Can you do an educational post on Life Insurance? A lot of people in our community still depend on donations when there is a bereavement, I think they’d be surprised to find out how cheap it actually is to get life insurance.
Firstly, I need apologise because I got this request in September 2017 when I was so focused on finding a job. It’s been at the back of my mind ever since but deaths from COVID-19 have prompted me to get round to writing this as a matter of urgency!
So, how do you know if you need life insurance?
The test is very simple. If you answer yes to any one of the following two questions, you need life insurance:
1.Is anyone financially dependent on me?
2.Would my death cause a financial burden for anyone else?
If you have dependents then you need life insurance. The dependents might be your children, your parents, your partner or someone else entirely.
Even if everyone is completely independent of you, if you don’t have enough money in the bank for the funeral then you need some kind of insurance, either life insurance or funeral insurance depending on your age.
Should you get life insurance or a funeral plan?
With a funeral plan you essentially prepay some of your funeral costs. The specifics of what is covered vary from provider to provider. Also, to get a funeral plan you usually need to be 50+, I won’t say much more about funeral plans in this post other than if you want to cover more than just your funeral then a funeral plan is NOT what you need.
What is life insurance? How does it work?
When you buy life insurance you make monthly payments to an insurance provider and in the event of your death they pay a pre-agreed amount of money to the dependents named on the policy, these are called the beneficiaries of the insurance policy.
There are two main types of life insurance?
Term life insurance and whole-of-life insurance
Term life insurance pays out if you die within a specified number of years. So, you buy the insurance policy for a fixed term of say 20 years and if you die after that 20 year term there is no pay out because the life insurance will have expired.
This is ideal if you want your dependents protected only for a specified time. For example you might choose a term that coincides with the 21st birthday because you decide that by that point a) the child will no longer be dependent on you or b) you will have saved enough money by that point to cover your dependents’ financial needs.
In addition to protecting dependents you might want to cover extra funeral costs. For example in my last will and testament I state that I want to be buried in the UK as that is where my husband and children live but I also state that flights must be covered for my parents, siblings and the children of my siblings to attend the funeral.
Think carefully about what you a) need and b) want to be covered in the event of your death. If it’s just your dependents’ living costs for x years think carefully through what their annual cost of living is likely to be, does it include school fees? or university fees? Make sure you don’t forget anything that is important to you.
If your family has a monthly budget then you can use this as the basis for calculating your dependents living’ costs.
Whole-of-life-insurance pays out whenever you die. It is more expensive because you are definitely going to die at some point. You would buy a whole-of-life policy if, say, you want to cover inheritance tax as well if you expect to have enough wealth to be subject to inheritance tax.
Most people just buy term life insurance because they just want to protect dependents. Inheritance tax only kicks in for estates worth £1million and over. This is a not a problem for most folk but is more likely to be an issue for the type of folk that listen to personal finance podcasts.
TERM LIFE INSURANCE
If you decide to buy term life insurance, in addition to the term, you need to make three critical decisions:
Level term insurance pays a fixed amount whenever you die while decreasing term insurance falls towards zero as the maturity date or the end of the term approaches.
You would usually buy decreasing term insurance to cover your home mortgage. So you would set the maturity to match the date when you will finish paying off your mortgage and over time, as the mortgage balance falls, so does the pay out.
The interest rate used to calculate the balance on your decreasing term insurance policy is usually much higher than the interest rate you actually pay on your mortgage. How this impacts you is that your mortgage balance falls faster than the pay out of the policy. This is obviously good as it means your pay out will be a little higher than the mortgage balance if the terms match exactly.
Critical illness cover increases the price of an insurance policy by A LOT but it means that if you get any of the covered illnesses you will get a pay out. Most people add critical cover to the decreasing term life insurance policy that covers their mortgage.
If you fell critically ill, the policy would pay you enough to clear your mortgage. This would be really useful if you are the main breadwinner and lost income because of your illness. As the mortgage is usually the biggest monthly expense, not having mortgage payment to worry about would reduce the household’s stress significantly.
