InsuranceGuide

Whole of life insurance

By Madeline Thomas editorial@consumerchoices.co.uk

Whole of life insurance is effectively a stock market investment. Find out what you need to know before you sign-up for a whole of life policy.

Level term insurance will pay out an agreed sum of money if you die within a certain period of time. The period of the term insurance could cover the length of the mortgage, the children growing up or your earning years.

Whole of life insurance will always pay out because it covers your entire life. Premiums (the amount you pay each month) are more expensive than level term premiums because the sum has to be paid out in the end. However, the entre product is structured differently – it's basically a stock market-based investment.

The insured pays monthly premiums to the insurer. These monies are put in a stockmarket-based fund. The insurance company charges a monthly sum to manage that investment for you (which is taken out of the premium). Each month, some of the money is taken out of the fund and used to pay for the cost of the cover. When you die, the policy pays out and the investment stops. However, the longer the policy continues, and the more contributions that are made, the more the investment pot grows. Indeed, insurance companies provide illustrations showing what the investment could be worth after 5, 10, 15 and 20 years.

If you cash-in the policy it is unlikely you'll get back what you've paid in, in the first 10 years

However, this is not an investment for the sake of it and therefore cannot be treated as such. The policy will be worth more with each year that passes but, if the policyholder decides to “surrender” or cash-in the policy, he or she is unlikely to get back what they’ve paid in, in the first 10 years. As with any other investment, the cash-in value increases over time.

Why whole of life?

Anna Sofat, independent financial adviser and director of Addidi Wealth, says whole of life policies are most useful as an inheritance tax (IHT) planning tool. However, simply taking out the policy will not do the job. That will increase, rather than decrease the tax bill. The trick is to put the life policy “in trust”, which can be done with a simple form. That ensures the money from the insurance policy is paid directly to dependants and will not form part of the overall estate.

The reason this can help with IHT planning is because it provides dependents with some money to meet any inheritance tax owing on the overall estate.

However Rebecca Turner, Director of Dunham Financial Services, says that term insurance can do the same job, can also be put in trust and might be more appropriate as people get older.

“Whole of life policies are reviewed as you get older and so the premiums go up in later years. With term assurance, the cost remains the same.”

Turner also points out that term insurance policies can work out cheaper because policyholders are only paying for the life insurance element; there are no investment costs to manage.

However, the reason Whole of Life sells is because of its flexibility. A young professional could take out a whole of life policy to cover the needs of a growing family and to ensure the entre estate is left to them. As time goes on and the needs of the family change, the amount of benefit can always be reviewed as premiums increase and children fly the nest.

Combining protection and life cover

Combining a critical illness policy with a life policy is becoming increasingly popular. That way the sum assured is paid out on the first event of either a diagnosed medical condition (such as certain cancers, multiple sclerosis etc) or death. The policy only pays out once and after that, it ceases.

There are two main reasons why people choose critical illness cover:

To cover liabilities – such as a mortgage, bills or school fees
For lifestyle reasons – to fund a comfortable quality of life during a period of acute illness.

As Sofat says, while liabilities eventually diminish and disappear altogether, lifestyle choices will always be there. If people are seeking protection for lifestyle rather than liability reasons, that would be more appropriately done with a combined whole of life/critical illness policy.

However, a combined policy should always be done in conjunction with a “split trust”. That ensures that the critical illness element could remain outside of a trust and be spent and controlled by the policyholder while the life insurance element stays in trust for inheritance tax reasons.

Why not whole of life?

Sofat and Turner are both quick to warn against using whole of life policies for the wrong reasons.

Yes, whole of life policies have an investment element but they are not savings products and should not be treated as such. The only time a policy holder will get their money back is if they decide to “surrender” or cash-in the policy and because they are not pure investment vehicles. They will never perform as well as investments.

“The investment choices are way too limited to get asset allocation in any meaningful way for it to be a decent investment,” Sofat says.

Secondly, as Turner says, they are not a cost-effective way to cover a liability (a debt that will continue even after death). Mortgages and school fees may seem never ending but they will end and choosing a term insurance policy to cover the appropriate time period is likely to be better value.