Life assurance is one of the most basic yet crucial forms of protection. With so many options to choose from, Stephanie Spicer explains what advisers need to know to get the best benefits for their clients
For a client with dependants life assurance is one of the most simple and valuable products you can sell them.
Term insurance, where the policy pays out on death within a certain time frame, is very simple and cheap. The amount of cover is fixed for the term of the policy.
Term insurance can also be written on a decreasing term basis where the policy is taken out to cover a financial liability, which will decrease over time, for example, a repayment mortgage, so the amount of cover also decreases over time. Family income benefit policies are term assurance policies, which pay out a tax-free income if the policyholder dies.
Whole of life (WOL) assurance, which pays out on death and lasts the client's lifetime, provided premiums are met, usually has a guaranteed death benefit and an investment element. For this reason it is a bit more expensive. It can be a more complex sale as clients need to choose the underlying investment element.
The options for investment-based insurance are with-profits funds or unit-linked funds.
With-profits funds invest in a range of investments including equities, property and fixed interest investments. Performance fluctuations are smoothed out to avoid losses if the fund matures after a poor investment period. Bonuses are added to the fund to boost the guaranteed minimum payout. These types of investment are usually better value for younger and healthier clients because part of the investment will be used to pay for the life insurance element.
Unit-linked policies invest in units in an investment fund which can be invested in equities, fixed interest funds, property, unitised with-profits (buying units in a with-profits fund) or cash funds.
Long-term options
Regular premium unit-linked plans can be on an endowment basis providing a higher level of life cover. These should be viewed as long-term investments most commonly used for mortgages, although they have lost some of their appeal in recent years because investors have been disappointed by the returns ' often insufficient to pay off their debt.
Flexible WOL plans provide cover for life and allow you to adjust your level of cover as your clients' needs change.
Maximum investment plans are hybrid plans ' a unit-linked life assurance plan with the minimum of life insurance included in order to maximise the investment element. The life insurance element must be sufficient to enable the policy to achieve qualifying status.
Usually these policies attract higher rate taxpayers due to the tax-free lump sum on maturity. Tax-free withdrawals can be made after seven and half years on a 10-year policy. When the policy matures, the investor could leave the funds invested for capital growth, continue the policy for another 10 years, or continue making payments and take a tax-free income.
However, the investment element of whole-of-life policies is not the most important. These policies are long term and should not be seen as a main form of investment. Certainly if the policy has to be cashed in early it is unlikely the client will see a return, even on their premiums.
Premiums on WOL policies must be paid until death, something to consider when the client comes to retire if their income falls. Unless the policy is a with-profits one ' which pays out a bonus on top of the guaranteed lump sum ' and the client lives for a long time, the amount paid out at the end might not be as much as the premiums paid in.
Michael Ward, managing director of broker network Lifequote, says: 'Most whole of life policies are on a reviewable basis. Usually premiums are reviewed after 10 years, then every five years. Usually after age 70 they start to get expensive.'
Tax implications
Investment-based life assurance incurs tax, but this is generally paid by the insurance provider and cannot be reclaimed by the policyholder. This is the case for both Income and Capital Gains Tax. Provided the policy is a qualifying one, no tax will be paid by the policyholder when the policy pays out.
However, if your client is a higher rate tax payer and cashes in their plan before it has been going for 10 years or three-quarters of the policy term, whichever is less, they might have to pay the difference between the higher and basic rate of income tax on any gains.
When selecting the best policy for a client you need to advise them of other features they can opt for. For example, increasing premiums and therefore cover that is in line with the Retail Price Index will keep potential benefits in line with inflation. Taking precautions against not meeting premiums can be made through waiver of premium, so if the client is unable to work due to accident or sickness the plan continues without them having to meet the premiums. Total disability cover means the provider might pay out the death benefit early if the policyholder is unable to work due to an accident or sickness. An accidental death benefit option will pay out an extra lump sum.
Some policies are flexible in that they allow the policyholder to stop and start premiums, for example, if the client is made redundant. There is usually a time limit on how many payments can be missed and they must be paid later for cover to continue.
There will be times when your client might need to increase their level of cover, or perhaps the term of the policy. If this is likely at the outset, for example, if the client is planning a family, or know they will be taking out a larger mortgage in the future, they will want a plan which allows them to do this without undergoing further medical underwriting. Many plans will allow an increase in cover for a significant event such as having a baby.
Given the value of insurance cover it is surprising how many advisers fail to ensure their clients have it. There is a huge market in term assurance alone attached to mortgages with, 'around 75% of mortgages not fully insured. Around 60% of mortgage business is introduced and yet in many cases the mortgage introducer does not complete on the life insurance element,' according to Ward.
Looking after the family
Once the client has selected the type of insurance which best suits their needs the required amount of cover should be calculated. It is not the cheeriest budget plan to write, but your client needs to consider what their dependants would do if your client were to die. The largest bill is likely to be the mortgage loan repayments or rent. However, there will be other bills that need to be met, so they should calculate the cost of all monthly outgoings, including gas, electricity, phone bills, council tax, building and household insurance, car and pet insurance. Then an amount should be factored in to cover the food bill, clothing and holidays. Does the client also have school fees that must be met? For real peace of mind all these outgoings should be included so the client's family are financially secure on the client's death.
A rule of thumb is that a family will need to achieve income to meet their needs once their main liabilities, for example the mortgage, have been covered. 'Take the amount of income you need,' says Ward, 'for example, you want £1,000 a month, that is £12,000 a year, then divide that by 0.05 which would give you a sum assured of £240,000 if you invested the money fairly cautiously but tax-efficiently.'
Mortgages and funds to look after the living expenses of the family on the death of the client are the usual reasons for life assurance. There are often liabilities your client may want to help their dependants with, for example inheritance tax (IHT). If this is the case the policy should be written in trust. This is because if the client dies and their whole of life policy has an investment return, the proceeds will go to their estate and therefore become liable to IHT.
The most common form of trust is the flexible trust, which allows the client to leave everything to their beneficiaries. The trust is flexible in that the beneficiary can be changed if needs be. It can be used to provide for your family and also be used with a with-profits bond or capital investment bond to give a a lump sum gift of money. Provided you are alive seven years after setting up the trust IHT will not apply to the original sum invested.
Life insurance really benefits it is usually because someone has died. But there are some good returns: 'Some whole of life plans will pay the sum assured it you get to age 100,' says Ward, 'whether you have died or not.'
Stephanie Spicer is a freelance writer
Cover notes
• WOL policies are more expensive than term life assurance and are more complex to sell as they are often linked to an investment.
• When deciding the right investment option to link with a whole of life policy, the client's age, health and tax liability should be considered.
• Term assurance policies either provide a fixed benefit for the term or a decreasing benefit, which is usually used to protect an outstanding mortgage.
