A simple way to save an inheritance
We consider whether whole-of-life insurance is a good way to save an inheritance, pay an inheritance tax bill or pay for a funeral.
“Whole-of-life insurance” pays a lump sum to your heirs whenever you die, whether that's tomorrow or in 50 years’ time. A full payout is typically in the low thousands, or low tens of thousands.
It's often sold as a simple way to save an inheritance for your heirs, or to pay an inheritance-tax bill or funeral expenses. It's frequently targeted at older people.
This compares to the useful and more common “term life insurance” which are insurance policies frequently targeted at families that pay out only if you die within an agreed period, e,g inside 20 years. These policies are usually to help dependants pay the bills after you're gone.
I'll jump straight to my one-line conclusion, and then I'll elaborate: I doubt whole-of-life insurance is the most suitable or cost-effective plan for most people.
How whole-of-life insurance works
Some whole-of-life insurance plans have a guaranteed payout and you pay fixed monthly premiums. You should expect these sorts of plans to start off more expensive.
More commonly, the payout and premiums are variable subject to review, and at least part of the plan is invested. Depending on how well the investments perform, you may have to take a lower payout or increase your premiums as time goes by.
If there's an investment element, you can often close the plan early and get something back, although don't expect it to be much compared to the total premiums. Other plans, with no investment element, will not pay you anything if you stop paying the premiums.
Some plans insist you pay the premiums right up till your death, whereas others will stop taking premiums at 80- or 90-years'-old – but you'll still get the payout if you die later.
The insurance usually pays the full cover from day one if you have an accidental death, but only after 12 or 24 months if you die of natural causes. Some policies will, at least, return the premiums paid to your estate if you die of natural causes within that initial period.
I've seen some ludicrous justifications of whole-of-life insurance from those who sell it.
One example is that it could partially be used as collateral on a loan but, if you had saved and invested the premiums yourself, you wouldn't need a loan or collateral – you could use the savings instead.
However, I'll focus now on the three most convincing reasons, and why I still disagree with them in the majority of cases:
1. As a funeral payment
Let's set aside the fact that you can, actually, have a very cheap funeral indeed, and that the government will often pay non-means tested benefits to help you.
Let's also say that you have debts or so little savings that, if you were to die in an accident tomorrow, your heirs could not afford a funeral from your estate.
If your financial situation is that dire, does it really make sense to tie up precious pounds in yet another insurance policy? You will, surely, be better off saving that money for emergencies or other more immediate needs, or paying down debts, rather than passing more money into the hands of funeral directors.
If you never need the money for immediate needs, the savings you have created, hopefully with a bit of interest, will help pay for your funeral anyway.
2. To pay taxes
Another argument is to pay inheritance tax if your estate goes over the inheritance-tax threshold, currently £325,000.
If your heirs genuinely need more money than the taxed estate will provide, you should take steps to ensure that your wealth increases to match their needs – not to match the tax that will be due.
If the heirs' genuine needs are £20,000 above the taxed estate, you should take steps to put together another £20,000 for them, and ignore the size of the tax bill completely; whether that bill is £10,000 or £200,000 is irrelevant.
But even in this case, saving is still more flexible, especially since you can't know for sure if your heirs will need that extra money in years to come. Also, if you give money sooner and survive seven years, it won't be subject to inheritance tax anyway.
Yes, if you die tomorrow you won't have saved anything, but since whole-of-life insurance is so inflexible, it's possibly as much a risk to buy it as it is to not do so. Yours and your children's circumstances can and, surely will, change over the years.
There's more of an argument for using insurance to pay the tax bill if a property makes up most of the estate and it's essential that one or more of the heirs are able to keep it, rather than have to sell it to pay the tax bill. It's very difficult to estimate how much extra they'll need in insurance if you die many years from now, however.
3. To pass something on to your heirs
If your heirs aren't going to get much of an inheritance, in my opinion, that's just the way it is.
If you're not rich enough to have savings, investments and property to pass on to your kids, you should, in my view, enjoy what you've got and keep some of it for your own emergencies and needs.
You don't owe your kids anything beyond raising them into adulthood. (For which other insurance is much more suitable – see my third paragraph.) They should be grateful if you give them something, but they shouldn't expect it either. After all, it's your money that you earned.
The cost of whole-of-life insurance premiums over the years is perhaps something like £10 per month for a £4,000 payout if you start at 50-years'-old. This seems steep for such an inflexible product when compared to what you could achieve by merely saving or investing.
Products that combine investment and insurance have a bad history and salespeople are mostly unconvincing when they try to give you reasons to buy it.
Insurance exists to pay for disasters that you (or your heirs) genuinely couldn't afford to pay for or deal with by themselves. If you (or they) could, you shouldn't pay the premiums.
Due to all of the above, I doubt the worth of this insurance for everyone, or nearly everyone.