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Term and whole-of-life insurance - a helpful guide

08th November 2018

Life insurance is a somewhat morbid topic that we do not really want to consider needing. We often prefer to push that thought to the back of our minds and avoid tackling the issue head on. Despite this, it is often very important that you have a life insurance policy. After all, it is inevitable that we all die at some point. The reality is that almost everyone would benefit from having a life insurance policy. You may however be confused as to what each different type of policy offers, and which kind of life insurance you should choose.

In this article, we look at the pros and cons of two different types of life insurance: term and whole-of life and when to use each type. We hope to facilitate an understanding of the differences in these two types and which kind of policy would be most suitable for you.

Term insurance

Taking out term insurance involves paying for a policy to cover a specific period of time (that is, if you die within the policy’s period). This term could range from any amount of time, but is typically between 5 and 40 years in length.

Level term insurance: pros

  • The amount of cover does not change. This makes it great for ensuring that your family are protected upon your death or the policy is usually in conjunction with an interest only mortgage.
  • Beneficial if you require a specific amount of cover for a specific amount of time. This may seem illogical but, for example, you may wish to cover your interest-only mortgage with your life insurance. If so you need cover for the 25-year mortgage term, but you will not require insurance once this is paid off. Another reason may include responsibilities to children ‘expiring’ as the children become of age.
  • Family income benefit policy. These exist to pay a regular income (rather than a lump sum) to your family after you die. They are usually used in conjunction with educational fees or other financial responsibilities.
  • Premiums are guaranteed to remain the same throughout the term- based on your current age and health etc.
  • You can index link your policy – so the benefits/cover increase annually for example to cover inflation. Note: the premiums will also increase to pay for this.

Level term insurance: cons

  • There is no further cover once the term has expired. It is difficult to plan and forsee the future financial responsibilities of yourself and your loved ones. If additional costs, responsibilities or debt arise that your policy does not account for, your loved ones may not be sufficiently covered by your policy.

Decreasing term insurance

Policies often offer decreasing term cover. This means that the payout (and premiums) decrease over the life of the policy. This is useful if you have debts/responsibilities that are decreasing with time. The purpose of this type of policy would be to pay off such decreasing debts. People may do this in conjunction with paying off a repayment mortgage or student debt. Of course, as the insurer has a reducing liability as the customer you pay a reducing premium.

Whole-of-life insurance

Whole-of-life insurance is another type of life insurance. There are no terms and instead, as the name suggests, this kind of insurance covers your entire life with a guaranteed payout when you die. With whole-of-life policies, usually the premium remains the same for the first ten years when it is then reviewed and usually increased. The benefit of this for you as a customer however, is that the insurer builds up a surplus pot of money that they would pay to your beneficiary if you die. If you decide to cancel your policy, for example when the premium is increased, your insurer will pay whatever is in this pot back to you. This is not an investment as in reality you are only gaining your own money back but it is reassuring to know you will not be at a loss.

Whole-of-life insurance: pros

  • Policies can be beneficial for tax-planning purposes. Your policy payout could cover your inheritance tax bill so that your beneficiaries are not affected by this tax. You will therefore be able to pass more money onto your beneficiaries.
  • This is recommended for cases when a client’s inheritance liability is high but they have young or still-dependent beneficiaries. For example if they have a high tax liability but young children.
  • So long as you keep your policy, there will be a pay out whenever you pass away.

Whole-of-life insurance: cons

  • Premiums are more expensive.
  • There are few cases when whole-of-life policies bring worthwhile benefits when weighed up against the cost of the premiums. Of all your financial responsibilities, the majority will decrease as you grow older. The only one that may not, is inheritance tax responsibility. But the need for your inheritance by your loved ones usually decreases with time. That is, unless you have loved ones who would be dependent on receiving your full inheritance, there is little to be gained from paying premiums to cover inheritance tax.

There are some new policies being introduced which offer guaranteed and stable premiums. But the premium is more expensive to account for this.

Should I get term or whole life insurance?

To answer the question as to which – term or whole-of-life – insurance is better is not a one-size-fits all answer. It is entirely dependant on your personal situation.

If you are younger and are able to pay the higher initial premiums, you could consider taking out a whole of life policy. The main motivation for doing so would be to avoid your loved ones’ inheritance being decreased as a result of inheritance tax liability.

In most cases the only financial responsibility that remains into old age is inheritance tax – not responsibility to children, loved ones and debt. If you require life insurance as a security measure for paying off any debts when you pass, or to give your family a regular income to keep them on their feet when you are gone, a term policy may be most beneficial for you. Level term means level benefit – the level insurance payout throughout the term remains the same. As your financial responsibilities end, so too do your premium bills (if you have planned your policy accurately and in accordance with your financial responsibilities). If your financial responsibilities are decreasing with time and you would like to decrease your monthly premiums, decreasing term cover may be a good option.

Historically people have chosen more expensive whole-of-life insurance premiums to cover inheritance tax and as a combination of modern insurance and a savings plan. Nowadays however, we usually advise people to take out fixed term insurance and invest the difference into an ISA or other savings vehicle instead. This way they are more likely to make money on their savings.

For expert advice on which type of life insurance would be most beneficial for your personal situation, get in touch with the friendly IMC team today.

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