Life insurance is one of the most commonly overlooked aspects of personal finance in the UK. Yet being underinsured can leave families facing significant financial hardship in the event of an unexpected loss.
In this guide, we’ll explain how life insurance works, share tips on finding the most affordable quotes, and highlight key factors to consider when choosing the right cover for your needs.
What is life insurance?
Life insurance is a policy designed to provide financial protection for your loved ones in the event of your death. While it may feel uncomfortable to think about, it’s a crucial form of cover that can offer peace of mind—ensuring your family receives a lump sum or regular payments to help cover living costs, debts, or other financial commitments if the worst were to happen.
How does life insurance work?
When you take out a life insurance policy, you’ll agree to pay regular premiums—usually on a monthly basis—to keep the policy active. If you pass away during the policy term, your insurer will pay out an agreed sum to your chosen beneficiaries, such as your partner, children, or other dependents.
It’s essentially a worst-case scenario safety net. While no one likes to plan for such circumstances, life insurance provides a vital layer of financial security for your family during what would undoubtedly be a very difficult time.
Life insurance is especially valuable in unexpected situations where no other financial contingency plans have been made, offering crucial support when it’s needed most.
Types of life insurance policies
The different types of life insurance available are as follows:
1. Term Life Insurance
Term life insurance covers you for a set period—commonly 10, 20, or 30 years. A payout is only made if you pass away during this agreed term.
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Level Term Insurance provides a fixed payout amount throughout the policy term.
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Decreasing Term Insurance is often used alongside a repayment mortgage, with the payout reducing over time in line with the outstanding balance.
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Increasing Term Insurance, sometimes called index-linked, gradually increases the payout amount—either at a fixed rate or in line with inflation—to help protect against the rising cost of living.
2. Whole of Life Insurance
As the name suggests, this policy provides cover for your entire lifetime. A payout is guaranteed as long as you keep up with your premium payments. Because a payout is certain, whole-of-life policies are generally more expensive than term-based options, but they can be a good choice for estate planning or leaving a financial legacy.
3. Joint Life Insurance
This type of policy covers two people under a single plan, making it a popular option for couples—especially those with children. The policy pays out on the first death, providing financial support to the surviving partner. However, it’s important to note that once a claim is made, the policy ends and does not continue to provide cover.
While a joint policy means only one monthly premium, it’s not necessarily half the price of two individual policies. The main benefit is often the simplicity of managing a single plan.
Additional cover for policies
In addition to choosing the core type of life insurance, many insurers offer optional extras—similar to add-ons in other types of insurance—that can enhance your level of cover. Two of the most common policy additions include:
Critical Illness Cover (CIC)
This provides a lump sum payout if you're diagnosed with a serious illness covered by the policy. It’s particularly valuable if your condition prevents you from working, as the payout can help cover living expenses, medical bills, or mortgage repayments. The payout may be a pre-agreed lump sum or calculated as a percentage of your life cover.
Keep in mind that each insurer has its own list of covered conditions, so it’s important to read the fine print to understand exactly what is—and isn’t—included.
Terminal Illness Cover
If you’re diagnosed with a terminal illness and your life expectancy is 12 months or less, this cover allows the policy to pay out early. In many cases, terminal illness cover is included as a standard feature of life insurance policies, but it’s always worth confirming this when comparing options.
Is it worth getting life insurance?
For most people, life insurance isn’t just helpful—it’s a fundamental part of sound financial planning. If you have a partner, children, or family members who depend on you financially, life insurance provides vital protection. It ensures your loved ones aren’t left facing additional financial pressure at what would already be an incredibly difficult time.
The only scenario where life insurance might not be necessary is if you’re single, have no dependents, and carry no significant financial obligations, such as a mortgage or other debt. However, if you have any financial or familial responsibilities, life insurance can be an essential safeguard for your family’s future.
How money gets paid out with life insurance
Here is how life insurace payouts work...
What Happens When a Life Insurance Claim is Made?
If you pass away and have a valid life insurance policy in place—with all premiums up to date—your chosen beneficiary (or beneficiaries) will need to file a claim with the insurer.
The exact process can vary between providers, but it’s recommended that your family contacts the insurer as soon as possible to begin the claims process. Once the claim is verified and approved, the insurer will release the agreed payout.
Do You Pay Tax on a Life Insurance Payout?
Life insurance payouts are generally not subject to income tax or capital gains tax, which means your beneficiaries will receive the full amount stated in the policy.
However, there can be inheritance tax (IHT) implications. Life insurance payouts form part of your estate and, if the total value of your estate exceeds the IHT threshold, the payout may be taxed at 40%.
How to Avoid Inheritance Tax on Life Insurance
To protect your beneficiaries from inheritance tax on the payout, you can place your life insurance policy in trust. This means the policy sits outside your estate and is paid directly to your chosen beneficiaries, bypassing probate and avoiding IHT.
Setting up a trust is relatively straightforward, and many insurers offer this option when you take out the policy. Speaking to a financial or insurance advisor can help ensure everything is set up correctly from the start.
Other things to consider
While it’s always a good idea to speak with a life insurance expert to fully understand your options, here are some essential terms and concepts to help guide your decision-making when searching for the right policy:
Premiums
This is the monthly payment you make to your insurer to keep your life insurance policy active. Premium costs are influenced by several factors, including your age, health, type of policy, level of cover, and any optional extras you choose to include.
Beneficiaries
Your beneficiaries are the individuals who will receive the payout from your policy if you pass away. These could be your partner, children, other family members, or anyone you specifically name on the policy.
Level of Cover
Determining how much cover you need is a personal decision. You’ll want to account for existing debts, such as a mortgage, as well as the future financial needs of your beneficiaries—like living expenses, education, or childcare. Because of this, life insurance policies often provide cover for significant amounts.
Exclusions
Most policies come with specific exclusions. Common examples include:
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No coverage within the first 12 months
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Exclusion of suicide within the initial policy period
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Limited or no cover for high-risk jobs or hobbies
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Death resulting from alcohol, drug use, or pre-existing medical conditions
It’s crucial to read the policy documents carefully and ask questions about any unclear terms.
Optional Extras
Many insurers offer additional benefits that can be added to your policy, such as:
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Critical illness cover
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Terminal illness cover
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Accidental death benefit
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Other insurer-specific features
These extras can provide more comprehensive protection but may also increase your premiums.
Understanding these basics will help you make more informed choices—and discussing your needs with an advisor can ensure you get the right cover for your situation.
Examples of life insurance providers
The right life insurance provider for you will be specific to your circumstances and needs, but here are some examples of popular mainstream insurers:
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Legal & General: The policies include terminal illness cover as standard. You can also choose to have fixed premiums that won’t fluctuate unless you make changes to your policy, starting from just £5 a month.
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Aviva: With Aviva, existing customers can get a 10% discount on life insurance policies, starting at £5 a month. Aviva also makes it relatively straightforward to put your life insurance policy in a trust.
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Scottish Widows: You can choose between two main options with Scottish Widows - ‘Plan & Protect’ or ‘Scottish Widows Protect’. The Plan & Protect offers basic coverage up to £500,000 but the Scottish Widows Protect has more benefits and life cover up to £18 million.
It’s best to have a quick chat with an expert advisor to find the right life insurer for your needs. Some insurers specialise in specific areas like younger or older applicants or those who work in high-risk professions.
Frequently Asked Questions
It’s not a legal requirement but most mortgage lenders recommend it to ensure your mortgage is paid if something happens to you. If you have a mortgage and no life insurance (or other type of protection), then your family may be forced to vacate your home or find a way to pay the mortgage without you.