Term life insurance provides financial protection for a specified period (the policy term). For example, while you’re raising children or paying off a mortgage.
However, with this policy type, if you don’t pass away during the term (and the policy expires) you won’t get a pay out or any money back. Even if you’ve paid into the policy over many years.
For this reason, term cover usually offers the lowest monthly premiums (lowest monthly cost) as the risk of passing away during the term is generally low.
To avoid this particular drawback of life insurance, you could look into a life-long policy such as whole of life or over 50s life insurance.
Cancelling a life insurance policy after the insurer’s cooling off period, which is typically 30 days, is likely to forfeit any monthly premiums paid.
There are also no refunds if your policy is cancelled by the insurer due to missed payments.
While cancellation could be necessary in some cases, it can be possible to make changes to a policy or switch to a different type of cover for no extra cost as an alternative solution.
One main potential drawback of life insurance is that you could pay more in premiums than the total amount paid out when you pass away.
This is more likely to happen with certain types of life insurance, such as over 50s or whole of life insurance, as premiums need to be paid until you pass away or reach a specified age (such as 90).
This risk depends on your age when you take out the policy, how long you live and the cost of your monthly premiums.
This is where high interest savings accounts or investments could offer better value.
Life insurance taken out today may not always be suitable for your needs in the future.
As life evolves, so may your protection needs, which could result in gaps in your cover.
For example, throughout a policy term, you may experience some key milestones, such as:
- Getting married
- Getting a new mortgage
- Paying off the mortgage
- Growing your family
- Getting a promotion or changing jobs
- Moving overseas
While this could be a potential drawback, most policies allow you to make changes to your cover following certain life events.
For example, you may be able to increase your level of cover after getting married, buying a house or having a baby.
A life insurance policy can span over many years, during which rising inflation could affect the buying power of the pay out.
For example, a policy taken out today with a pay out of £200,000 is unlikely to cover the same costs in 20 or 30 years time.
However, for those concerned about the rising cost of living, there are policies available which are designed to help combat this risk.
Known as increasing or index-linked life insurance, you can take out a cover amount that increases each year in line with any inflation changes.
Honesty is essential when applying for life insurance.
Providing false information or failing to disclose certain details when asked by the insurer could result in your policy being invalidated.
If this happens, your loved ones may not receive a pay out when they need it most.
It’s important to answer all questions fully and truthfully to reduce the risk of a claim being declined.
A life insurance pay out is typically added to the value of your estate when you pass away to work out how much inheritance tax you owe.
If the total value of your estate, including life insurance, exceeds the tax-free threshold, then up to 40% inheritance tax could be charged – reducing the amount your loved ones receive.
While this is a potential risk, one way to avoid or minimise inheritance tax on your life insurance is to write it in trust. This is usually a free process that separates the pay out from your taxable estate, helping to provide a larger sum for your family.
This can also result in a faster pay out, as the money won’t usually need to go through probate.
