Life insurance: How does it work and is it worth it?

Only 35% of households in the UK reportedly have life insurance cover, but many more agree it would benefit their family and help to support them after they're gone. But how does it actually work, how much does it cost and - crucially - is it worth it for you?

What is life insurance?

Life insurance is a type of cover you can buy to pay out a lump sum or regular instalments of money to your chosen beneficiaries if you die during the policy term. It may also pay out if you’re diagnosed with a terminal illness and are not expected to live longer than 12 months.

It's typically used to cover your own funeral costs and legal services after you pass away - potentially saving your loved ones thousands of pounds - but can also pay off debts and mortgages or be left to someone to help them pay for things like a house deposit.

Though it can feel daunting at best and upsetting at worst to think about your death, putting a life insurance policy in place can be a way of ensuring you continue to support your loved ones even after you're gone.

Research by Direct Line Life Insurance found that in 2022 around 35% of UK households held a life insurance policy, though six in 10 households agreed that it would benefit their family.

What are the different types of life insurance?

There are several different types of life insurance policy and, though they're all quite similar, there are some key differences in how they pay out. Here's a breakdown of five of the main life insurance policy types.

Level-term life insurance

Level-term life insurance only lasts for a specified term, such as 10 or 25 years, and only pays out if you die within this term. Your monthly premium payments are the same price throughout and the payout if you die stays the same too.

Decreasing-term life insurance

Similarly, decreasing-term life insurance policies only last for a specified term. What’s different is how they pay out. Instead of staying consistent, the payout decreases over time – often in line with mortgages or other expenses that you’re gradually paying off. This usually makes it a cheaper option.

Whole-of-life insurance

Less common and more expensive than the previous two, whole-of-life insurance does what it says on the tin. Instead of having a fixed timeframe, the policy lasts until you die and guarantees a fixed lump sum payout. You might also see it referred to as 'life assurance'.

Death-in-service life insurance

Not a policy you buy yourself, death-in-service life insurance is typically offered by employers as a workplace benefit. On average, it pays out between two and four times your annual salary, provided you die while being employed by the company. It’s worth checking if you have this before you buy any other policy - you may find it in the small print of your employee contract.

Over-50s life insurance

Unlike other policies, you don’t need to provide your medical history for over-50s life insurance, which is helpful if it’s not looking too good because other policies can get very expensive. This policy lasts until you die, pays a lump sum, and is paid for with regular monthly premiums that stay the same throughout. It's often reasonably cheap but comes with strict conditions and is mostly used to cover funeral expenses.

How much does life insurance cost?

The price you pay with your monthly premiums is based on the type of life insurance policy you get, as well as your health, lifestyle and other factors (more on this below).

Whole-of-life insurance, for example, is typically more expensive than over-50s life insurance. Or if you’re healthier, insurance companies see you at a lower risk of dying and therefore likely to continue paying for your policy over a longer timeframe - which makes it cheaper.

Reassured, the UK's largest life insurance broker, said that in 2022 the average cost of a life insurance policy was £38.15 a month. However, there are a number of factors that can affect how much your premium could cost.

Factors that can affect how much life insurance costs

• Age - Generally speaking, the older you are, the more expensive your life insurance policy will be.

• Health - If you have a pre-existing medical condition - particularly if it's a more serious, chronic one - you will typically pay more for your premium.

• Lifestyle - An unhealthy lifestyle can also lead to higher premiums. For example, if you're overweight or drink more than average.

• Family medical history - Some policies will ask about your family's medical history. If you're at a greater risk of developing a serious health condition, you may find your premium is higher.

• Job - Obviously, if you have a dangerous occupation, you're more likely to die than someone with a regular 9-5 office job. This could also drive your premium up higher.

• Smoker status - If you're a smoker - or have smoked before - this can impact your premium, as you're statistically more likely to develop health problems or die prematurely. This often applies to vaping as well.

• Length of cover - The length of your life insurance policy can also affect the cost of your premium. Typically, longer terms will be more expensive than shorter terms.

