Funding after-life care – the options

Life insurance policies and prepaid funeral plans are financial products designed to provide security and peace of mind, but they serve different purposes and have distinct characteristics. When it comes to later life planning, it can be difficult to differentiate between these two product types, and understand how the two are related.

However, it’s crucial to have a clear understanding of the core differences between these two options, to help you make informed decisions about end-of-life planning and financial protection for you and your loved ones.

What’s the purpose of life insurance and prepaid funeral plans?

A life insurance policy is designed to provide financial support to the beneficiaries of the insured person upon their death. The primary purpose is to offer a lump sum payment, known as a death benefit, which can be used to cover living expenses, pay off debts, fund education for dependents, and any other financial obligations ¹ There are different types of life insurance policies, including term life insurance, which covers a specific period, and whole life insurance, which provides lifelong coverage.²

A prepaid funeral plan, on the other hand, is specifically designed to cover the costs associated with a funeral, rather than for use to cover other costs following a death. This plan allows individuals to pay in advance for their funeral services, thereby locking in current prices and alleviating the financial burden on their families left behind.³ This has proven a particularly savvy investment for those who locked in their funeral plan costs before the cost of living crisis hit, with inflation peaking at 11% in October 2022. Prepaid plans can cover the costs of coffins, transportation, cremation fees and other funeral services, dependent on the type of plan chosen.⁴

Financially, what is the difference between a life insurance policy and a prepaid funeral plan?

In most circumstances, life insurance policies are funded through regular premium payments, which can be made monthly, quarterly, or annually depending on the policy chosen. The cost of a customer’s premium is dependent on several factors, including the insured’s age, health, lifestyle, and the amount of coverage chosen.⁵ Often, term life insurance premiums are lower initially but can increase upon renewal, while whole life insurance premiums are mostly higher but remain fixed over time.⁶ Additionally, whole life insurance policies may accumulate cash value, which can be borrowed against or withdrawn during the insured’s lifetime.

Prepaid funeral plans can be funded in various ways. Individuals can make a single lump sum payment or spread the cost over several years through installment payments. The total cost is determined by the specific services and products selected in the plan. Once the plan is fully paid, no further payments are required. Prepaid plans do not accumulate cash value and are specifically earmarked for funeral expenses. In some cases, funeral plan providers offer monthly payments through a credit agreement, which can incur additional interest charges against the plan.

In the United Kingdom (UK) there are some initiatives which have been introduced to tackle the rising costs of funerals. For example, in 2019 the Government introduced the Children’s Funeral Fund (CFF) which ensures bereaved parents will no longer have to pay the cost of their child’s burial or cremation up until the age of 18.⁷ This initiative provides bereaved parents with much-needed support, many of whom will have suffered years of financial hardship as they tried to meet the additional costs of caring for a potentially ill child.

Additionally, the Department of Workplace Pensions (DWP) have also developed the Funeral Expenses Payment (FEP) to help pay for some of the cost of funerals fees.⁸ For example, they can support with funding for a particular plot, cremation fees including the cost of the doctor’s certificate, travel to arrange or go to the funeral, the cost of moving the body within the UK, if it’s being moved more than 50 miles, and death certificates or other documents.⁹ Although, how much support you are eligible for depends on your personal circumstances.

What happens if there is a change in circumstance?

The flexibility of life insurance lies in the versatility of the death benefit. Beneficiaries can use the proceeds for any purpose they deem necessary, whether it’s paying off a mortgage, funding children’s education, covering living expenses, or even investing the money. This flexibility provides a financial safety net that can be tailored to the beneficiaries’ needs at the time of the insured’s death.

In contrast, a prepaid funeral plan offers less flexibility because the funds are specifically allocated for funeral expenses. Although people are able to change or cancel their plan should it be required, it is important to note that the terms of cancellation and ability to change such policies may differ between providers, so be sure to check the contract prior to payment.

What are the risks and guarantees of life insurance policies and prepaid funeral plans?