One extra thing, you can reduce the cost of life insurance by getting a policy that pays out monthly or annually for given number of years instead of getting one lump sum. So, instead of £300,000 paid out in one go you can have a pay-out of £30,000 a year for ten years or £2,500/month for 10 years. You need to decide if this is worth the reduced monthly cost of the insurance policy. Get a quote for both before you decide. You might decide to go for the annual or monthly pay-out if you think your dependents wouldn’t use the money wisely if used in one go.
How much does insurance cost?
It depends on how old you are and what level of cover you want, i.e. the monthly payment on insurance that would pay out £100,000 if you died is cheaper than insurance that would pay out £500,000.
The younger you are, the cheaper it is but obviously the younger you start the longer you will be paying the provider for.
I know it’s easy to think I don’t want to pay for something that is likely not to be needed. Possibly the insurance won’t be needed and that’s awesome because it would mean you’ve stayed alive, the better way to think about it, however, is that “in the unlikely event of my untimely death would I regret having paid £x per month to ensure my dependents do not suffer?” Even if all you can spare is £10 per month you should be able to get some life insurance for that amount.
How long does it take for life insurance to be paid out?
Usually you can expect a payment within 30 to 60 days of filing a claim, but delays can arise—if the insured person dies within the first two years of the issuance of a policy, for example, that may need some investigating.
At a base level, this is all you need to know. So, let’s summarise to help you with next steps. If you have figured out that you do need life insurance then you need to decide:
My thoughts are that at a minimum you should have enough life insurance to cover your mortgage and the costs of living until your youngest child is 18. Critical illness is great but if you can’t afford it don’t stop yourself from getting life basic insurance. Please don’t leave your dependents to depend on the good will of people, get insured.
I hope this helps! Much love and stay blessed.
Have a money question for me?
I'm 22 years old and I've been trying to get a good control of my finances. I'm still a student so I don't have a regular income. I've set up a LISA account to save for a house but I'd also like to begin saving for retirement. I've looked everywhere online but nothing seems to explain what different kinds of pensions there are, how to open them and how they work. Please help!
Alex, this is an amazing question to be coming from a 22 year old! Well done for setting up a Lifetime ISA, that's a good move especially as they are considering phasing that scheme out.
I have been meaning to write a post on personal pensions this since Christmas because another person asked a few specific questions so I’ll tick their questions off in this post too as they could apply to you as well at some point in the future.
Pensions are one of my favourite topics. If you were in a job you would have access to either:
What you need to open is a self-invested pension plan or SIPP.
When you do have a work place pension, you can also have a SIPP in addition to it; there are no penalties for doing so unless you’ve reached the annual limit for investing in a pension but this isn’t something most people need to worry about.
Once you open a pension account, you need to decide how you want your money to be invested. This is your decision unless you hire a financial adviser. However, even if you do get financial advice I always strongly advise getting some financial knowledge so that you can judge whether you agree with the advice you are getting or not. Every financial adviser has her own beliefs and biases about investing, that's human, the question is whether you agree with her.
Most people don’t know a lot about investing (including me when I started working) so some investment sites might ask you to answer a few questions on how you feel about risk-taking and then they suggest “ready made portfolios” to you to invest in which would be aligned with what you say your risk tolerance is, your “stated” tolerance for risk.
On some sites you might have access to “target retirement funds” this means you state when you want to retire and they adjust the risk of your investments based on that. For example, if you want to retire at the age of 62 which is 40 years from now, in your case, you would select a 2060 target retirement portfolio. The fund manager would then manage the risk by investing in more risky stuff now when you are far away from retirement and as you approach retirement the balance of investments would be adjusted away from higher risk, higher return investments towards lower risk, lower return investments.
The risk-return relationship is very important here. If you say you have a lower tolerance for risk then the options you will be given will have a lower associated risk but also a lower return on your money.
