insured were into the millions and my fee was, if I remember rightly, £2,500 in the form of a nice cheque from the client. Had I taken the ‘standard’ commission, it was something like £37,000! You might think that it was silly for me to walk away from this tempting amount, but that would have been 189¼ hours @ £195.50 per hour and it didn’t take that long to sort out!

    More importantly, the client will have saved £72,000-odd in premiums over the policy portfolio’s life and I’m glad to say he has used these savings towards his pension (which I look after, too).

    But for most of us arranging ‘modest’ policies, commission is the way to pay.

    Remember, there are no free lunches!

  • 10 HK Expat June 13, 2018, 6:04 pm

    Wow.
    2013/2520 for the first 4 years plus 3.75% of the premium for the remaining 8 years equates to 2372/2880 out of 14400 total premiums; 16.47%/20% of the lot heavily weighted towards the early years so DCF/compounding means a much higher effective % take.
    Based on those numbers it looks like insurance is long overdue a shake up like stockbroking commissions!
    When that amount goes in fees even before the insurance company profit that suggests less than 50/60% of the premiums go into the pot to pay out claims which makes even term life insurance (which i agree is the best of the bunch in most circumstances) of questionable value.

  • 11 Matthew June 13, 2018, 6:27 pm

    I agree wow, good point Mark, it’s above my level of understanding but I can certainly see how they would rip off monthly payments like a form of credit like they do with car insurance, and as you say being able to put down a deposit gives a much stronger hand. I noticed a lot of the cashback offers had a minimum lock in such that you can’t get more than half back.

    Personally I just have pension death benefit and my wife would sell up and seek state help and still be better off than a lot of people renting, I accept the risk that their lifestyle might change and think they’d be better off in a not so empty house that didn’t remind them of me, money isn’t the primary concern I have about death.
    I don’t find much worth chasing cashback for! Just energy and bank switches

    And I don’t think we should regulate insurance more, or anything else, as we ourselves are invested in insurance and any regulation must hamper supply. If it’s very profitable for them then theoretically competition should increase

  • 12 SemiPassive June 13, 2018, 6:52 pm

    Nice article, thanks. By coincidence I just cancelled a mortgage protection double policy (decreasing amount over time) in favour of a fixed amount 10 year term policy.
    The new policy, joint life, is about a quarter of the monthly cost of the old pair of policies that an IFA had set up for us.
    The amount of cover will be higher as well, in future years especially.
    Thanks moneysupermarket – IFAs must hate you.

    As for income protection, that has always been too expensive to consider as a contractor, with too many get out clauses.

  • 13 David June 13, 2018, 9:13 pm

    I’d recommend renewable or one with guaranteed insurability, you never quite know what is around the corner. Fit in your 20’s, you could be uninsurable in your 40’s or 50’s (cheery thought I know)!

  • 14 Brod June 13, 2018, 10:09 pm

    I thought the premiums on Life Insurance were fixed for the duration of the policy?

    I took a job with L&G and they had a very generous 25% discount on the policy I took out – £200k from mid-forties to retirement age (67) fixed at £22 per month. Not huge, but with savings it’ll see my wife and two children through if the worst should happen. Especially now the mortgage is nearly paid off.

  • 15 Mp June 13, 2018, 10:20 pm

    As I understand it those with a good amount in their DC pensions don’t really need life insurance as their pension becomes immediately accessible, tax free, to the spouse should they snuff it at any age before age 75. Worth pointing this out.

  • 16 James June 13, 2018, 10:27 pm

    Thanks Mark. Great article.

    You note that some employers offer group life cover for their employees. This sounds great as an employee but are there any problems here? I can think of if an employee changes their job, or perhaps is made redundant – the impact of this if the employee is in poor health may make this even more of a problem as they may be unable to arrange cover at an acceptable premium.

    Therefore, my question is, what do you often recommend to clients? Take out an individual term policy as well? How much should this be for – less than if no group cover?

  • 17 dearieme June 14, 2018, 12:55 am

    Thank you, MM: good stuff yet again.