Life insurance policies come with certain risks, particularly related to premium payments and policy terms. For example, if premiums are not paid, the policy may lapse, leaving the insured without coverage.¹⁰ Additionally, term life insurance policies provide coverage only for a specified period; if the insured outlives the term, no death benefit is paid unless the policy is renewed or converted to a whole life policy. Whole life policies, however, guarantee coverage as long as premiums are paid.

Prepaid funeral plans generally come with the guarantee that the services and products agreed upon will be provided at the time of death, regardless of inflation or the age that the planholder lives to. This guarantee offers peace of mind, knowing that funeral expenses are covered and that loved ones will not face unexpected costs or the cancellation of a plan by a provider.

How life insurance and funeral plans are regulated

Life insurance policies are regulated and must adhere to strict guidelines to ensure consumer protection. In the UK, insurance providers are dually regulated and must follow strict laws set out by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). ¹¹ These regulations include requirements for solvency, disclosure, and fair practice standards. In the UK policyholders are also protected by Government guarantee associations, which provide a safety net in the event of an insurance company’s insolvency. To find out more about this visit here.

Prepaid funeral plans on the other hand are regulated solely by the FCA. The FCA works to bring greater transparency, protection, and confidence to the prepaid funeral plan market, ensuring that consumers’ interests are safeguarded. To address any potential consumer grievances, the FCA requires businesses to have robust complaints handling processes; and access to the Financial Ombudsman Service (FOS) for independent dispute resolution.

Additionally, the FCA mandates that funeral providers safeguard customers’ funds by holding them in trust or backing them with insurance. This guarantees that the money will be available for the funeral even if the provider goes out of business. It is crucial for consumers to understand the regulations and choose a funeral plan provider that has been approved by the FCA to sell funeral plans. Information relating to the activities that a company has been authorised to undertake, can be found by searching the FCA Register here.

The tax implications of life insurance policies and funeral plans

When it comes to life insurance, death benefits are generally tax-free unless it forms part of your estate in which case it would likely be subject to inheritance tax.¹² Whereas funds in a prepaid funeral plan are typically not subject to income tax, as they are considered prepayment for services, rather than an inherited asset.

If you’re unsure of the tax implications for your individual circumstances, it is always best to  consult a financial advisor.

How do you decide which product is the most suitable for you?

A life insurance policy is generally most suitable for individuals seeking to provide broad financial protection for their loved ones. It is particularly beneficial for those with dependents, significant debts, or future financial obligations.

When deciding on whether or not to take out a life insurance policy you should consider factors such as long term financial goals, family needs, health, and budget. Taking out life insurance can offer a financial safety net, but may not be the most appropriate product for your individual circumstances.

A prepaid funeral plan on the other hand is suitable for individuals who wish to ensure that their funeral expenses are covered and to relieve their families of the financial and emotional burden of planning a funeral. Funds are directly allocated for funeral related expenses rather than more generally as in the case of a life insurance policy. It is particularly appealing to those who want to lock in current prices and have specific preferences for their funeral arrangements. The decision to purchase a prepaid plan should involve careful consideration of the provider’s reputation, the plan’s terms, and any potential limitations.

While both life insurance policies and prepaid funeral plans offer several valuable benefits, they cater to different needs and priorities. Life insurance provides broad and more generalised financial security for beneficiaries, with flexibility in how the funds are used, whereas prepaid funeral plans focus on covering specific funeral costs, ensuring that arrangements are made according to your wishes.

It’s also important to consider the cross-over between the two product types for an individual. Many believe that having both life insurance and a funeral plan will allow them to pay for the funeral out of life insurance coverage, either before or after death. This is not the case – a funeral plan needs to be fully paid up before death, for the funeral to be undertaken without additional costs needing to be covered by family. Life insurance will only pay out when the policy holder passes away, so funds are unavailable to put into a funeral plan.

Understanding the differences, benefits and drawbacks of both life insurance policies and prepaid funeral plans is essential for making informed choices that align with one’s financial goals and end-of-life planning preferences. As is having a clear understanding of whether you or your loved ones are entitled to any funeral payment support.

If you have any questions about anything that has been discussed in this article, please don’t hesitate to reach out to our friendly team on 0800 471 4689, or by sending us an enquiry.