Choosing life insurance

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Coming to terms with the loss of a loved one is tough enough without adding financial hardship to the burden.

That's why many people opt for some form of life insurance.

Life insurance offers financial protection to replace earnings. It can pay the mortgage and household bills and provide your family with financial security just when it's most needed. Take 10 minutes to consider your options

Before you begin: Do your sums
Of course, no one can put a price on someone's life. But you can at least work out the amount of life insurance your loved ones would need to carry on should the worst ever happen.

Start by getting together details of your household income and outgoings. Remember, if you have young children then you'll need to cover the cost of childcare in the event of the death of a non-working partner. You'll need to cover outstanding debts and provide a reasonable standard of living for the future.

You also need to work out whether your dependants would need a lump sum (and how much), and whether they would need an income (how much and for how long).

Step 1: Check out the policies on offer
At its most basic, life insurance (sometimes known as life assurance) pays out a lump sum on the death of the person insured. It can be taken out on a single or joint life basis (see Step 6). There are two types of life insurance: term insurance and whole life. The simplest is term.

Step 2: Go for the cheapest?
The cheapest form of protection is term insurance. This kind of policy pays out a fixed amount if you die within a specified period (the term). It is not investment based, and it has no surrender value if you stop paying the premiums (ie, if you can't cash it in). If you die outside the term, there's no payment.

There are various types of term insurance. With some the amount you are insured for remains the same throughout. Sometimes it decreases (this kind of policy is often used to pay off a mortgage). With others you have the option to renew after a set period (without needing to give further health information) or to convert to a whole life policy (see Step 5).

Step 3: Do you want to combine mortgage and life insurance?
If you have an endowment mortgage, life insurance is automatically included as part of the package. But if you have a repayment mortgage, the cheapest option is Decreasing Term Life Assurance, which is designed just to pay off your mortgage debt. The more you pay off over time, the lower your potential insurance payout.

Step 4: Do you want a monthly income?
If so, then you can look into family income benefit policies, which will pay regular amounts to your dependants instead of a lump sum. Income can be paid monthly, quarterly or yearly, depending on the policy.

Step 5: Tell me about whole life insurance
Whole life insurance could be for you if you want life cover to carry on indefinitely rather than finish at the end of a fixed period. When you die, a whole life policy pays out either a minimum guaranteed sum or the investment value that's built up from the money you put in. But it also has a cash value, which you'd get back if you cancelled the policy.

Whole life premiums are more expensive than term life premiums, as this type of policy is certain to pay out. With some policies you pay the premiums until you die, while others stop at a certain age. Whole life policies are often used for tax planning (see Step 7).

Step 6: Do you want to insure both of you?
Couples can go for separate or joint policies. A joint policy will pay out on the death of the first person. It may be cheaper but is only really suitable if you would need the same amount of cover for both of you. It's worth shopping around and comparing quotes for both single and joint cover.

Step 7: Look at reducing your tax bill
When you die, life insurance payouts become part of your estate. If your estate is valued at more than a certain level (£285,000 in the 2006-7 tax year), then you will have to pay inheritance tax (IHT).

It is possible to write your life insurance policy in trust so that the money doesn't form part of your estate from an inheritance tax point of view. The payout can then be used by the person who inherits it to pay any IHT due on the rest of your estate. This is a complicated area, and you should seek expert advice from a solicitor or accountant specialising in life insurance and tax planning.

Step 8: Buy your life insurance cover
The cheapest way to get the right cover to suit your circumstances is to go through an insurance broker. You can buy online but it's advisable to talk to an expert first.

All life policies have a 14-day cooling off period in which you can examine the policy and change your mind if you choose.