    I suggest that James may have given you a topic for a future post: how to view employer life insurance, income protection insurance, disability insurance, and so on, in the light of the possibility of leaving that employer.

  • 18 browngeek June 14, 2018, 2:40 am

    Hi, excellent article.
    As someone who has just recently had kids, life insurance is one of those things we are looking into.
    I know this site (and probably your business) is driven towards UK residents / taxpayers, however do you have any advise re expats but those who might still be considered UK domiciled (and therefore liable for IHT)?

  • 19 Vanguardfan June 14, 2018, 6:38 am

    My vote would be for an article on long term care needs and financing…

  • 20 John June 14, 2018, 9:44 am

    Curious as to the preference for a renewable term policy, over a term policy just taken out with a lengthy term. A male born 1/1/1986 can take out a 35 year policy (to age 67) covering £250,000 for less than £10.80 per month (AIG quote £10.31 per month). Already more expensive at the outset, the renewable term policy will get more expensive at every renewal. Missing something?

  • 21 Mark Meldon June 14, 2018, 10:33 am

    I see that I have been asked as to why I prefer renewable term insurance? It’s a good question and I suppose the answer, in truth, has been driven by personal experience. Many years ago, when I was working in Bristol, I dealt with a family of five where the wife had just been given some very bad news by her medical advisers. The family in question was what the Americans like to call ‘blended’, i.e. it was a second marriage. The mother’s eldest child was nearly 18, but his half-siblings were still very young at around 3 and 18 months, IIRC and the parents were into their 40s. I was asked to help sort out their financial affairs.

    There were 2 term life insurance policies that had been arranged years before by ‘direct’ sales agents, one representing Legal & General and one Allied Dunbar (now Zurich Assurance). Unfortunately, the L&G policy, which had a 18-year term (IIRC – arranged when the first child was born to the mother), was just about to expire. The Allied Dunbar policy for £110,000 was ‘renewable convertible term’ and the renewal option was about to expire, too, as, understandably, the family were preoccupied with their dreadful situation. We knew that the mother had months to live, sadly, but I was able to renew her Allied Dunbar policy, a week after the policy should have lapsed, with no health questions asked, as the firm took the view that ‘well, there is a direct debit mandate in force, so we will assume that the renewal request got lost in the post’, which was commendable (the journalists were not very interested – had Allied Dunbar stuck to their T&C’s there would have been a ‘story’), in my opinion.

    Six months later the mother died and the Allied Dunbar paid out £110,000 to the trustee (her husband) as I had arranged to place the policy in a ‘flexible trust’. Although the money didn’t bring her back, it paid off the rest of their small mortgage and gave the family some cash to hand, too.

    Without the renewal option, this just wouldn’t have been possible due to the mother’s terminal illness. Horrible, but a good job done and a big lesson learned.

    So, why renewable term? When you buy a 10 or 20 or 25-year term insurance, you’re hoping that you won’t need it by the time the policy expires. Your kids will be grown and you’ll have enough saved for your spouse to live on if you die. Or you’ll be single and won’t have anyone to protect.

    But, as the story above demonstrates, there’s a chance you’ll need life insurance for longer than you thought. Maybe you married late and have young children. Maybe you used or lost your savings through bad luck or bad investments and have to keep working to help support a spouse. Renewable term, with no health questions asked, can cover this off. You MUST build in the right options at outset – ‘straight term’ rarely has them – ‘just in case’.

  • 22 Richard June 14, 2018, 11:30 am

    Could a pension substitute for insurance? If the pension exceeded the mortgage for example, would it remove the need for life insurance (all other things remaining the same)

  • 23 Jim Brown June 14, 2018, 8:52 pm

    Is it prudent to have more than one life insurance policy?

    I currently have 3 policies. Some might say I should role it into one . But I like to diversify,just in case I have or my trustees have issues with one .

    Furthermore I set one up many years ago and as my circumstances change I increased my coverage using other providers. I might save by using only one policy but I like the comfort of knowing that my policies are spread across 3 insurers.

