Article on: lump sums
Meaning of Lump Sum?
The meaning of lump sum with a life insurance policy, differs dependant on the types of policy. In this article, we will look at the benefits of 4 different types of life insurance lump sums v the benefits of a monthly pension style of life insurance.
As Life Insurance Agents we are often asked this question…which is better – a Lump Sums Life Insurance payment or Monthly Family Income Benefit Insurance ?
1] Level Term Life Insurance ‘Lump Sums’
A Level Term Life Insurance policy, means the lump sum amount of payout cover remains the same or level, from the start to the end of the plan. This means the payout risks to the Life Insurers remain the same from start to end.
In other words, if the level term life insurance was setup for £250,000 lump sums and you died in year 10, it would still payout a £250,000 lump sums.
However, as it runs for a specified term eg; 25/35/45 years, then any lump sums claim payout will only be within that time frame. So if your plan ran for 25 years, but you died in an accident in year 25 and 1 month, then the plan has ended and also any lump-sums meaning it would not payout.
Note: You could choose a convertible or renewable life insurance lump sums option from outset within this plan, allowing the choice to either replace it with a whole life insurance or another plan, without health evidence.
2] Increasing Term Life Insurance ‘Lump Sums’
Increasing Term Life Insurance policy, the lump sum amount of payout cover increases annually from the start to the end of the plan (to help offset inflation). You can choose whether this increase is by Average Earnings, RPI or a fixed rate ie; 5%. This means the payout risks to the UK Life Insurers also increases from start to end. Some Insurers therefore charge an extra premium from outset, to account for this increasing insurance risk, without asking for ongoing medical evidence at each increase.
In other words, if the increasing term life insurance was originally setup for £250,000 lump sums over 25 years but you died in year 15, it may now payout for example £300,000 lump sums (due to increasing by say RPI).
The same rules apply as above re time frames and any lump sums claim.
3] Decreasing Term Life Insurance ‘Lump Sums’
A Decreasing Term Life Insurance policy, means the life insurance lump sum amount of payout cover reduces, from the start to the end of the plan. This means the payout risks to the Life Insurers also reduces from start to end.
Usually these plans are used for Mortgage Life protection or Loan repayment ie; It follows the reducing debt over its term.
In other words, if the policy was originally setup for £275,000 lump sums over 30 years but you now sadly died in year 20. The decreasing plan may now payout around £140,000, meaning lump sum has decreased inline roughly with what you owe on your mortgage.
4] Whole of Life Insurance ‘Lump Sums’
A Whole of Life Insurance policy, means the lump sums amount of cover will always payout, whenever you die (as long as the premiums have been paid & policy terms fulfilled).
In other words, if the policy was setup for a sum lump of £100,000 and you then lived amazingly upto aged 195…it would still payout ie; £100,000 lump-sum meaning is essentially guaranteed.
Abit like when you retire, often you may have a choice to make. Do you take a full monthly pension? Or instead any tax free lump-sums and then the balance or rest as a reduced monthly pension?
So having looked at lump-sum life insurance options, let’s have a look at the benefits now of having family income benefit life insurance.
Monthly Family Income Benefit Insurance
A Family Income Benefits plan [FIB] is an insurance that pays upon death a tax-free monthly income, within the agreed policy term. Some FIB plans you can opt to be paid the benefits quarterly or annually at claim.
Most plans will also include free ‘terminal illness’ cover. You may also have the option to include critical illness cover FIB benefit.
With a family income benefits policy, the Insurers cover risks instead decreases monthly. As such, the income payout risks to the Life Insurers also continually decreases from policy start to end. In essence, it therefore works abit similar to mortgage decreasing lump sums cover.
Cost Analysis Difference between the 2 plans
A Family Income Benefits insurance plan is often cheaper to buy than lump sum level term life insurance, as it is a decreasing style plan. The reason being, the risks to the Insurer also decreases over time. Let’s see in practise what this means at different yearly timeline stages.
Person aged 35, non smoker, fit & healthy and looking to spend around £30pm. They want family protection insurance cover over 25 years term.
They ask you what is the general Timeline benefit payout differences roughly between the 2 policies? Here are some typical broker quotes for this budget.
So they could typically get either around £750,000 (£750k) level term life insurance for 25 years. Or a Family Income Benefits term life insurance for 25 years £50,000pa (£50kpa ) or £4166pm.
In this example comparison below, both £750k level term & £50,000pa FIB plans are level ie; benefits are not inflation proofed to ease a general comparison. With some Insurers you could commute the FIB income at claim, to give lump sums instead (but this maybe reduced for some Insurers. It may also cause IHT issues – see our below FAQ).
|Death Claim Paid
|Family Income Benefits | Payout
|FIB v Lump Sum | Timeline
|* Year 1
|£50k x 24 Years = £1.25 m
|FIB = Extra £500k
|* Year 5
|£50k x 20 Years = £1 m
|FIB = Extra £250k
|* Year 10
|£50k x 15 Years = £750k
|FIB = Same
|* Year 15
|£50k x 10 Years = £500k
|FIB = Less £250k
|* Year 20
|£50k x 5 Years = £250k
|FIB = Less £500k
|* Year 24
|£50k x 1 Year = £50k
|FIB = Less £700k
So, in this above typical 25 years case study, we can see that for the first 10 years, the family income benefit plan is potentially financially better value than a sum lump of £750k.
However, from year 10 onwards, FIB gets financially worse as it continues to reduce over the time period ie; comparison shows FIB equivalent if commuted to a full lump sum at claim (whereas mentioned, some Insurers may reduce this amount if commuted).
Lump Sums Invested v Monthly Income
Let’s also look however at the issues of having a lump-sum life insurance payout at claim when invested, to try and give a monthly or equivalent returns. Note: Inflation may erode your capital and we are not investment advisers.
