Jason Butler explains the basics of income insurance and how to use it as the foundation of your financial security.
Insurance is essential to protect you and your family against those risks that might adversely affect your financial security. Getting the right cover for the right price is essential, so follow my top tips and ensure that you insure.
Protect your income
If you are still reliant on income from working then it is essential that you have income protection insurance (also known as permanent health insurance or PHI) to replace your income in the event of a prolonged incapacity. A personal policy will usually cover up to 75 per cent of your normal income and is tax free. If you are covered by your employer’s group income protection scheme then this will be taxable in the same way as salary.
In addition to the amount of cover, the four variables that affect the premiums of a personal income protection policy are:
- Deferred period before the benefit is received (from one to 12 months)
- The age at which the cover/benefit ceases (typically between 55-60)
- Whether or not cover and/or benefits are protected against inflation
- Whether benefit is payable if you can’t carry out your own, a suited or any type of occupation. This last point may be more important for certain specialised and higher-paying occupations.
The cheapest premium will be offered for a policy with a long deferred period before a valid claim is paid, which ceases at the earliest age and which is only paid if you cannot do any form of paid work. The cheapest policy is not, however, always the best, and claims history and policy features need to be considered. Make sure that the cover meets the amount of reasonable lifestyle expenditure that would continue in the event of your incapacity. No more and no less.
Protect your life
Life insurance pays out if you die and this can be as either a lump sum or instalments. If you have liabilities such as a mortgage then you will need a lump sum policy to cover that. Otherwise you will probably be better off buying an instalment policy, otherwise known as a family income benefit (FIB) policy.
FIB is usually much cheaper than a lump sum policy because the risk to the insurance company reduces as you progress through the policy term. For example, a £100,000 ten-year level policy would pay out £100,000 in year ten, whereas a ten-year FIB policy which pays out £10,000 pa would only pay out £10,000 in the last year.
If you need life cover on two individuals’ lives then two separate life policies will usually be only slightly more expensive than a joint life first death policy but will provide twice the amount of cover. In the event that the two individuals subsequently require it, each can retain their own policy even if there is no longer a relationship between them. But note that a joint policy would need to be cancelled and replaced, requiring new underwriting and possibly higher costs due to increased ages.
If you can afford it, arranging insurance on an annual premium basis is about 4 per cent cheaper than monthly premiums. While interest rates on cash remain low, it makes sense to pay annually.
Use a trust
To ensure that the proceeds would be paid out quickly and also to avoid potential inheritance tax, it usually makes sense to place a life policy under a trust. This means that the insurance company will pay the claim to the trustees on production of the death certificate, regardless of what is going on with the deceased’s estate. A trust is not appropriate if you need to assign the policy to a third party, such as a mortgage lender.
Life of another is useful
If you have a financial interest in someone else, known as insurable interest, then you can take out a life policy on that person, subject to them completing the required medical underwriting. This can be useful where, for example, someone owes you money or is an ex-spouse who is paying you maintenance and you need to take responsibility for paying the premiums. A life of another policy can also be placed in trust, as long as you personally do not want or need to benefit from the policy.
Critical illness is not critical
It is also possible to buy lump sum or instalment insurance which pays out if you suffer one of a range of critical illnesses or suffer permanent disability, known as critical illness insurance. As a general rule this type of cover is about three times more expensive than life insurance and much less likely to pay out than income replacement insurance and as such it should be seen as a ‘nice to have’ if you can afford it, rather than a ‘must have’.
Medical insurance – preference and location
Private medical insurance is expensive and its value will depend very much on your personal preferences and the quality of the National Health Service in your locality. Remember that most life-threatening illnesses and serious diseases still have to be treated in NHS hospitals so it might be cheaper to pay for initial medical investigations or tests yourself and then rely on the NHS to treat you.
Other ways of reducing the cost of health insurance include:
- Restricting the available hospitals
- Increasing the excess payable per claim
- Restricting access to private hospital treatment unless the NHS cannot provide the cover within a given time period
Insurance is something that no one wants to pay for but against which they are always happy to claim. It is essential to remove those risks that you and your family cannot or do not want to bear personally. A good financial adviser will help you to work out what, when and how much cover you need so that, if the worst happens, you and your family are at least financially secure and have choices.
To find the right protection for your family speak to a financial adviser.