If you have a long time until retirement, and being 22 Alex, you have a very very long time until you need to retire then you can afford to take more risk. Personally, 100% of my stock investments are in equities (that is, they’re invested in company shares) because I get a fixed bond-like return from property investing so that balances it out.
By comparison, the average investor will usually have a portion invested in bonds and a portion in equities. By buying bonds you lend money to companies or a government and they pay you a fixed amount for that loan. As a lender, you are not a part-owner of the company and as such you don’t get a share of the company’s profits as you would if you invested in the shares. By the way: shares, stocks, equities are usually used interchangeably – they mean the same thing in most cases.
Equities vs. bonds
I won’t go into too much detail on equities vs. bonds but here are some important differences:
Why am I telling you all this? Because you need this sort of high level knowledge to decide how your money will be invested. What portion of your investments will you put into equities and what portion into bonds?
If you’re investing in ready-made portfolios and they give you an indication of risk, the higher risk portfolios have more equities and the lower risk portfolios have less equity investments.
Single stocks or index funds
You can manage your risk by only investing in funds or portfolios that invest in a wide variety of companies.
Some people find it more exciting to buy a single company's shares (single stocks) but that is much more risky than investing in funds because a fund is a diverse portfolio of lots of companies. As Index funds include a large number of companies, the complete failure of any one of those companies would have a much more limited impact on your return. I have dabbled in buying single stocks myself and I can tell you that it’s very difficult to choose winning stocks – to maximise your chance of winning “buy a whole stock market”, either by buying index funds that track a whole country or by buying index funds that track a whole industry.
If you do want to dabble in single stock investing, don’t put any more than 10% of your portfolio into them and as your portfolio gets larger I would reduce that to 5%. So, for every £1,000 invested don’t put more than £100 into single companies and as you move towards a portfolio worth £100,000 I would personally reduce single stocks to no more than 5% of my investments. These are arbitrary percentages and as you gain experience you will decide what feels more appropriate for you.
Actively managed vs. passively managed funds
There are two main types of fund to choose between, actively managed funds and passively managed funds.
Passively managed funds track a whole market such as the S&P500 which tracks the 500 largest, listed companies in the US or the FTSE100 which tracks the 100 largest listed companies in the UK - I emphasise listed because there may be companies that are just as large as those listed on the stock market but because they are privately owned you wouldn’t have access to buy their shares.
Alternatively, instead of tracking the whole market in a given country you can choose to invest in a specific sector such as utilities or technology or consumer goods.
Actively managed funds have an actual person choosing which shares are likely to outperform the market and investing in such undervalued shares or choosing companies that are likely to grow rapidly and enjoy a rapid increase in value. The objective of an active manager is to beat the market index, while the objective of a passive fund is to match the return on an index.
Now, you would think active funds, managed by "clever" fund managers are likely to beat the average market return from passive funds, right? Unfortunately, history has taught us that this very simply isn’t so: over 95% of the time fund managers do not beat index trackers. Not only that, the fees on actively managed funds are higher so even if you observe that an actively managed fund has achieved the same gross return as a market tracker you would be earning less from the active fund after fees have been deducted.
Where to start? Where to start?
I realise that this is all very technical stuff especially if you are beginner so here are links to a few indices to get you researching and investing. These are all funds I am invested in but I am not recommending you invest in them, only that you look at them to see what is included in each fund, what countries are represented, which companies are invested in, what the fees are and what returns have looked like over the last 5 years.
I have put the fees each fund charges in brackets as the fees charged is one of the primary reasons I choose whether or not to invest in a fund. Fees can dramatically erode your return so you should always consider what the fees are before you invest in anything:
Even from the above you can see the large difference in fees between my actively managed fund and the passively managed ones. However, I am personally convinced by the management of Fundsmith. Their investment philosophies are aligned with mine and I think they have the potential to beat the market over time but I don’t put all my eggs into the Fundsmith basket despite my confidence in them.
