What is life insurance and what should you know before you buy?

Life insurance provides financial support for the people you love should anything happen to you. 

Life insurance can be a bit of a minefield, with lots of jargon to get your head around, plus small print that can be confusing. So, to give you a head start and make your search a little bit easier, here's what you need to know about life insurance before you buy a policy.

What is life insurance?

Life insurance is a policy that pays out money to your loved ones if you pass away during the policy term. It can pay a lump sum amount of money or a regular income depending on the type of policy you choose. 

A whole of life policy pays out however old you are when you pass away. A term life insurance policy only pays out within a set period of time. People generally take term life insurance to run alongside their mortgage term. The premiums vary depending on a few factors including how much cover you want, how old you are when you buy the policy and how long you want it for. 

Life insurance isn't just for bread winners

Life insurance is important for people who have dependents who rely on them, even if they don't have paid employment. Research found that the role of a stay at home parent would cost as much as £30,000 to protect if they passed away. If money is a struggle at the beginning of parenthood, new parents can get £15,000 of 12 months free life insurance cover from Aviva if their child is four years old or under.

Do your sums carefully

When calculating the cover you'll need, take into account your current salary, any debt repayments including your mortgage and any lump sums needed for things like funeral costs or university fees for your kids. You could factor in any ‘death in service’ benefits you might get through your employer and subtract this from the total, as this could cover a portion of what you need.

Terminal vs. critical illness cover

Life insurance providers will often give you the option to include terminal illness cover in your policy for an additional cost. This pays out as a lump sum if you’re diagnosed with a terminal illness. Critical illness cover is broader and includes illnesses that aren’t necessarily terminal. Check the terms and conditions carefully so you know the specific criteria for each policy you're considering.

Keep reviewing your life insurance policy

Taking out life insurance when you’re young is a good move, as it usually gets more expensive as you get older. Review your policy as your needs change, for example, as you have kids (or more kids!), if your partner stops working, or if you start a new job with more (or fewer) benefits. This ensures you’re not paying for more or less cover than you need.

Shop around

There are loads of places where you can buy life insurance, including your bank, mortgage provider, credit card company, a specialist broker, financial advisor (IFA), or an online comparison site. There are also robo-advisors that specialise in life insurance, enabling you to do the whole thing from an app. Research all your options to find the most suitable life insurance policy for you.

Assurance and insurance are different

Life insurance and life assurance are different things. With life insurance, you decide on a set term for the cover at the start of the policy – usually between 10 and 25 years. So, you’ll only receive a payout if you pass away within that period. Life assurance, also known as whole-life insurance, covers you until you pass away - even if you live to 120!

Your health may be assessed

Some life insurance providers will need details about your health and any existing medical conditions, so be prepared to answer questions around these - you may even be asked to have a medical examination in some cases. If you already have a serious health problem, your policy might not pay out in the event of death resulting from that illness. Check terms and conditions carefully or have a chat with the provider if you’re worried about this. Insurers like Vitality reward you with points for being active, which can then be traded for benefits like Starbucks coffee and cinema tickets.

Joint cover might not be the best deal

If you and your partner are both keen to get covered, some providers give you the option to take out a joint policy. Before you sign on the dotted line, make sure you compare with two separate policies, in terms of price and the level of cover. 

There could be tax implications

While life insurance policies aren’t subject to income or capital gains tax, they can be included in inheritance tax, alongside your other assets. If you’re worried about the impact this could have on your loved ones, you can write your life insurance in trust, which means it will be ring-fenced from the rest of your estate. An independent financial advisor can help you with this.

Your mortgage provider may require it

Life cover isn’t a legal obligation like car insurance, but some mortgage providers may require you to take out a policy as a condition of lending to you. Lenders often offer life cover automatically, but this could be expensive so do shop around. If you want a life insurance policy to cover a mortgage, you could buy decreasing life insurance. This means the amount that's paid out will decrease in line with your mortgage balance. 

Need added peace of mind?

If you’re worried about what you'd do if you were unable to work and cover your premiums due to serious illness or injury, then look out for a ‘waiver of premium’ option. It might cost you a bit extra but means that your premiums would be covered if you’re incapacitated due to illness, injury or disability. So you wouldn’t lose out on your life protection on top.

Read reviews before you buy

Life insurance reviews from other customers are a good way to see how insurers rank against each other when it comes to the products and services they provide. Our community of Smart Money People reviewers have shared who they recommend and who could do better. You can also leave a review of your own if you’d like to share your experience of life insurers you’ve bought policies from.