What will happen to your income if you are injured or ill and cannot work?
How long can your cash reserves last for if you are injured or ill and cannot work?
Can you still afford to pay all your bills if you cannot work for one month? Three months? Or six months?
What happens if you become total and permanent disabled?
These are confronting questions. As a financial adviser, it is confronting how many people do not think about these questions.
Most people I speak with will have their car insured, the home contents insured, but will not have their largest income producing assets – themselves – properly insured.
Below are the four main types of insurance policies available to protect you and your family:
Life cover/death cover
Life cover is one type of cover that falls under the heading ‘life insurance’ and may also be known as ‘term life insurance’ or ‘death cover’. Life cover pays a set amount of money when you die. The money will go to the people you nominate as beneficiaries on your policy. If you have not named someone on your policy, then a Trustee or your estate will decide where the money goes.
How much life/death cover do you need? Something I consider with clients is how much of a mortgage can be serviced by a surviving spouse? We determine how much the mortgage needs to be reduced so that a surviving spouse can meet loan repayments on their sole income. For some clients, the idea of being completely debt free in this situation is a priority. Thus, a lump sum benefit may completely discharge a mortgage, so a surviving spouse does not need to worry about mortgage repayments as all on one income.
Other things to consider are the age of any children. What financial support would be needed for education. A lump sum could then be invested to help produce an income stream to cover education costs.
Life or death insurance can be owned inside your superannuation fund. This has a benefit from a tax perspective as the premiums offset the taxable income in your superannuation fund.
Total and permanent disability
Total and permanent disability (TPD) insurance provides cover if you are totally and permanently disabled. It helps cover the costs of rehabilitation, debt repayments and the future cost of living.
Your insurer will define TPD as when you either:
(1) cannot work again in any occupation, or
(2) cannot work in your usual occupation.
Similar to life/death cover above, I generally will determine what portion of a home mortgage would need to be discharged. Additional considerations include the fact that if you are total and permanent disabled, what home care arrangements would be needed. Unlike death, a person who is total and permanent disabled still needs to eat, have transport and likely special health care. In this regard I see that total and permanent disability may ‘dovetail’ alongside an income protection policy. Income protection policies generally cover you for up to 75% of your income. A lump sum from total and permanent disability benefit invested can make up the 25% shortfall from an income protection benefit.
For example, if someone earns $100,000 per annum, an income protection policy will likely replace $75,000 (or 75% of that income). To get a recurring income from a lump sum invested of $25,000 per annum. I would assume a return of 4% per annum. The maths shows a lump sum of $625,000 earning 4% or $25,000 per annum can substitute the 25% of your income not replaced through income protection insurance.
For total and permanent disability benefit calculations, I also factor assumed ancillary medical costs of $125,000. Research shows that generally in Australia, if we contemplate all medical events that render a person totally and permanently disabled, you may be out-of-pocket up to this figure for items not covered through Medicare or private health insurance.
Importantly, this also provides a budget to purchase health aides such as wheelchairs or retrofitting a home.
Total and permanent disability insurance can be owned inside your superannuation fund. This has a benefit from a tax perspective as the premiums offset the taxable income in your superannuation fund.
Income protection
Income protection insurance replaces the income lost through your inability to work due to injury or sickness. It is especially suitable for self-employed people, small business owners or professionals whose business relies heavily on their ability to work.
There are a few variables to consider with income protection insurance:
- How much income replacement do you need? For most people, their lifestyle could not be maintained if they experienced a reduced income. In this instance one would consider obtaining an income protection policy that replaces the maximum 75% of their income. There are some providers out there who may consider 85% income replacement. However, for people who may now have adult children and most of their home loan paid off, full income replacement may not be necessary. In this instance working out your living expenses and ensuring that is replaced may be more appropriate. For example, I have one client who earns a cool $475,000 per annum, However, we have determined family living expenses for them are around $8,000 – $10,000 per month. We have a monthly benefit in place of $15,000 as income protection benefits are considered as taxable income. This means their income protection plan will only cover them for 38% of their current income. However, we don’t need to pay for unnecessary extra cover.
- How long can you rely on cash savings, annual leave, sick leave or long service leave before you run out of cash? With income protection benefits you can choose your waiting period. I.e., do you need to wait 30, 60, 90 or 180 days before you lodge a claim? The waiting period can be a long as 2 years. The longer the waiting period the lower the insurance premiums will be too. Keep in mind, income protection benefit is paid monthly in arrears. So, you will need to ensure you can still survive for an additional 30 days of no income after lodging a claim.
- How long do you need a benefit for? Income protection benefits be paid for 2 years, 5 years, or all the way to your 65th Some insurers are now providing cover to age 70. We had a family friend who unfortunately suffered a stroke and could not work. They were fortunate in that they had sufficient income protection in place. Hence, when our friend was unable to work, their income and lifestyle was maintained thanks to the income protection benefits.
Income protection policies can be owned inside or outside of your superannuation fund. A benefit of personal ownership is that the premiums are tax deductible at your marginal tax rate. For most people this will be a higher deduction than the superannuation tax rate of 15%. Another benefit of personal ownership is any benefit will be paid directly to you.
If your policy is owned by your superannuation fund, you then need to meet a ‘condition of release’ get these benefits then paid to you personally. Not a problem if you have a permanent injury or illness. However, if you have short-term incapacity, your benefits may be paid to your superannuation fund, but you may not be able to access it.
Trauma/critical illness
Trauma/critical illness insurance provides cover if you are diagnosed with a specified illness. These policies include the major illnesses that will make a significant impact on your life, such as cancer or a stroke. Trauma insurance pays a set amount. This can be used for things like:
- any private medical costs above your health insurance
- an income stream if you stop working.
- the ongoing cost of any therapy and special transport costs
- adjustments to housing
- repaying your debts.
Statistically, this is the most likely policy you will make a claim. I generally recommend one year’s net income plus a lump sum of $125,000 to cover ancillary medical expenses. There are several conditions such as cancer where you may have periods of reduced income generating capacity. However, you may not qualify to have your income protection or total and permanent disability benefits paid. This formula enables you to choose if you want to take leave from work with no pay to focus on your medical recovery. Last year I had a client in his mid-40’s with two young children diagnosed with stage 3 melanoma. This policy enabled him to take the time off from work for what he wanted. They had not financial pressures in making such a decision.
It is important to note that due to the nature of trauma/critical illness insurance, it cannot be owned in your superannuation fund. The premiums will be paid personally and are not tax deductible. However, the benefit paid is tax free.
The above is a high-level summary of how personal insurance works. There are many other considerations as well. It is good to seek expert advice to ensure you have a suite of policies that are appropriate for you. Now and into the future as circumstances change.
Source: Life insurance claims comparison tool
Andrew Zbik
Senior Financial Adviser
Creation Wealth
0422 038 253
andrew.zbik@creationwealth.com.au
www.creationwealth.com.au