Oops, You Bought The Wrong Protection!

Imagine how much more clear-cut life would be if you knew almost exactly when you were to die.

For example, if you knew that you were going to kick the bucket in, say, May 2026, you would have twenty years to build up your wealth, secure your (and your family's) future, make an up-to-date Will, and take steps to limit the impact of Inheritance Tax.

Sadly, life is full of uncertainties, which is why everyone with any dependants (someone who relies on them financially) should have some kind of protection against the financial impact of dying. So, if you have a partner or spouse, you need some cover to help them out if you die, and vice versa. What's more, life insurance is essential if you have children, because, without life cover, the loss of your income could leave your family up the proverbial creek without a paddle.

Alas, when it comes to buying the right life cover to suit our needs, most of us make at least one major howler, which, at the extreme, can cancel out the point of buying this protection in the first place! So, if you're planning on buying life insurance, or have an existing policy which you'd like to improve on, watch out for these five pitfalls:

1. See an independent adviser, not a salesperson

The first mistake that most of us make when buying protection is going to a "tied source", such as a high-street bank or building society. These firms are usually tied to a single provider, which means that they cannot search the entire market on your behalf. Hence, they don't employ independent advisers, only tied salespeople, and should be avoided at all cost. If you want the best price and advice, ask an independent broker to shop around for you.

2. Choose the right policy

At its most basic, life insurance is a very simple product: it pays out if you die during the life of the policy. However, there are dozens of different variations on this theme: life insurance to cover a repayment mortgage (mortgage protection, or "descending term" cover), life cover with payouts that increase each year ("increasing term" cover), even cover which pays out a tax-free monthly income instead of a lump sum ("Family Income Benefit"). Make sure that what you're buying exactly suits your needs and, if it doesn't, don't buy it. After all, having the wrong policy is almost as bad as having no cover at all.

3. Choose the right level of cover

If you earn, say, £25,000 a year, there's no point in buying a policy which pays out, say, £750,000 on your death. Frankly, you don't want to make a claim (because you have to die to do so!), so there's no point in over-insuring yourself with a Lotto-sized jackpot payout, because you're just throwing your money away on higher premiums. Around ten times your gross (before tax) annual income is enough for most people.

If you have young children, covering any debts plus around £150,000 per child is usually adequate, so a father of two children with a £100,000 mortgage who insures himself for around £400,000 will leave his family in reasonable financial comfort.

4. Don't buy one policy when two are better

Many couples buy "joint life, first death" cover, which provides a single payout if either of them die, leaving the surviving partner uninsured. However, buying separate "his and hers" policies makes good sense, as it provides two potential payouts for just a few pounds more each month. What's more, if you separate, you each take your own policy with you, whereas it's almost impossible to divide up a joint policy!

5. Put your faith in a trust

Potentially, the taxman can take two-fifths (40%) of every penny of your estate above the nil-rate band for Inheritance Tax (IHT), which is £285,000 in the 2006/07 tax year. To avoid this punishing charge, it pays to put life insurance policies into trust, which means that you avoid IHT and the payout is quickly paid to your beneficiaries outside of your estate, which means bypassing any lengthy delays waiting for probate.

In the second part of this article, I provide another five tips on buying better life insurance.

More: For quality quotes for life, home, motor, health and travel insurance, visit our Insurance centre!

Many thanks to Kevin Carr at LifeSearch for his help with this article.