Term Insurance

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Lump-sum Term Insurance

You choose what level of cover you need and the period for which you require it, e.g., until the children have finished their education, or beyond the time when Great Aunt Florence can reasonably be expected to rely on your support. The lump sum is paid out tax-free if you die within that term.

The premiums you pay are set at the time you take out the policy and depend largely on the level of cover, the term you choose, your age at the start and your state of health. You will normally be charged more - or even refused cover, if your work, hobbies or lifestyle are deemed to be particularly risky. Some insurance companies reserve the right to increase the premiums, often substantially, if they experience unusually high levels of claims against their term insurance policies. This is a device that was adopted in response to the problem of deaths through AIDS.

Warning - Investment-type life insurances, such as endowment policies, are an expensive way to buy life cover.

Tip: Overall, term insurance is the cheapest way to buy large sums of life cover to protect your family. A maximum protection plan might be cheaper in the early years, but watch out for premium increases later on.

Increasing term insurance

This works much like the basic term insurance, except that the level of cover increases - and usually the premiums too - for example by five per cent a year or in line with inflation. It is worth considering this type of policy, especially if you are insuring for a long term, because increasing prices eat away at the value of a fixed level of cover.

Increasable term insurance

This variant gives you the option to increase the level of cover either at set intervals, such as on each anniversary of taking out the policy, or when particular events occur, e.g. marriage, or the birth of a child. You pay extra in premiums for any increase in cover, but the premiums are worked out on the basis of your health at the time you first took out the original policy, even if your health has subsequently deteriorated.

Decreasing term insurance

With this variant, the amount of cover reduces year by year. The two main uses for this type of insurance are to repay loans, such as a mortgage, or to cover a potential inheritance tax bill on a lifetime gift.

Renewable term insurance

This version allows you to extend the insurance term when it comes to an end. The premium you then pay is based on your health at the time you took out the original policy, even if your health has subsequently deteriorated. This can be a useful variation for dealing with the unexpected, for example a child who stays in full-time education for longer than you had anticipated.

It is also a good option if you cannot, at present, afford the level of cover you need for the period you want. Instead, you could take out the cover you need but for a shorter period. At the end of the period, you could take up your option for a further period. Premiums would then be higher because you would be older, but there would be no additional charge even if you had developed health problems.

Convertible term insurance

With this type of term insurance, you have the option at specified dates to convert your protection-only policy into an investment type insurance policy based on your health at the time you took out the original term insurance. This option is of limited use.

Family income benefit insurance

Instead of paying out a single lump sum, this type of term insurance pays out a series of regular tax-free lump sums that you can use as income. The income starts to be paid at the time of death until the end of the policy term. Since the policy pays out less overall the longer you survive, this is generally the cheapest form of term insurance and can be a good choice for families. A useful variation allows the regular income to increase over time to counteract the effects of inflation.

Pension-linked term insurance

If you are eligible to contribute to a personal pension or stakeholder scheme (other than one simply used for contracting out of part of the state pension scheme), you are also eligible to take out pension-linked term insurance. With a personal pension, in 2000-1, you can pay up to 5% of your 'net relevant earnings' (basically, your earnings if you are an employee or your profits if you are self-employed) towards pension-linked term insurance. You can do this even if you are not actually making contributions towards your pension.

From 6 April 2001 onwards, the rules change. From that date, you can use up to 10% of whatever you actually contribute to your personal pension or stakeholder scheme to buy pension linked term insurance. This means you must be paying towards a pension to be eligible for the related term insurance.

The big advantage of taking out this type of term insurance is that you get tax relief on your premiums at your highest rate of income tax. The drawback is that what you pay towards any term insurance reduces the amount you can put towards a pension.

One should not assume that pension-linked term insurance will always be the cheapest cover. You should always compare it with the premiums payable for ordinary term insurance too.

If you are in an occupational pension scheme, you will often get some life cover through the scheme. Usually, the most this can be is four times your salary. If your scheme offers less than the maximum cover, you may be able to increase it by paying additional voluntary contributions (AVCs) either to an in-house AVC scheme or a free-standing scheme.

In either case, what you pay qualifies for tax relief at your highest rate, but does reduce the maximum you can pay towards your pension.

Tip: If you cannot afford the amount of life insurance cover you need, you do not necessarily have to insure for less. Consider taking out the full cover but for a shorter time, using renewable term insurance, which guarantees that you can take out a further policy at the end of the original term when you may be able to afford to pay more.