The biggest mistakes you can make with life insurance

Thursday, 12 January 2012 03:40

By Kate Saines

If your New Year’s resolution is to take out life insurance you will no doubt be eager to sign up to the right policy.

But getting it right is no mean feat, especially when there are so many protection plans available and plenty of pitfalls to be aware of.

So before you go looking for a policy, it’s worth ensuring you are well versed in the basics of life insurance. By being aware of the mistakes that could be made you can avoid wasting your money or having a policy which might not pay out.

Here are a few common life insurance mistakes and how to avoid them

Mistake 1 – assuming life insurance in unnecessary

Many people think life insurance is just for those with families or dependants. And, to a certain extent, they are right. Someone without any liabilities would have nothing – or no one – to gain from owning a policy.

But just because you are single or without children it does not mean you should go without any protection. This is because life insurance – in its various forms – is also a way of protecting those of us with any major responsibilities should we lose our income through unemployment or serious illness.

Neil Baker, an independent financial adviser for Protection & Investment Ltd, said life insurance should become an important factor when you take on any liability, even a mortgage or a large loan, such as a business loan.

And even if you are covered for death in service through your employer, you should not rely solely on this benefit.

Mr Baker explained: “When purchasing a house I would always recommend [clients] take out personal cover to solely protect the mortgage, as with the way people move around jobs these days, you may find the company you go to does not give you that death in service.

“And unless it’s at the front of your mind, you might find yourself uncovered.”

There are a variety of different life insurance policies available, and your own personal circumstances will dictate which is most suitable for you.

Mr Baker said: “If [a client] has taken on a mortgage we would need to work out if the mortgage is a repayment mortgage because then a decreasing term policy might be the best option. If it is an interest-only mortgage a level term assurance policy would be better.”

And he added: “You can also look at adding things like critical illness cover, which is something a single person without kids might want to do, because if they were to get a critical illness they would benefit from the lump sum.”

It’s not just those who have no dependants who assume they do not need life insurance. Often parents who are renting their property overlook this form of protection.

This tends to be because anyone taking out a mortgage will usually receive financial advice of some description but those renting will not.

“This is still very important,” said Mr Baker, “as if you asked most parents whether they would be prepared to pay £10 to £20 a month to give their child financial cover if they were to die, most parents would say ‘yes’.”

To summarise: If you have any liabilities, life insurance could certainly pay off. Just make sure you take out the correct type of policy to suit your needs.

Mistake 2 – Forgetting about or ignoring your policy

Simply taking out a life insurance policy is just half the job, unfortunately. Once you have signed up, you’ll need to review the plan regularly to make sure it’s still relevant to your circumstances.

There are a raft of scenarios which can occur in your life which could make a difference to your premium and any potential claim you might make.

Anything from remortgaging your house, to taking on other debts, or from starting or increasing the size of your family to quitting smoking will all effect your life insurance.

Neil Baker said: “Any time you have another child the cover should be reviewed, and also any time you change your mortgage term it should also be reviewed.

“Policies should also be reviewed if you change from being a smoker to a non-smoker as you will find that after 12 months of not smoking your monthly premiums will seriously decrease.”

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Mistake 3 – Taking out protection for the main breadwinner only

A mistake made by many people taking out life insurance to protect their families is to buy cover for the main breadwinner only. This is a common error made when one parent in a family is the sole breadwinner and the other stays at home to look after young children.

It’s a mistake easily made – after all, it would seem obvious that if the main breadwinner were to die there would be no one to pay the mortgage.

But Neil Baker explained that if the stay-at-home parent were to die there would be just as many financial implications.

“What would happen to the kids?” he said, “Who will look after them during the day now? Will you all of a sudden need costs for childcare? Will the main breadwinner want to spend a bit more time at home with the kids and therefore decreasing his work hours and salary?

“These are all possibilities and in this position a family income benefit, which in theory is life insurance, would be a great option.”

Mistake 4 –relying on over-50s plans for your life insurance needs

Over-50s plans are available for people who have no life insurance or financial provision for family members when they die.

Customers pay monthly premiums and provided they have contributed these for at least one or two years – depending on the provider – their family will receive a fixed sum upon the policyholder’s death.

On the plus side there are no medical requirements – the provider will not ask about your health, so they are a good option for those with serious conditions.

On the other hand a certain amount of caution should be applied as research suggests these plans could leave pensioners short by thousands of pounds.

Consumer group Which? found, on average, a 60-year-old man paying £15 a month into a plan for 30 years would earn a lump sum of £2,980.

Yet, by putting the same amount into a cash ISA with a rate of four per cent he could earn more than three times that amount, £10,313, over the same timescale.

Which? branded the plans as bad value. It said if customers stopped payments they would forfeit a payout or even the return of their premiums. And if inflation were to follow the same pattern over the next 25 years the real value of some plans by January 2037 could be less than in today’s money.

Peter Vicary-Smith of Which? said: “For most people over-50s plans are bad value. They are inflexible and, for the majority of customers, they will pay out far less than you have paid in.

“For those that are looking to leave their family a cash sum, our advice is to steer well clear of these plans, and put your money into a cash ISA instead.”

Mistake 5 – Not seeking financial advice

Of course you can avoid all these mistakes by seeking advice from a professional. If you are going to get help, make sure it’s from an independent financial adviser as opposed to a ‘tied adviser’ who works for a company selling life insurance.

Neil Baker said: “I would always recommend you speak with a financial adviser first to properly review your circumstances and to make sure, if you are going to find insurances yourself, you are looking for the right policies.

“Far too often I see people with the wrong cover for their needs, and when I ask why they have that level of cover a lot of the time people cannot tell me.”

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