What do you need your life insurance to cover?
Life insurance provides a reassuring financial cushion for your loved ones if you’re no longer around to provide.
However, calculating exactly how much life insurance cover you need isn’t straightforward. Everyone’s circumstances are unique and therefore it requires careful consideration.
Let us run you through all the key factors to help you make an informed decision on the level of cover YOU need.
Personal factors which will strongly influence the level of cover you secure include:
- Whether you’re a parent or have dependants
- Number of children that depend on you
- Age of your children, (how long until they are financially independent)
- The size of your mortgage
- Your age, (how long until you’re at retirement age)
- Your lifestyle
- Whether you have personal savings
- How much you can afford.
To really work out ‘how much life insurance do I need‘ let’s look at the key factors, one by one.
Are you a homeowner? According to research from themoneycharity.org.uk the average mortgage debt in the UK is £121,687.
To ensure your family home is secure, you’ll probably want to ensure your life insurance covers your mortgage.
This means if the worst were to happen your mortgage could be cleared, allowing your family to remain in their home and not have to worry about the monthly repayments.
A decreasing term policy is commonly used to cover a repayment mortgage. As the amount owed on your property decreases over time, so does the cover amount. This is also the most cost-effective option.
If you rent, instead your pay out could cover your monthly payments until, for example, the children have left home.
Obviously paying the mortgage off is vitally important so not to burden your family with a huge debt. However, don’t forget there are also many on-going costs associated with running a home.
You may need your life insurance to cover these future costs too. For example:
- Council tax
- Property maintenance/repairs.
Future family living costs
If you were no longer around you’ll want the reassurance that your loved ones would be able to continue their current lifestyle.
Your life insurance pay out could help enable your family to maintain their current standard of living. Have a think about your loved one’s day-to-day living expenses.
This budget planner could help you calculate your monthly outgoings »
Remember, if you have young children they’re likely to become more expensive as they get older. For example:
- Leisure activities.
In order to meet these on-going living expenses, you may consider family income benefit. In contrast to traditional life insurance which pays out a cash lump sum, instead, a FIB policy pays a monthly income for the duration of the policy.
This policy could also be taken out in conjunction with life insurance. For example, you may have a decreasing term policy to cover your mortgage and a FIB policy effectively replacing a lost income and meeting day-to-day expenses.
When it comes to life insurance and working out how much cover you need, the stay-at-home parent is often overlooked.
People assume they need to cover only the family breadwinner. This is a common mistake.
Think for second about all the unpaid jobs a stay-at-home parent fulfils. Then think about how you would replace these roles and the costs involved.
Take childcare for example. Could you afford fulltime childcare? If no, you may have to reduce your work hours and therefore your salary in order to look after them.
You may want to consider joint life insurance, which covers both you and your partner. However, it will only provide one pay out, normally on the first death.
We have written a blog post on the true value of a stay-at-home parent »
Provide an inheritance
You may want to leave an inheritance to your children or perhaps grandchildren after you’re gone. You could provision for this in your life insurance.
A key consideration here is tax. Inheritance laws state that if any part of your estate is valued over £325,000 (if single or divorced), or £650,000 (if married or widowed), it’s taxable at 40%.
Therefore, if you own a property and have a healthy life insurance policy, many UK estates will easily exceed this threshold. To avoid this you could write your life insurance in trust.
If you have children then the cost of education may be a factor in the level of cover you need.
Remember, your child will go to school for a minimum of 11 years. Then potentially 2 years at college and/or 3 years at university.
- Private school fees
- University/tuition fees
- School trips
- Uniform/sports kit
Critical illness cover
Statistics prove that you’re much more likely to fall critically ill during your working life than pass away.
As a result, you may want to pay for additional critical illness cover, either as part of your life insurance or as a stand-alone policy.
This will provide you and your family with extra protection if you were to fall ill and unable to work.
If you have any outstanding debts you might want to cover these with your life insurance too:
- Car finance
- Credit card bills
- Personal loans.
If you’re in your 20s or 30s, the rising cost of a UK funeral is probably not at the forefront of your mind.
At this age, you’re probably looking for your life insurance to protect your first home or the living costs for your new-born.
However, as we age funeral costs become more and more of a factor. The average UK funeral now costs £4,078 (SunLife), with all the associated costs this rises on average to a staggering £8,905.
If you’re aged between 50-85 it’s commonplace to take out an over 50s plan or a funeral plan to cover these costs.
Read our blog post on the rising cost of funerals »
What level of cover can you afford?
In the ideal world, we would protect all of the above and more. However, the more cover you take out the higher the monthly premiums.
Therefore, for most of us, it’s a case of identifying the perfect middle ground. Ensuring you have enough cover to look after your dependants, but not being overprotected and paying unnecessarily high premiums.
Life insurance and inflation
If not given consideration, inflation and the increased cost of living could mean that your pay out loses ‘real-terms’ value.
When taking out life insurance it’s important to take into account the effect inflation may have on the pay out sum.
For example, £100,000 now may not seem so significant in 50 years time. To offset this, some policies are linked to one of the main indicators, (indexation facility).
This can be the Retail Price Index (RPI) or the Average Earnings Index (AEI) and ensures that the value of your policy increases in line with inflation.
Since 2004 the cost of living in the UK has increased 4 times that of inflation. So even taking into account inflation, you should also factor in the likely increase in living costs.
Employee benefits (death in service)
Some employers offer their employees some protection, like ‘death in service’.
If you benefit from such cover you may want to factor this into the level of personal cover you take out.
However, it’s worth noting that if you were to change employers this benefit is highly unlikely to move with you.
What if your personal circumstances change
When you take out life insurance, you set up the policy to protect your life as it is at that point in time. However, as we know personal circumstances can change.
You may have another child, buy a larger house or go through a divorce. All these life events would probably mean that your policy no longer meets your needs.
Depending on the policy you choose, you may be able to trigger a special event option. This allows you to increase your level of cover without the need for additional underwriting.
Alternatively, you may wish to cancel your existing policy and take out a new policy with more coverage. If you do this you will lose the premiums you have paid in.
- Cover large debts, like a mortgage
- Factor in the costs of running a home
- Cover future family living expenses
- Stay-at-home parents need protection too
- Factor in the effects of inflation
- Employee benefits may reduce the level of cover you need
- If your circumstances change, so can your policy
- If you have children consider education expenses
- Critical illness cover could provide greater protection
- Consider any outstanding debts
- In time you may want to cover funeral costs.