Life insurance

What it means

Life insurance covers a person, not property: the insurer pays an agreed sum on death and, with some products, on surviving to a set age. Risk cover is the cheapest because the whole premium buys cover, while endowment and unit-linked policies also carry saving and the costs of the contract.

Cover is not unconditional: the exclusions and the health questionnaire signed at the outset decide. The policyholder who pays need not be the insured, and the death benefit goes to the beneficiary named in the contract, outside the estate.

Life insurance differs from accident insurance in what triggers the payout. Accident cover pays only for the consequences of an accident, whereas life cover pays on death from any cause the exclusions do not remove, illness included. The two are often sold in one contract as riders, and the offer has to be read to see which cover applies to which risk.

How it works in practice

A death benefit is exempt from income tax; a maturity benefit is not, and the insurer withholds tax on the difference between the sum paid out and the premiums paid in. The deduction for life premiums was abolished, unlike the one for the third pillar.

In a company such a policy serves as security for a bank loan or as key-person cover. Where the employer pays the premium for an employee, it is that employee’s benefit in kind, taxed and levied together with the wage.

When an entrepreneur arranges cover with a broker, we often supply the inputs: an overview of loans, leases and personal guarantees for the company’s debts. An appropriate sum insured is derived from them, because it should cover what the family or partners would be left to repay after the entrepreneur’s death, not a round number from the offer.

What to watch out for

A company pays life cover for its director, books it as a cost and leaves it off his payslip. On an audit the payment is reclassified as his taxable income and tax and levies are assessed for every month the policy ran, with interest on top. The premium stays deductible only where it is agreed in a contract or an internal rule and is genuinely taxed on the employee.

A unit-linked life policy gets cancelled after a few years when the company or the household needs cash. In the early years the surrender value is only a fraction of the premiums paid, since the costs of the insurance contract are taken at the start, and tax may still be due on the sum paid out.