Personal protection equipment or PPE is now a routine part of our daily lives — a hygiene factor that keeps us safe from harm and allows us to continue our daily lives with some semblance of normality. But interestingly, most of us fail to apply the same level of protection to our finances.
Fail to plan, plan to fail
Protection should always be considered as nobody knows what the future holds. Financial planning is about giving you and yours the best chance of achieving your life goals and preparing for any unexpected bad times. Failing to plan can have dire consequences!
Before you can get stuck into saving towards your long-term financial goals, you should aim to have some rainy day savings and no bad debt (credit cards, high-interest loans, payday loans etc). The best way to cushion yourself from the worst is to have an emergency fund with at least three to six months’ monthly expenditure (we blogged about it here).
In practice, it can take quite a while to pay off debts and build your emergency savings pot, so while keeping a cash reserve is a good idea, it’s worth combining it with some form of insurance plan.
Common insurance myths
I’ll never need it. None of knows what the future holds, and the pandemic has shown just how easily things can change dramatically. Many lives, jobs and businesses have been lost in 2020 with some employment sectors in almost permanent decline.
I can’t afford it. It’s cheaper than you think. You can buy some basic protection for a few pounds a month.
The state will take care of me. Up to a point. If you lose your job today, you’ll receive basic universal credit (currently £409.89 for single claimants) plus a local housing allowance that is well below market rents. If you want to be in charge of your own finances, the safest option is to rely on yourself. Make sure you have savings and the right protection in place.
Types of insurance
Term assurance
The simplest and cheapest form of insurance is designed to help your dependents in case you die unexpectedly. It pays out a lump sum. The insurance cover last for a certain time, known as the term, during which time you’ll pay regular premiums.
The premiums will depend on how much cover you want and lifestyle factors such as your age and health. The premiums can stay the same or rise with inflation. There are also joint policies which pay out on the first or second death.
This sum assured can either stay the same or decrease over time. Decreasing terms are commonly used to cover the outstanding balance on a mortgage that is being repaid.
A lump sum will be paid directly to your chosen beneficiaries. When you buy term assurance, you usually have the option for the sum assured to be paid into a trust to exclude it from your estate for inheritance tax purposes.
Family income benefit
Family income benefit is a variation on term assurance. It provides a monthly income to cover expenses for your family in the event of your death. Some people prefer a regular income to cover ongoing childcare, school fees or university fees for example.
If you die, your family receives a regular, tax-free, monthly income for the rest of the policy’s term. You can decide whether you want the income to stay level or to increase with inflation.
Income protection insurance
Income protection insurance pays out an agreed percentage of your salary if you are unable to work due to illness or injury. Cover is usually limited to a maximum of 50-65% of your current gross salary and may be level or linked to inflation. Premiums can be guaranteed or reviewable. Some pay for a set period while others continue until you find work.
The chances of being unable to work because of illness or injury are much higher than those of death. Most employers will only provide sick pay for short periods and benefits are unlikely to be enough to cover your monthly essential living expenses. The plan pays you a tax-free monthly income. There is a pre-agreed waiting period before the income starts (often 1, 2, 3, 6, 12 or 24 months); the longer the waiting period, the lower the premium.
Critical illness cover
This insurance plan pays you a lump sum if you are diagnosed with a serious illness. It only applies to a specific list of health conditions or illnesses and does not include mental health conditions. Not all conditions are covered by all plans, so it is even important to obtain professional advice for this type of cover.
Serious illness can happen to anyone and can cause financial hardship at a time of terrible emotional stress. Covid 19 has shown us how precious and precarious life can be. Critical illness cover can help by ensuring that your mortgage is paid off or providing a lump sum for medical expenses. Your employee benefits package may include ‘death in service’ benefits which may cover some of these elements.
Whole-of-life insurance
This type of insurance lasts for the rest of your life (assuming the premiums continue to be paid) meaning that your dependants will receive the sum assured when you die. As it is open-ended, the premiums are normally a lot higher than for term assurance, and they usually increase every ten years.
This type of protection can be used to cover any inheritance tax liabilities for your family and is often part of a larger financial plan for your estate. Unlike Term Assurance there can be an investment element to these policies, and a surrender value (although cover stops if the plan is surrendered). With inheritance tax planning, you should always speak to a qualified financial adviser.
How to buy
What do I need?
Depending on your age and family circumstances, your needs will change over time. A young adult, with no dependents will only need income protection. But if they do have dependents then they should consider income protection, term assurance, family income benefit and whole of life assurance. Parents should always have life assurance, and of course once you’re in your later years you might be thinking about inheritance tax and other elements. The table below is a guide for where to start depending on your status.
| Term assurance | Family income benefit | Income protection | Critical illness cover | Whole life | |
|---|---|---|---|---|---|
| Young adults, no dependents | x | ||||
| Young adults, dependents | x | x | x | ||
| Parents | x | x | |||
| Later years | x | x |
How much do I need?
To work out your income protection needs, add up your household expenses, childcare costs, school fees, and any other essential monthly outgoings including things like holidays, clothes etc.
To calculate a lump sum for life insurance and critical illness cover, it pays to consider your current household earnings, any outstanding mortgage balance, credit cards or personal loans. A good rule of thumb is ten times your highest earner’s salary, plus outstanding debts on top. Remember to check and subtract any cover you already have. If you’re employed, check whether your employment benefits package includes ‘death in service’ cover (i.e. life insurance) or income protection.
Before you buy
Shop around. There are lots of price comparison and insurance websites available, but remember they earn commission from selling you insurance, so shop around and read the small print to make sure you’re getting what you expect. Insurance policies may not make for a good read, but you need to make sure that your cover provides you with the right level of protection.
Questions to ask before you buy
- Are there any policy exclusions? (Under what circumstances might the insurer not pay out?)
- Will I need to undergo a medical examination?
- What happens when my policy ends?
- What if I can’t afford the monthly payments?
After you buy
Diarise a yearly or five-yearly review of your insurance needs. If you get married, buy a house, have a family etc. your insurance needs will change, so it pays to review regularly.
Photo by Vera Davidova on Unsplash