In summary, if you invest in a self-invested pension plan there is no commitment to a fixed pension income at the point of retirement. You therefore need to carefully decide how the money is invested. In doing this you need to consider:
Where can you open a SIPP?
The biggest difference between the various platforms where you can open a SIPP is the user interface, customer service and the FEES.
In a nutshell you might be charged any and all of the following fees:
Here are a few places you can open a SIPP account including the fees. The money to the masses website has a table showing what the fees look like depending on the amount invested. I recommend you have a look at that but below I share four that I consider to be popular and cost effective.
Halifax share dealing
Having only Vanguard’s funds is not necessarily a bad thing, they are cost effective and if you have an ISA elsewhere in addition to the SIPP at Vanguard, you can use that to invest in funds run by other institutions, e.g. Legal and General and Fidelity to name a few. Vanguard are very well rated in terms of performance and customer service in addition to having good fees. That said, you could save money on the account fee by investing in Vanguard funds via Halifax share dealing or iWeb and those two platforms would give you access to a wider variety of funds as well.
Also, Vanguard’s minimum investment is £100/month or £500 lump sum. If you want to start out with £25/month which at your age is absolutely fine, then you need a platform that will allow lower monthly contributions.
Where do I invest?
I have a SIPP for my son at Hargreaves Lansdowne and I have a SIPP for myself at iWeb. The fees at iWeb were the cheapest for my ISA and I decided to have my SIPP there too as the fees were reasonable although not the cheapest at the time I opened it. It didn’t make sense to have a SIPP elsewhere to save not very much money.
iWeb don’t offer junior ISAs and I wanted to keep my son’s SIPP with his ISA as well so I added it to his Hargreaves Lansdowne account. Based on the small amounts being added to his SIPP (£100 per month) the SIPP fees were actually cheaper at HL but they would have been more expensive for me because my SIPP account has much more invested than my son’s.
To cut a long story short, where you choose to open a SIPP can also be influenced by where you have an ISA and whether you want these to be kept together. It’s not necessary to have your investments all in one place, I certainly have several investment accounts for various reasons. Before you decide speak to a few people including family members so you have a flavour for where your social circle seem to be investing, if at all.
How much can you put into the SIPP each year?
You can have a SIPP if you're resident in the UK whether or not you pay tax but your earnings impact the maximum amount you can put in each year.
If you are not employed via the PAYE system, the maximum is £2,880 if you are not employed which becomes £3,600 including the government top-up which is equal to what you putting times 100/80.
When you are employed you can put the equivalent of your full salary into your pension up to a maximum of £40,000 per year.
I won’t go into lifetime limits for you as you are so young and will discuss those in my general post on pensions.
Can you have a SIPP if you are a British citizen living abroad?
You cannot make contributions to a SIPP if you are not a UK resident even if you have a British passport. You have to be a UK resident. If you have spent some of the year abroad and some of the year working in the UK, HMRC counts the number of days spent in the UK to confirm if you are UK resident. I won’t go into detail here because the actual number you need to qualify as a UK resident depends on whether you were a UK resident in the previous few years.
You can, however, set up a SIPP if you're resident overseas and want to transfer a UK pension from a previous job to the SIPP (but you cannot make further contributions to it). So, for example, if you have a pension with a UK employer and want to transfer that to a SIPP while you are abroad, you can do that.
If you’re resident abroad but paid in the UK and pay tax here you can also have a SIPP. So, for example, some British expats work abroad but are paid in the UK and pay a portion of their tax in the UK and are likely to qualify, however, speak to an accountant or financial planner to make sure you don’t fall foul of any rules if you’re ever in this complex domicile situation.
What happens if the company you have your SIPP with goes bust?
If your SIPP provider becomes bankrupt, your money should remain unaffected. Your money is not invested in the SIPP provider themselves; they either simply manage your investment or act as a platform for you to manage your own investments.
I hope this helps!
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Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.