In the example below, we still follow the £750,000 lump sum payout if invested v £50kpa Family Income Benefit plan like for like. You will see that it would require an investment return of at least 6.666% to return £50,000pa and maintain the original capital values.
Naturally, in this example also, if you need to only take £22,500pa then a 3% return will retain the original £750,000 capital lump-sum invested.
|Lump Sums Invested
|V FIB £50kpa
|Same as FIB
Should you opt for a lump-sum life insurance versus a family income benefit insurance, you will then have to decide at claim where best to invest your capital risk wise, to help you provide a steady monthly pension style income. Also, Govt savings tax issues could arise with any investment returns.
Naturally, if the main family breadwinner died, then this could be the last thing you may want to think about?
Ordinary Working People are Ordinary Millionaires?
On the Money Saving Expert Life Insurance website, Martin Lewis on Life Insurance says for a good working rule of thumb, his Best formula is use ‘THE 10 x RULE’ ie; aim to cover 10 x the Annual income of the main breadwinner or highest earners until any kids have finished full-time education.
So, in this Martin Lewis formula if you earned £35,000pa then he says consider family life insurance lump-sum for at least 10 x salary = £350,000 to insure yourself for (after any mortgages, loans & debts are repaid ie; consider cover for them seperately)
As such, you may wonder how we quoted working people are Ordinary Millionaires above (rather than some financial freedom plan) when that sounds implausible for many?
BUT following on from this simple Life Insurance coverage example formula, if you earned say £35,000pa and then worked for the next 30 years until retirement, you could potentially earn over £1 million gross ie; £35,000pa x 30 years [or more with any future inflation wage rises].
Apart from losing a loved one & family breadwinner, this real hidden income threat is what could be lost if sadly the main earner died prematurely.
How much does this all cost?
- Often average prices can start from as low as £5pm (for 1 product)
- But your monthly or annual premium costs will vary in a few ways
- Premiums will depend on your ages, health, lifestyle, amount of cover, policy term
- It could be you are offered standard costs or have to pay abit extra insurance price risk
- Eg: Extra premium risks if smoking, have raised BMI Kg or Diabetic
- Any paid for extra features (like critical illness) you want will also affect the cost
- Is the lump sums cover to remain level or increasing to offset inflation rises ?
- Remember cheaper here, doesn’t necessarily mean better
Joint or 2 x Single Life Insurance Lump Sums?
The benefit of having 2 x seperate lump sum plans (known as dual life insurance) if in a relationship & one partner claims, then the surviving partner still has their own seperate lump-sum policy. That single life insurance will cover just that 1 person only. It then pays out the chosen amount of sum-lump cover if that person dies, or is terminally (or critically ill if benefit chosen) during the term of the policy.
A ‘joint’ names policy means it jointly covers 2 lives but crucially then pays out on ‘1st death or claim’ lump-sum basis. This means once the chosen amount of cover is paid, the policy benefits would then end. This is usually the cheaper option for Insurers (as it only pays benefits once) but conversely leaving the surviving partner without any cover. You pays your money & takes your choice.
Terminal Illness Cover vs Critical Illness
Critical Illness coverage is a special insurance benefit that helps protect you if you are diagnosed being critically ill (as specified by Insurers). The top 3 benefits most Uk Insurers cover are for types of cancer, heart disease & stroke* ABI.
It can pay out a tax-free lump-sum that you can use, however. To help repay the mortgage, cover toward monthly expenses or health-related costs,. Or lost income while you recover (although income protection maybe a better longer term policy in that respect).
What does putting Lump Sums Into Trust mean?
- It tells the Life Insurance Company who you want to get the lump-sum money if you sadly died
- Ensures it should go direct to you nominated beneficiaries via the trustees
- Putting your policy into ‘trust’ may also help to avoid probate delays & inheritance tax
- Without a trust the policy could fall back into your estate
- This applies even if you have made a valid will
- Most Insurers do supply free a good range of generic life insurance trusts, ideal for many client situations
Importance of Disclosure & Claims
All Insurers are in business to protect, insure & payout. Lifecover is therefore based on your full disclosure at the time you take the original policy out ie; being 100% as honest & accurate as possible. It is not always easy to remember all your historic health details when applying.
The Consumer Insurance Act 2013 says you must not be acting careless, deliberate or reckless manner when applying. If so, it may not payout ! eg; you had raised blood pressure or cholesterol, then you must tell them (even if it costs more).
Should you make a claim, your Insurers will send you a claim form for you to complete. Once received back, they will usually contact your GP to confirm any health details.
They will then assess if your insurance claim is valid and cross check if you originally disclosed all the correct details. If you look at most Insurers recent claims payout, you will see that it is Good (but like most Insurers – not 100%).
What if health or lifestyle changes after starting a Life Insurance?
Any health or lifestyle changes since, usually does not void your existing policy, if it wasn’t relevant at that time of initial underwritten insurance application eg; later diagnosed with heart disease. It maybe the Insurers request GP reports when you originally apply, to check any health details disclosed. Likewise they may not.
So take care to doubly re-check on your application what you initially disclosed to the Insurers, as this information then stands now and in the future. Please check your original T&C’s.
You can now see the main differences between different types of lump sums life insurance policy. As Financial Advisers, we recommend to ideally ‘Protect 3 Things’…
- LUMP-SUM > Repay any mortgage & debts, cover funeral costs
- INCOME > Help cover all your monthly bills
- LUMP-SUM > Back up for holidays, education, emergencies
This basic formula is naturally dependant on wether you are married or cohabiting, have young or older dependants, retired or both working still. Have sufficient backup already in your savings & investments.
Please check out & Compare Online Broker only deals here to decide how much these may cost.
If you have dependant family members on you, then you know it makes good sense