    Does the 10 year iht tax rule applies to life insurance placed in trust -If the policy exceeds the nil band iht rate ?

  • 24 dearieme June 15, 2018, 12:24 am

    “Does the 10 year iht tax rule applies to life insurance placed in trust -If the policy exceeds the nil band iht rate ?” You probably mean the seven year rule?

    I have read that the capital paid out into trust by the policy escapes IHT altogether, but that the premiums paid for the insurance might be treated as if they were gifts from the estate. I read this in the context of Whole of Life policies. Perhaps an expert can tell me whether I’ve got that right?

  • 25 Jim Brown June 15, 2018, 7:08 am

    Thanks dearieme

    There is also a tax to be paid in some cases on each 10 year anniversary of setting up the trust . Not sure if that tax applies in the case of life insurance policy. According to HMRC the tax should not exceed 6%.

  • 26 IanT June 15, 2018, 8:24 am

    I’ve got a query regarding a ‘decreasing term’ policy that my wife and I jointly hold, which was taken our as mortgage protection when we bought the house we currently live in some years ago.

    Does the amount insured decrease with the printed ‘schedule’ that came with the policy documentation, or does it decrease in line with the actual mortgage balance outstanding?

    The reason I ask this is because we have made modest overpayments over the years which has resulted in a discrepency between the two amounts.

  • 27 Mark Meldon June 15, 2018, 9:06 am

    @Dearieme/Jim Brown,

    You are referring to the arcane world of ‘chargeable lifetime transfers’, where inheritance tax can be paid during your lifetime (it’s usually a death thing). The CLT rules are not designed to ‘catch’ simple life insurance policies but the transfer of ‘property’ into a trust, such as cash, investments, etc.

    The reason that a simple life insurance isn’t caught is that it has no value at the time of transfer (because most policies are ‘pure insurance’) but only at the date of death, if that were to happen during the term of the policy.

    It’s really important to use a trust as it makes sure that the right money gets into the right hands at the right time outside of your estate. The last death claim I dealt with (and there have been more than a few) was very quickly paid – less than a month from the date of death to the trustees having the cash in the bank.

  • 28 Mark Meldon June 15, 2018, 9:09 am

    @IanT,

    Your policy will be subject to the schedule on your policy, not the actual balance of your mortgage. A few years ago I had a death claim to deal with where the late policyholders had been making substantial overpayments. From memory, the mortgage balance when the husband sadly died was around £156,000. The policy paid out £192,350 (IIRC); the wife didn’t send Aviva a cheque back for the difference!

  • 29 L June 15, 2018, 9:10 am

    Mark,

    Thank you for another illuminating post, you are a great advert for your profession!

    What are your thoughts on the accuracy of some of the online “needs calculators” available to try and determine how much insurance is required? For example, I had a tinker with the Aviva one this morning and it all seemed pretty sensible (I even considered a contribution towards our toddler’s potential university living costs, something I would never have thought of).

    Are these a decent starting point for someone in the “arrival of children stage” who would rather be a little over-insured than the opposite?

  • 30 Mark Meldon June 15, 2018, 9:13 am

    @Richard,

    You are right to say that a DC (‘money purchase’) ‘pension’ fund has attractive death benefits akin to term assurance. Really, though, that’s a side-effect of so-called ‘Pension Freedoms’ and you fund is there to provide you with an income when you are old in one way or another.

    It’s really important to make sure that you have an up-to-date death benefit nomination form in place as unexpectedly dying without one causes a lot of trouble for your survivors and the scheme Trustees!

  • 31 Jim Brown June 15, 2018, 9:14 am

    Mark

    Thanks for the clarification. Makes it much clearer now . I have my trust forms ready to go but then the guidance/aviva said there might be tax implications.

  • 32 L June 15, 2018, 9:19 am

    @Mark,

    Also, is it worth allowing for Widowed Parent’s Allowance and any Survivor’s pension(s) when calculating cover needs?

