Protect your family should disaster strike

Many of us think nothing of spending £10 a month to insure our mobile phone or take out pet insurance.

But, according to independent advisers LifeSearch, for the same amount a 40-year-old man could take out £89,648 of life assurance over a 20-year period, while a 30-year-old man could get as much as £197,892 of cover.

"People massively overestimate the cost of life cover," says Bonnie Burns, product and technical director at Legal & General.

"But cover can cost very little and give huge reassurance that your family is looked after if something does happen to you."

How much cover? 

One of the stumbling blocks for taking out cover is deciding how much you need.

A simple calculation of 10 times salary used to be the way to calculate this, but as interest rates have become more volatile life assurers recommend assessing your financial situation to get a more accurate level of cover.

"Cover your debts such as your mortgage, loans and credit cards, and your funeral expenses then think about how much your family will need to live on," explains Ian Smart, head of product development and technical support at insurer Bright Grey.

Smart adds that insurers will allow you to have a sum assured equal to your debts, plus between 15 and 20 times your annual salary, as a maximum amount.

"More than this and you will need to give a reason, such as inheritance tax planning, for the extra cover," he says.

Which cover? 

Another potential problem when taking out cover is working out which type you need. Although the concept of life assurance is very simple there are a number of different types of policy.

The standard form of cover is level term assurance. This pays a set amount (the sum assured) if you die during a set period of time (the term). Premiums are based on your age, sex, health, the sum assured and the length of the term.

"Your premium can be guaranteed, which means it remains the same throughout the term, or reviewable, which could start cheaper and increase during the term," says Smart.

While this can be very straightforward, you can also index the cover so it keeps pace with inflation or by a set percentage, which is typically up to 5% a year.

Your premium may also increase, although you could opt for a higher premium that's fixed throughout the term.

Rather than increasing cover you might want to decrease it over the term. As an example, if you have a repayment mortgage you could take out cover that falls in line with the outstanding debt.

This works out cheaper than level cover. For instance, at LV= a 40-year-old woman would pay £12.47 a month for £150,000 of level term assurance over 20 years but £9.03 a month for decreasing cover.

One type of cover that is commonly overlooked is family income benefit. This pays a set amount each month for the remainder of the term.

"People are fixated with lump sums, but this fits people's requirements much better," says Mark Jones, head of protection at LV=.

As an example, he says that you could take this out to cover your salary until retirement. "Because the total potential payout reduces each month this is cheaper than maintaining a lump sum throughout the term," he adds.

To illustrate the difference in cost, taking out £600,000 of life cover over a 25-year term would cost a 40-year-old non-smoking male £58.60 a month with Legal & General.

If, instead, he took out family benefit paying £2,000 a month this would cost £30.80 a month.

Cover options 

Possibly the biggest consideration when taking out life assurance is whether to have a joint life policy or two single life ones. There are plenty of arguments in favour of taking out two policies.

Burns explains: "Two single life policies only cost a little bit more but give you the potential of two payouts. On a joint life policy there"s only one payout and then the policy is cancelled."

Joint life policies need to be unravelled if partners separate. Most life companies have separation options that effectively turn a joint life policy into two separate ones, but it can be a hassle.

In some situations joint life policies are the best option. Jones says: "If all you want to do is ensure the mortgage is paid off if you or your partner dies then a joint life policy is fine and will be cheaper."

For example, with LV= a couple, both aged 30, would pay £15.59 a month to take out their own individual policies for £150,000 of cover over 20 years. A joint life policy would cost them £11.79 a month.

Whether you take out single or joint life policies, one thing you might want to check is if your cover has guaranteed insurability options.

These allow you to increase cover without further underwriting, in the event of a major life event such as the birth of a child, marriage, a new house or a promotion.

Burns adds: "These types of event do often mean you need more cover and most companies will include these options.

"We allow you to increase cover up to three times on your policy, with each increase equivalent to up to 50% of the existing sum assured or £150,000 subject to a maximum overall increase of £200,000."

Another important option is terminal illness cover. Smart explains: "This pays out the sum assured if you are diagnosed with a serious illness that means your life expectancy is less than 12 months.

"It can help towards the cost of treatment and allow you to sort out your finances before you die."

Use a trust 

Whichever type of cover you take out one thing you shouldn't overlook is getting your policy written in trust. This ensures that if you die the payout goes straight to the person named as the beneficiary in the trust.

This prevents it becoming part of your estate, which could see up to 40% of it going to HM Revenue & Customs as inheritance tax. Furthermore, because it"s paid before probate it enables the beneficiary to settle any outstanding bills.

It's very easy - and free - to do this. Smart explains: "Most companies provide a trust form and all you need do is sign it and provide your name, policy number and details of the trustees.

"Less than 10% of policies are written in trust, although almost everyone would benefit from doing this."

Even if you've already taken out cover and it's not in trust you can change this. Just contact your adviser or the life company and they can supply all the necessary paperwork to put it in trust.

Finally, if you have been put off by the cost of cover in the past it's worth looking again. Although premiums rise with age, life assurance premiums have fallen significantly over the past 10 years, making it more affordable than ever.

This article was originally published in Money Observer - Moneywise's sister publication - in July 2010