So, you’ve got all your finances in order or are in the process of doing so. That’s great! But life often throws things at us when we least expect it. Failing to have adequate protection insurance in place is the one thing that could derail any financial plans you have worked hard to put in place.
Have you ever thought about how you or your family would cope financially, should anything ever happen to either of you? What if the main earner was unable to work for 6 months to a year due to an accident or critical illness? Or even worse, how would the surviving spouse cope financially if, god forbid, the main earner were to die? How would the mortgage get paid? Unless you are comfortably financially independent, then the chances are that you will need some kind of insurance(s) to cover these eventualities.
The primary risks that could derail your financial security are early death, critical illness and the ability to earn an income. They are in the order of the least likely to happen. So you are more likely to suffer a critical illness than you are to die. And you are more likely to be unable to work due to a bad back or an accident, than you are to suffer from cancer or another critical illness. In terms of financial impact, the least likely, i.e., a death, is sure to have the biggest financial impact.
Determining The Amount Of Cover Required
There’s no straightforward answer as to the amount of cover required. It’s possible to have too little cover and probably possible to have too much cover. When considering insurance, most people will need to compromise. To have all the insurance you need or want, may well be too expensive.
There are 3 types of cover we’ll need to look at in order to address each of the risks involved. They are Life Insurance, Critical Illness and Income Protection. You need to look at each risk and assess what the financial impact will be. You need to review and combine any personal policies you have along with any benefits you get through your employer. Once you know what you are already covered for, you will need to fill in any gaps.
Ask yourself, if you were to die tomorrow, what would the financial impact be for those left behind? Is there anyone that will be financially disadvantaged by you no longer being alive? If you are the sole or main breadwinner in a relationship, the answer almost certainly is yes.
Whilst not necessary, I would recommend putting your life insurance in a trust. A trust is like a legal box in which you can place your life insurance policy. A life insurance policy held in trust will fall outside the estate. Therefore it wouldn’t be subject to probate and is more likely to be paid out quickly. A trust can also help you put some controls in place. I highly recommend seeking advise from an adviser that understands how trusts work if that’s something you wish to consider.
How much do you need?
You’ll need to take into consideration any debt you have, such as a mortgage or any loans outstanding. Debt doesn’t die with you, you’ll need to make provision for it to be paid off. If your single and have a mortgage, you may be happy for your house to be sold when you die, to pay the mortgage off. In which case, you may not need any life insurance. If on the other hand you need to leave the house to someone, you’ll need some life insurance to pay off the mortgage. I would say that’s the minimum amount of life insurance cover that anyone needs. Grieving families don’t want to be worrying about debt and because life cover is cheap, there is no reason to scrimp here.
However, you should also aim to have extra cover so any dependants have a financial buffer. A buffer to provide a cash lump sum or a regular income. Everyone is different but I would aim to cover for debt + £250,000. If you have children, then maybe cover for debt + £500,000. These figures are my very general rule of thumb and are the figures I have used myself.
Critical Illness Cover
Critical Illness insurance provides you with a tax free lump sum should you be diagnosed with an insured illness. Such illnesses include a heart attack, a stroke, cancer, kidney failure, loss of sight, hearing, speech or major organ transplantation. The impact of suffering from a critical illness may be that you are unable to work for a prolonged period of time. You may need caring for. Whilst you are unable to work, debt still needs to be paid. You may have to convert your home or may even have to move home. You may have to pay for childcare if you are unable to look after your children. Even if someone else is responsible or negligence is involved, you may get a payout but that could take years.
How much do you need?
It would be preferable to have your debts paid off and have a financial buffer. Critical illness cover is prohibitively expensive though, so you may want to insure for maybe two years worth of income or mortgage payments.
Income protection gives you a proportion of your regular income if you are unable to work due to illness or injury and suffer a loss of earnings. Your ability to earn an income is your greatest asset. So you need to think about what the financial impact of you not being able to earn a living would be. If you couldn’t work due to illness or injury, would you have other sources of income or savings to support you or your family while you recovered? If your household has two incomes, would one income provide sufficient support? Do you have dependants who would need financial support if you were unable to work for an extended period?
How much do you need?
With income protection, you are somewhat limited as to how much protection you can take. You can’t protect an income you don’t have. So you can’t take out a £50,000 income protection policy when you only earn £20,000 a year. The maximum amount of Income Protection available is normally around 65% – 75% of your gross income. You should aim to get as much income protection cover as possible.
Check Your Employer Benefits
Check what benefits you already get at work through your employer. As part of my benefits package, I already have life insurance and some income protection cover as standard. I chose to pay a little extra to up the levels and also added some critical illness cover. Employers often provide some soft of sick pay cover. You might get full pay for 6 months and then half pay for 6 months. This is something you’ll need to ask your employer about.
Check Your Policies Regularly
You should be checking and reviewing all your policies regularly, maybe on an annual basis. Circumstances change all the time. Maybe you got married? Divorced? Had children? Your salary is likely to increase over time, probably on an annual basis. Maybe this is also a good time to review these policies? If you have started or stopped smoking or there is a significant change in your health, these would have all been taken into consideration when you took out cover.