Life Insurance Explained
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Whatever your star sign, today is the day you find out more about life insurance, especially if you’re one of the 42% of mortgage holders in the UK who do not have life insurance cover1. Life insurance can bring financial benefits and peace of mind to the policyholder and their family. However, many people do not understand what life insurance is and how it works. Life insurance doesn’t have to be complicated, especially when you have a Sherpa with you to help.
Investopedia defines life insurance as 2:
A contract between an insurer and a policyholder in which the insurer guarantees payment of a death benefit to named beneficiaries upon the death of the insured. The insurance company promises a death benefit in consideration of the payment of premium by the insured.
To break that down, you pay a monthly fee to a life insurance company for a predefined length of time. If you die during that time, the insurance company will pay a sum of money to whoever you nominate.
Why Life Insurance?
The main reason people buy life insurance policies is to protect their loved ones should the worst happen. Our financial commitments range from essentials like mortgage or utility bills to luxuries like a Netflix subscription. You took out a mortgage because you thought you would be alive to pay it off. But if you died suddenly, would your next of kin be able to cover those payments? Life insurance is there to soften that blow.
Life insurance is also there to help cover your immediate post-death costs, such as a funeral. The average price of a funeral is £4271 4.
Our final reason that people buy life insurance is peace of mind. When you have life insurance, you can relax knowing you are providing for your loved ones in the event of your death. The payment from a life insurance policy could even leave them in a better financial situation than before.
Why Do People Not Buy Life Insurance?
There are very few disadvantages to taking out life insurance. That’s why it’s a surprise that more people do not do it. In 2017, 1 million fewer people took out life insurance policies compared to 2014.
If you reach the end of your insurance term and you are still alive, you lose the premiums you have paid in. On the other hand, you’re still alive!
The other reason is that people do not like to think about their own mortality. Thinking about what will happen to your loved ones after you have gone is not fun.
Key Definitions for Life Insurance
When you investigate life insurance, you may encounter some complex-sounding terms. Don’t worry. We’re here to explain them for you.
What are Life Insurance ‘Terms’?
The ‘term’ of your life insurance policy is its length. During the term, you pay a monthly premium to your insurance company. If you should die within the term, the insurance company will pay your nominated beneficiaries.
‘Term’ in this case is not to be confused with ‘Terms and Conditions’. You will have terms and conditions with your life insurance policy which you will need to read and understand.
If you have a ‘level term’ life insurance policy, your premium will stay the same throughout the term.
For a ‘decreasing term’ life insurance policy, your premium falls as you go through your term. The payment in the event of death reduces with it.
Premiums for ‘increasing term’ policies rise as you go through your term. However, the available payment increases along with it.
What Kind of Life Insurance Policy Do You Need?
Now you know about the different types of life insurance, which is right for you?
When Level Term Policy is Best
Level term life insurance is the simplest type of policy. If you need a lump sum of money to help repay debts or support your loved ones, this could be sufficient.
When Decreasing Term Policy Is Best
Decreasing term life insurance excellent for people with mortgages.
As you make payments towards your mortgage every month, the amount you owe decreases. So, the longer you go through your term, the less money you need to cover your mortgage in the event of your death.
With decreasing term cover, premiums and cash benefits fall in line with your mortgage.
When Increasing Term Policy Is Best
Increasing term life insurance cover brings two benefits. You pay less at the start of your policy when you are younger and healthier. Also, while your premiums rise over time, so does your cash benefit. This means that your benefits are where they should be, taking inflation into account.
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We hope this article has helped you understand the ins and outs of life insurance. To find out more, subscribe to Sherpa today.