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Life Insurance

Also known as: Life Assurance, Death Cover, Life Cover

Definition

Life insurance is a financial product that pays out a lump sum or regular income to your chosen beneficiaries when you die, providing financial security for your loved ones.

Understanding life insurance is essential when creating a will, as these policies work alongside your will to protect your family financially. When properly coordinated, life insurance can provide immediate funds to cover debts, replace lost income, and even pay inheritance tax bills.

What Does Life Insurance Mean?

Life insurance is a contract between you and an insurance company: you pay regular premiums (monthly or annual payments), and when you die, the insurer pays an agreed sum to people you've nominated, called beneficiaries. In the UK, there are two main types. Term insurance covers you for a specific period like 10, 20, or 30 years, while whole-of-life assurance covers you until death, whenever that occurs. These policies are regulated under the Financial Services and Markets Act 2000, with tax treatment defined in the Finance Act 2012.

Setting up life insurance involves completing an application with personal and health information. Insurers ask about medical history, smoking status, occupation, and hobbies to assess risk through a process called underwriting. Premiums vary significantly based on these factors. For example, a 30-year-old non-smoker might pay £12 monthly for £200,000 of 25-year term cover, while a 50-year-old smoker might pay £45 for the same cover. When you die, your beneficiaries submit a death certificate and claim form, and insurers typically pay out within three to four weeks. In 2024, UK insurers paid 97.9% of all life insurance claims, totalling a record £8 billion, dispelling the myth that insurers routinely avoid paying out.

Life insurance plays a crucial role in estate planning, particularly for inheritance tax purposes. If your policy isn't written in trust, any payout becomes part of your estate and may be subject to 40% inheritance tax if your total estate exceeds £325,000 (£650,000 for married couples). For example, if you have a £400,000 estate plus £100,000 life insurance not in trust, your total £500,000 estate incurs £70,000 inheritance tax. However, if the life insurance was written in trust, it stays outside your estate, reducing the tax bill to £30,000. Many people use whole-of-life assurance specifically to create funds for paying inheritance tax bills, ensuring their family doesn't need to sell property to cover the liability within HMRC's six-month deadline.

Common Questions

"What's the difference between life insurance and life assurance?" Life insurance typically covers you for a specific term (e.g., 10, 20, or 30 years) and pays out only if you die during that period. Life assurance covers you for your entire life and is guaranteed to pay out when you die, as long as premiums are maintained. Term life insurance is usually cheaper because it has an end date.

"Do I need to include life insurance in my will?" You don't include life insurance in your will itself, but you should coordinate them. Most life insurance policies let you nominate beneficiaries directly, which means the payout bypasses your estate and goes straight to your chosen recipients. However, if the policy isn't written in trust, the payout may form part of your estate and be subject to inheritance tax.

"Will my life insurance payout be subject to inheritance tax?" Yes, unless the policy is written in trust. If your life insurance policy forms part of your estate, any payout will be added to your estate's value and may be subject to 40% inheritance tax if the total exceeds £325,000 (or £650,000 for married couples). Writing the policy in trust keeps it outside your estate for tax purposes.

Common Misconceptions

Myth: Life insurance is too expensive for most people.

Reality: Life insurance is far more affordable than most people think. Research shows 92% of millennials overestimate the cost, believing term life insurance costs three times more than it actually does. For example, a healthy 30-year-old non-smoker can get £200,000 of 25-year term cover for around £12-15 per month, less than many people spend on streaming services.

Myth: Insurers find ways to avoid paying out life insurance claims.

Reality: UK insurers paid 97.9% of all life insurance claims in 2024, with the industry paying over £8 billion in claims that year alone. Claims are only declined in rare circumstances, typically when applicants provided materially false information during the application, such as failing to disclose smoking or serious medical conditions.

  • Life Insurance Trust: A specific type of trust structure used to hold life insurance policies outside your estate, avoiding inheritance tax on the payout.
  • Beneficiary Nomination: The process of specifying who receives your life insurance payout, which differs from naming beneficiaries in your will.
  • Death in Service: Employer-provided life insurance offering similar benefits but through workplace schemes, which should be considered alongside personal policies.
  • Inheritance Tax: Life insurance payouts may be subject to this 40% tax unless the policy is written in trust.
  • Trust: The legal structure used to hold life insurance policies outside your estate for tax purposes.

Need Help with Your Will?

Understanding how life insurance fits into your estate plan is essential for protecting your family financially. Coordinating your will with life insurance policies ensures your beneficiaries receive the full benefit of both.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.