  • 33 Mark Meldon June 15, 2018, 9:20 am

    @JimBrown,

    It doesn’t signify much having a bunch of policies or just one as long as the cover is appropriate for your circumstances. I have policies with L&G, LV=, Sun Life Financial of Canada, Scottish Provident and Canada Life, the latter being a ‘group’ scheme through the office. I’m worth rather a lot dead and pay out a lot of money in premiums each month, which I’m very happy to do.

    I ‘eat my own cooking’, you see, and my policies were arranged a long time ago. I don’t mind saying that I developed Type 2 diabetes (I’m well, thanks!) back in 2011 (and no, I’m not fat – there is a ‘family history’) and I’m out of the market for income protection insurance and critical illness insurance (I have these, too) and would pay around 3-4 times ‘standard’ premiums were I to apply for a new policy today. I was able to renew (and convert) a term insurance I had to a whole of life plan – a straightforward choice for me – with no medical questions asked which was a blessing at the time.

  • 34 John June 15, 2018, 9:37 am

    @Mark Meldon – Seems to me the moral of that story could just as much be ‘don’t buy cover with a fixed term that ends in your forties (instead buy to your retirement age)’ as ‘buy a more expensive renewable policy (that could lapse if you aren’t on the ball around the renewal date)’.

    @Jim Brown @dearieme – There are no exceptions for life insurance to the IHT treatment that you lay out for discretionary trusts. So the premiums could be treated as gifts that you need to survive more than 7 years, and the value of the trust could be subject to an IHT charge (of 6% of the excess over the nil rate band) on every 10 year anniversary (and a similar proportionate charge when the value of the trust is distributed to beneficiaries between those anniversaries).

    However, in the vast majority of the cases, the above does not apply in practice. Firstly, the premiums are typically covered by the ‘out of income’ exemption, or otherwise by the annual £3,000 exemption, so you don’t need to wait 7 years, and the premiums are immediately outside of the estate. Secondly, for as long as you are alive and not in terminal ill health, the value of the trust (i.e. the value of the life insurance policy) for IHT purposes is treated as negligible, so falls well within the nil rate band. The value of the trust obviously increases when the sum assured is paid, but as long as the trust is distributed before the next 10 year anniversary, no 10 year anniversary charge will apply.

    Therefore, unless (1) the premiums are particularly sizeable, or the sum assured exceeds the nil rate band and (2) you are in terminal ill health at the time of a 10 year anniversary, (3) you die just before such an anniversary, or (4) the life insurance payout is retained within the trust for the long term, IHT is not a major consideration. And 2-4 can be mitigated by having multiple life insurance policies with smaller sums assured assigned to multiple trusts (set up on different days).

    @IanT – it should decrease in line with the schedule (if in doubt, best to check with the insurer though).

  • 35 Mark Meldon June 15, 2018, 9:39 am

    @L,

    You have touched upon a subject that, in fact, isn’t very easy to resolve – how much cover do you need? The on-line calculators are good to get you thinking, but they are based on a whole bunch of assumptions that may, or may not, work out in practice. For many years, I used a table produced by a Professor Joseph M. Belth, which enabled you to work out the sum insured you need by looking at ‘net present values’. This means what size of lump-sum you need based on your income needs from the capital at a range of assumed ‘interest’ rates.

    Belth says, for example, if you need a fixed £2,000 a month for 15 years if you die and the interest rate on cash on deposit was, say, 2% then you need £393,180 sum insured. I won’t go into the details, as it will take ages to type, but it’s a very useful way of looking at the cover you need (and what drives some of the online calculators).

    More recently, I am persuaded by the good old ‘rule of thumb’ approach! For example, the Consumer Federation of America say that a married couple with two small children need eight times their joint annual income to cover future living expenses for 20 years (nine times for 30 years). Add a fund for university/college on top of that. Subtract any insurance you get automatically at work. The total gives you the amount to buy.

    Is this exact? No. But the future is unknowable, so this simple rule is close enough. It assumes that your survivor invests the policy’s proceeds conservatively and gradually uses up the money over his or her lifetime. At higher income levels, you might want 10 times income.

