How To Use Life Insurance To Protect Your Family Finances

Life insurance is one of the most effective ways to protect your dependents against the financial loss that can occur on the death of the main family breadwinner.

Like most insurance plans, price tends to drive life insurance buying decisions before product quality and ultimate suitability are considered. In reality, focusing solely on the monthly cost is not always an accurate indicator of the best value cover. Unfortunately, any shortfalls in cover are usually discovered when it’s too late after a claim is made.

An example of this is term life insurance plans which usually offer two premium options, guaranteed or reviewable. Guaranteed premiums are just that, fixed at outset and guaranteed by the insurer not to be increased if they experience a higher than expected level of claims. This is opposed to reviewable premiums which are subject to review, usually every five years and, can be increased at the insurer’s discretion.

Although guaranteed premiums are more expensive than reviewable rates they should be considered, particularly for policy terms in excess of ten years. This is because the level of each potential premium review increase is likely to rise the older you get.

Is a Lump Sum or Income Benefit Best?

A more accurate measure for getting the best value cover is to match the right policy type to need for protection. A good example is the fact that most policyholders choose lump sum cover when applying for a life insurance plan intended for family protection. Lump sum cover is fine if you need to provide large sums to settle debts such as mortgages and loans. True family protection cover is more about ensuring an income is provided to replace that lost on the death of the life assured and main earner. The potential problem with a lump sum used for family protection is where do you invest the lump sum to generate the required income? And will the income generated be subject to tax and sufficient to meet the needs of the surviving dependants?

A more suitable solution is cover that’s designed to provide an income to the end of the required term rather than a lump sum. This is known as Family Income Benefit and has many advantages over lump sum alternatives. The first of these is that it’s usually cheaper than a comparative lump sum plan because the risk to the insurer decreases over the policy term. For example, a 20 year level term assurance plan with a sum assured of £100,000 will cost the insurance company £100,000 if a claim is paid up to the end of the cover.

Compare this to a Family Income Benefit policy providing an annual income benefit of £10,000 over the same 20 year term which could potentially cost the insurer £200,000 if a claim was made shortly after inception. In practice this is unlikely so the risk to the insurer decreases throughout the term. So if a claim was paid during year 10 the insurer would pay the annual income benefit for the next 10 years.

An additional feature of Family Income Benefit is that the income benefit can be paid on an increasing basis if selected from the outset. This option is usually available as a flat rate percentage increase or as a link to certain indices such as Retail Prices or Average Earnings.

So overall, Family Income Benefit can provide an almost perfect solution to providing an income for your dependents on the premature death of a family breadwinner. Not only is often the cheapest form of family protection life insurance but it also currently provides the income benefit totally free of tax.