What is the point of life insurance?

What is the point of life insurance? I am a higher-rate taxpayer in my mid-40s with a £400,000 pension fund and a partner who works – but no children. As I understand, were I to die, my partner would get the £400,000 with no tax charge. So why should I pay for life insurance as well? Surely there must be many people in the same position, where building up a pension makes more sense than wasting money on insurance?

Laith Khalaf, pensions analyst at Hargreaves Lansdown, the financial advisers, says you raise a valid point: your pension benefits should always be taken into account in assessing how much life insurance you need.

In certain circumstances, a large pension fund can mean that a life insurance policy is surplus to requirements.

This is because, on death before retirement, defined contribution and personal pension funds can be paid to your beneficiaries as a lump sum free of inheritance and other taxes. Final salary schemes also typically offer death-in-service benefits that can be paid to your beneficiaries free of tax.

That might not be enough if you have a large mortgage to pay off, which would leave any dependants with little left from the pension fund to live on. What’s more, individuals who have a large pension fund are generally high earners and their family is therefore likely to be accustomed to a high standard of living. In the absence of those substantial earnings, the pension fund may not sustain that standard of living for very long and a life insurance policy may still be necessary.

However, in your case, with a working partner and no dependants, this is less of a concern.

You may also have some critical illness cover as part of your life insurance policy, which your pension doesn’t replicate. Again, though, your employer may provide benefits that reduce the need for this cover, plus, in some circumstances, you might be able to draw on your pension if you contract a long-term illness.

If your pension does meet your life cover needs, then by contributing to it rather than an insurance policy you are building up your retirement nest egg at the same time as protecting your dependants.

However, you still need to make sure that all your pension funds have written notice of any nominated beneficiaries. Providing this instruction to your scheme administrators in writing means that, in the event of your death, your pension fund can be distributed to the people you have nominated with a minimum of fuss.

Also, once you come to draw your pension, you should consider catering for your partner as well as yourself, either through a “joint-life” annuity or an income drawdown arrangement. If you simply opt for a “single-life” annuity, then you may be leaving your partner high and dry if you die after retirement, because a single-life annuity will then cease to pay out. A joint-life annuity will continue to pay your spouse or partner, while an income drawdown plan can provide them with an income or a lump sum. That said, your partner’s security in retirement may be less of a concern if they have their own substantial pension savings.

Finally, while life insurance may seem unnecessary now, a policy may become important in later life as part of inheritance tax (IHT) planning. A policy could be set up to pay for any IHT on your wider estate, or on any gifts made in the seven years before your death. If these gifts or your estate are paid to a spouse or civil partner, there would be no IHT to prepare for.