    So, if someone was earning, say, £60,000, you multiply that by 8 to get £480,000. Then add £100,000 for university/college, less, say death-in service of £120,000 (if you have that valuable perk) and you end up with £460,000 – that’s near enough.

    If you were lucky enough to be earning £100,000, you multiply that by 10 to get £1,000,000. Add £100,000 for college university, deduct, say £200,000 death in service and you end up with £900,000.

    It’ll do!

  • 36 Jim Brown June 15, 2018, 9:45 am

    Mark,

    The below is an excerpt taken from Aviva guidance on setting up trust for life insurance.

    “Trusts and UK inheritance tax
    If you put your life insurance policy into one of our protection trusts, HMRC will treat it as a lifetime transfer. This will be a chargeable
    lifetime transfer (a transfer of assets made during a settlor’s lifetime that is liable to an inheritance tax charge) where our Discretionary
    Gift Trust (Protection) or our Aviva Survivor Trust is used and a potentially exempt transfer if our Aviva Bare Trust (Protection) is used.
    But this doesn’t mean you’ll be presented with a tax bill.
    For a whole of life insurance policy, the value of the lifetime transfer when you set up the trust will be the greater of the:
    l open market value of the policy when the trust is created (if you’re in good health, the surrender value will give you a good idea of
    what this will be)
    l total amount of the premiums you’ve paid up to the time you create the trust.
    For a term life insurance policy, only the open market value counts. The surrender value is usually nil, but it can still have an open market
    value. This would be the case if the person covered by the policy is in poor health and likely to die before the policy end”

    This is what got me confused .

  • 37 Jim Brown June 15, 2018, 9:55 am

    Taken from Aviva brochure:

    “Example – John Black
    John Black is married with two young children. After getting financial advice, he takes out a life insurance policy for £400,000 and
    writes it under a Discretionary Gift Trust (Protection) for the benefit of his children.
    As the death benefit from this policy won’t be part of his estate, it won’t be subject to inheritance tax. Also, if John dies, we can pay
    the money from the policy to his surviving trustees as soon as we accept the claim. We won’t need to wait for probate or other grant
    of representation.
    Because he’s in good health, the open market value of the policy is nil when John creates the trust. This means there’s no
    chargeable lifetime transfer and no need to complete an IHT100 form. Also, John’s premiums are exempt so they’re not treated as
    chargeable transfers.
    As long as John is in good health at every 10-year anniversary, the policy will have little or no value. This means there won’t be a
    periodic inheritance tax charge.”

    What if he is in poor health at the 10 year anniversary,will there be a periodic iht charge?

  • 38 IanT June 15, 2018, 10:14 am

    @ Mark,

    I’m very grateful for your clarification. You should really be charging Mr. Monevator for this service to his clients. 😉

    On the schedule it refers to an ‘assumed interest rate of 10%’. To what does this refer, do you think?

  • 39 Mark Meldon June 15, 2018, 10:30 am

    @IanT,

    Most mortgage protection policies guarantee to pay off the balance of a repayment mortgage (less arrears) subject to a maximum interest rate of 10%. As, undoubtedly, your interest rate will be well below that, you are covered. The simple thing to do it to just ring up your insurer (or long-in to their webservice) and ask them ‘had I died yesterday, what would you have paid out?’

  • 40 John June 15, 2018, 10:50 am

    @Jim Brown – if you are terminally ill at the 10 year anniversary, then the value of the life insurance policy (and therefore the trust) will be somewhere between negligible (which applies if you are not terminally ill) and the sum assured, and nearer to the latter. If that value is less than £325,000 (or the nil rate band at the time), then there still would not be a periodic IHT charge. So you need a fairly large sum assured before you potentially have any IHT liability.

  • 41 Mark June 15, 2018, 11:49 am

    I suspect that there’s a pretty significant error in this piece. An endowment does not guarantee to pay the insured the face value if he or she has not died at the conclusion of the (usually 25yr) term. They were widely missold as having this characteristic, but it turned out that they didn’t and that the headline figure was merely an aspiration, the achievement of which wqs dependent on a combination of underlying investment performance and the whim of the issuer.

