What is life insurance? A complete guide

Planning for your nearest and dearest

What is life insurance? In short — it’s peace of mind. Having the right life insurance coverage in place can help you care for those who matter to you, even after you’re gone. 

So, how does life insurance work? We’re here to help. 

What is life insurance and how does it work?

Life insurance is designed to offer financial protection to your loved ones if you become terminally ill or pass away.

It’s worth thinking about life insurance if you’re about to embark on a new chapter in life, like buying a house, expanding your family, or starting a new job. 

But even if this isn’t the case, life insurance can help to cover certain costs, such as funeral expenses and the sometimes unforeseen fees that come with inheritance tax. 

The process is fairly simple. You agree to the terms of your policy with an insurance provider and pay monthly premiums. In exchange, they agree to pay out if you fall ill or pass away.

Life insurance explained 

What is the main purpose of life insurance?

Life insurance offers assurance that your loved ones will be financially looked after in the event of your death.

The security that it offers is particularly important if you have a mortgage or other debts to pay off, as it helps to ensure your family isn’t left with an overwhelming financial burden. But it will also help them get through the month comfortably when you’re not around.

What are the benefits of life insurance?

The benefits of life insurance are all etched in the same principle: by paying in a regular amount while you’re still here, you get to continue to support the people closest to you after your death.

This can help with various costs, including:

  • Paying off a mortgage
  • Funeral costs
  • Monthly costs
  • Education funds for your children

You can also opt for critical illness cover, which will help protect your family’s financial stability should you become seriously ill.

How does life insurance work?

Life insurance pays your beneficiaries in one of two ways:

  • A lump sum
  • Regular payments

You get to decide who will benefit from your policy. While it’s common to name family members as your beneficiaries, this doesn’t have to be the case. It’s completely up to you who your beneficiaries are. You can also have multiple beneficiaries. For example, you may want the policy to pay out 50% to your spouse and 25% to each of your children once they turn 18. 

You also get to choose how it will be paid out and whether it should be used to cover something specific (like a mortgage) or used in whatever way your family wishes. You can also decide if it’s to be paid out at the time of your death or at a later stage. You get to be in the driving seat of how you want your finances to be spent. 

What are life insurance policies?

Life insurance policies are legal contracts between you and your insurance provider where you agree to regular payments (premiums) in exchange for coverage when you need it, according to the terms agreed upon. Policies are based on risk assessment. Generally, the higher the risk to the insurance company, the higher the premiums you will have to pay. 

Some of the key factors they insurers into account when assessing risk include:

  • Your age: As a rule of thumb, the older you are, the more you’ll pay for your premiums. 
  • Your health: Pre-existing medical conditions can increase the cost of your premiums.
  • Your lifestyle: Smoking and heavy drinking, for example, are linked to shorter life expectancies, making them significant factors in how your insurance company calculates your premiums.

Once your risk has been assessed, the next step is to choose how much coverage you need. Not all life insurance policies are created equal — and thank goodness for that! It means there are various options on the market for you to choose from. 

It’s also important to note that life insurance policies work differently from other kinds of insurance policies. You can have multiple insurance policies at the same time if that’s what suits your needs. 

The different types of life insurance policies

Life insurance is divided into two primary categories: term life insurance and whole life insurance. 

Term life insurance

As the name suggests, term life insurance runs for a particular amount of time or term. That means the insurer will pay out if you pass away or fall critically ill during the term of the policy. If you want to continue coverage after this, you’ll have to take out a new policy.

How long your term runs for will be outlined in the agreement you make with your insurance provider when you take your policy out. 

Term life insurance policies are generally cheaper, so if you’re looking to save on your monthly costs, this could be a good option for you.

Whole life insurance

If you opt for whole life insurance, your loved ones will be paid out regardless of when you die. Basically, it covers the whole of your life. 

Because this type of policy assures that your beneficiaries will be paid out, it’s sometimes referred to as life assurance. 

For more details on the different types of life insurance, head here. 

Who needs life insurance?

While life insurance can benefit any household, it’s important to weigh up the monthly financial cost of your premiums with the benefits you’ll receive down the road. 

Life insurance is definitely worth considering if:

  • You’re the sole breadwinner of your family.
  • You have a spouse or life partner and would like them to be able to have the same quality of life they currently enjoy should you pass away. 
  • You’ve just bought a house. While having life insurance when you take out a mortgage isn’t mandatory, it is a good idea to consider it. That’s because your family can use the life insurance payout to pay off the mortgage. You can find out more about life insurance for a mortgage here
  • You’re a new parent. From immediate costs to university tuition fees, there are multiple financial considerations when you have a new baby. Life insurance is one way to relieve the stress of planning for unknown futures.
  • You own a business. Once you pass away, having life insurance in place will help to tide your family over until decisions are made about whether your business will be taken over or sold. Discussing the possibility of death or critical illness is also vital when you go into business with someone else. It’s important to have a strategy in place should something happen to either of you.

If you have life insurance in place, it’s important to review it at strategic moments in life, such as when you move house or welcome a new member of the family. 

Read more: When you should review life insurance

What life insurance should I get?

As we’ve discussed, life insurance comes in all shapes and sizes, and what’s right for one household won’t necessarily be best for another.

To figure out where your situation fits into the picture, follow this basic guide:

Determine your needs

The questions to ask here are:

  1. What are the current financial needs of my family?
  2. What sort of debt are we currently carrying, including our mortgage (if you have one)?
  3. What are the future financial needs of my family? 
  4. How would my family’s present and future financial needs be met if I were no longer around?
  5. Will these needs decrease as time passes and things change, such as when my children move out of home?
  6. Would my family benefit from a lump sum payment or regular, ongoing payments?

Consider your budget

Finding the right insurance policy is a balancing act between your financial present and your financial future. How much money do you have in your monthly budget to pay towards life insurance now? And how much coverage would you like in the future? 

If you want a more inexpensive policy, a term policy might be the best bet. 

If you want optimal coverage, you’ll want to opt for whole life insurance.

Remember, too, that the more of a risk the provider deems you to be, the higher your premiums are likely to be.

Choose a reputable insurer

You can take out life insurance from various places, including:

  • Life insurance brokers, whose job it is to find you the best life insurance policy out there for your needs
  • Life insurance companies — the companies who actually sell life insurance
  • Financial advisors, who look at your financial situation as a whole and advise you accordingly
  • Mortgage brokers, who find potential mortgage deals for you

With all those options, it can be hard to know where to start. If you need advice, get in touch with our brokers and we’ll take you through everything you need to know.

Quickfire summary

Although it’s not fun to think of, life throws us all sorts of curve balls. The best way to be ready for them is to plan as much as possible for an unknown financial future. Life insurance can help you do that. 

Life insurance is particularly important if you’re growing your family, have a mortgage to pay off, and/or provide financial support to others. 

Paying a monthly premium to an insurance provider means your loved ones will receive either a lump sum or regular payments should you pass away.

To find the right life insurance for your needs, you’ll need to look at your personal needs, risk factors, and budget. And then it’s important to talk to the right people

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