How does life insurance work?

What is life insurance? 

Life insurance pays out money as a lump sum or as regular payments if you die. It’s aim is to give you a piece of mind that your dependents will be looked after if something were to happen to you.

When considering your options, seek independent financial advice.

How much cover do I need?

The amount of cover you need will depend on; 

• any debts you have, 
• the amount you pay in mortgage or rent, 
• the number of dependents you have, and 
• how much your income is. 

It is also important to remember that if you have dependents their lifestyle costs will continue after your death, so they need to be included as well.
You can work out how much cover you need following the steps below:

Step 1: Check if you already have cover

You may already have life insurance cover if you’re employed, as your benefits package might include a ‘death in service’ pay-out – this a lump sum that’s a multiple of your annual salary at death. This will only be available if you're currently employed with the company at the time of your death, it will cease to apply as soon as you leave your employer. If your package does offer this, then check if there are any limitations on the pay-out.
Check if you have any personal life policies, including any old mortgage or endowment savings type plans.

Step 2: Add up what you need

• Your debts :your total mortgage and other debts, such as credit card debts or personal loans.
• Expenses you want the insurance to cover: Your basic monthly outgoings and any other costs, such as child maintenance, school or university fees. You might want to leave a lump sum for someone, or use it to cover your funeral costs.
• Dependants’ ongoing lifestyle costs. 

Use this L&G life insurance calculator. It is a clear and easy way to help estimate how much cover you may need based on your current situation.

Step 3: Calculator your insurance ‘gap’

When you have these two figures, take away the benefits or cover you already have from the total amount your dependants need. The result is the amount of life insurance cover you should take out. Alternatively, a common rule of thumb is to multiply your annual income by 5 or 10.

Now think about the length of time you want the policy to last. You might decide that it should end at the same time as your mortgage, or when your children finish full-time education, or up until you retire.

Example

John (42) and Judith (39) have a joint household income of £41,000 per year. They have an outstanding mortgage of £213,000 which they expect to pay off in 18 years. They also took out a £5,000 loan to purchase a car. Their basic monthly outgoings are £1,000 (£12,000 per year).

Through his employer, John has death in service cover worth four times his annual salary of £25,000,  a total of £100,000. Judith is self-employed and does not have a similar benefit.

They decide they need enough life insurance to cover their mortgage, their car and their basic annual outgoings. John’s death in service cover is enough to cover the car and living costs, so they take out an 18 year life insurance policy to cover their mortgage.

It is inevitable that your life insurance needs will change

You should review your policy to make sure your premiums are competitively priced and that you still have the right amount of cover.

Common reasons to review your life cover are:

• You’ve had another child
• Your partner has stopped working
• You’ve taken out a new mortgage
• You’ve changed jobs and your new benefits package includes a higher or lower ‘death in service’ benefit (if higher, you might be able to decrease your level of cover).
• The market cost of life insurance has fallen since you took out your cover.
• Your lifestyle costs have risen significantly since you last reviewed your cover.

No one wants to think about dying but the fact is people die early for all sorts of reasons. It’s a terribly sad thing to lose a husband, wife, partner, father or mother, but even worse to lose the other parent because he or she has to work all hours to provide for the family.

Life insurance allows you to offload the risk of leaving your family with a financial mess if the worst was to happen.