  • 42 TahiPanas2 June 15, 2018, 12:37 pm

    Read no further if you are looking for sensible advice!!!!!!!

    At 73 I have never paid an insurance premium that wasn’t compulsory. Probably saved myself a few bob in the process but it wasn’t conscious penny-pinching. It was down mainly to sloth. I just happened to have good luck.

    I did try to ensure that my dependents were covered to some extent from my initially meagre resources and my wife was fortunately highly employable given her profession.

    Don’t take this as anything other than a supercilious brag and a guide to what not to do!!!

    Apologies,

    TP2.

  • 43 Mark Meldon June 15, 2018, 2:11 pm

    @ Mark,

    I’m not wrong!

    You are thinking about so-called ‘low-cost’ endowment policies that were usually arranged with mortgages up until 20 years ago.

    With a ‘full’ endowment policy, the insurance company promises to pay a fixed amount (the basic sum assured) on the maturity of the policy or on the death of the life assured, if earlier. Most policies were ‘with-profits’, meaning that the sum assured went up with the addition of ‘reversionary’ bonuses each year and, maybe. a ‘terminal’ bonus at maturity (or earlier death).

    Low-cost mortgage endowments were usually a combination of the above and a decreasing term assurance. And, because of over optimistic assumptions and the collapse, particularly, in inflation, most fell short.

  • 44 Mark June 15, 2018, 8:10 pm

    No, honestly, most if not all endowment policies’ payouts on maturity are/were discretionary, not just the so-called low cost ones. If you don’t believe me, ask the FOS. And yes, I know the word ‘guaranteed’ was and may still be used in sales and marketing material, but the small print exclusions are still there.

  • 45 Nebilon June 16, 2018, 9:27 pm

    While i agree it is most important to cover the life of the breadwinner in the family years, it is also good to have some cover for the other spouse. This is because the breadwinner may have to step down from full time work or the full intensity if they are now having to do more child care, dealing with children who have lost a parent and need more care. If all or a good part of the mortgage is paid off this may be easier.

  • 46 Kris Wragg June 19, 2018, 4:03 pm

    You should always consider Critical Illness policies as well as Life Insurance in my opinion.

    I got diagnosed with skin cancer 2 years ago aged 31 and due to our combined life insurance / critical illness policy we had the mortgage paid off our home. Best £40 a month we have ever paid!

    What was better was my laziness in not cancelling my previous policy for my first home that I sold to buy a house with my partner meant I had a second payout, mostly got wisely invested in a Vanguard LifeStrategy fund for the future and a chunk used as a deposit on my dream car, a Tesla (after a life changing event sometimes a man needs to treat himself!)

    Legal and General paid out in about 1 week, Aviva paid out in about 3 weeks, although I guess that was partly due to more checks as that policy paid out about 3x the amount.

    It was great seeing how supportive companies are in these sorts of circumstances, for example our mortgage provider, Yorkshire Building Society, waived all early redemption fees for the mortgage once we’d provided proof that the money came from a critical illness insurance payout.

  • 47 Mark Meldon June 19, 2018, 4:11 pm

    @ Kris,

    That’s a heartening story, and I’m very glad you are OK. I think I’ll put CI cover on my ‘to do’ list!

  • 48 Kris Wragg June 19, 2018, 7:44 pm

    @Mark

    I think CI policies are certainly more of a “gamble” than a life insurance, I took mine only mostly because my mum forced me to when I bought my first house as she’d previously been diagnosed with breast cancer and wished she’d done the same.

    When my partner and I bought our house together it was a financial stretch and we took it out as if either one of us got very ill we would have struggled. Obviously as we progressed in our careers and paid more off the mortgage it became less of an issue but turned out to have been a wise move.

    I think CI probably pays off better when you are younger and your risks are higher, generally the premiums are less due to less health issues and also your more likely to have a much bigger amount left on your mortgage.

    Like most insurance it’s an odds game, and the insurance companies win overall, but if it’s there when you need it you will be more than thankful of that premium that’s the equivalent of a takeaway or restaurant meal once a month.

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