• Amount of cover - Typically, you get to decide how much you want your cover to be - i.e. how much money your beneficiaries receive when you die. The higher your cover is, the higher your premium is likely to be. Vice versa for lower cover and lower premiums.

Evidently the cost of life insurance can vary widely and it can be difficult to know how much you can expect to pay. The tables below helps to illustrate the average premiums recorded in 2022 according to policy type, gender and smoker status to give you a good idea of the sort of prices you're likely to encounter.

Average life insurance premium by policy

The type of policy you pick can have a big difference in the cost of your monthly premiums. As you can see below, whole-of-life insurance is usually the most expensive.

Source: Reassured. Correct as at October 2023.

Average life insurance premium for men and women

Your gender can have an impact on the cost of your life insurance premiums. Generally speaking, men tend to pay more on a monthly basis than women.

Source: Reassured. Correct as at October 2023.

Average life insurance for smokers and non-smokers

If you are or have been a smoker, you could find that your life insurance premium is a bit higher than someone who's never smoked.

Source: Reassured. Correct as at October 2023.

How much life insurance cover do you need?

When you apply for life insurance, your insurer will ask how much you much cover you want. This is up to you, but how do you know how much life insurance you actually need?

The amount of cover you need is dependent on a number of things, such as who you want to receive it, how many people it's being shared between and how dependent they're likely to be on this money when you're no longer around.

A rough rule of thumb you may come across is that your life insurance cover should be at least equal to 10x the annual salary of your highest-earning recipient. This should enable them to continue with a similar standard of living in your absence.

However, this is only a guide and could mean your monthly premium is unaffordable for you, so the 10x salary rule might not be suitable. There are many other factors you should consider when deciding how much cover you need.

Here's a list of things you should think about before deciding on a number:

Do you have a family?

If you have a partner and/or children, you might want to cover their basic costs and day-to-day needs so they won't need to worry about making ends meet when you're no longer around. It's a good idea to work out your average monthly outgoings on things like a mortgage or rent, utilities and groceries and then multiply this for how long you'd like the cover to last - for example, five years.

Do you have a mortgage?

Some mortgages are accompanied with life insurance policies to make sure your family doesn't end up homeless if you pass away before it's paid off. However, not all deals have this, so have a quick check through your policy documents and see. If you don't already have it, calculate the total amount you owe - with a buffer for interest or taxes - and make sure your life insurance is enough to cover it.

Do you have other debts?

If you've got debts or loans that will need to be paid, a life insurance payout can help to cover these - or pay them off completely - so you can have peace of mind. Work out the lump sum of what you owe, leaving some extra room for interest on top, and make sure that your life insurance cover is enough to pay it off.

Are you likely to be subject to Inheritance Tax?

This infamous tax your family pays to inherit an 'estate' worth over the £325,000 threshold (or £500,000 if you leave your property to your kids or grandkids) can be as high as 40%. Thousands of families get this nasty surprise during the grieving process and, from April to September 2023 alone, £3.9 billion worth of Inheritance Tax was paid. However, you can use a life insurance policy to help cover it.

Get help from a financial adviser

If you're still not sure how much life insurance cover you need, you can reach out to a financial adviser to help you crunch the numbers. They will assess your unique financial circumstances - and those of your family and chosen beneficiaries - to help you settle on a suitable amount of cover. They can also advise you on the right type of policy for your needs.

What if you need more life insurance than you can afford?

You may find that the amount of cover you need is more than you can afford to pay in monthly premiums. But don't panic, this doesn't mean you can't get life insurance or should settle for less. You have options.

There are financial advisers or 'brokers' who specialise in insurance (and life insurance specifically) who may be able to help you find a cheaper policy which still gives you the level of cover you need.

You can use our adviser directory to search for advisers with a specialism in 'Insurance'. Just click the link below. Or you can search the web for 'life insurance brokers' to see what's out there - just make sure to read our 5-step guide on how to find a good financial adviser before you decide.