If there is one topic that is bound to make us uncomfortable, it’s a discussion about just how much are you actually worth. Few of us are comfortable gazing into the eyes of our mortality.
Yet in this uncertain and economically turbulent world, insurance is increasingly essential, to secure your lifestyle, particular so, if you have a family.
Insurance is a subject that evokes much eye-rolling and glazed looks. It’s complicated, it’s expensive, it’s fraught with a minefield of potential conflicts of interest, it’s certainly not very exciting and even for those of us who buy insurance, it’s inevitably a grudge purchase.
Many of us think only houses and cars get insured. However, life insurance and income protection are sensible avenues to explore to protect your financial future.
Income protection insurance covers you if you fall ill, have an accident or become disabled, while life insurance covers you after death or if you are diagnosed with a terminal illness. It doesn’t cost much but can prove a blessing financially when you need it.
Buying Smart Cover
Most people don’t buy sufficient life insurance to cover their needs or that of their family. Of those that do, many end up making a poor decision and buying insurance that does not reflect their actual needs.
When it comes to life insurance and income protection, Australia’s are shockingly under-insured. Regardless of whether you are single or have a family, you need to protect yourself in the event of an illness, injury or death.
This begs the question, “How much are you worth?”
Navigating Your Way Through The Insurance Maze
These basics tips will help you understand what you are worth and navigate your way through the labyrinth that is the insurance world:
1. Identify Your Insurance Needs
Not everyone automatically needs life insurance. If you are young, single and don’t have dependents life insurance may not be for you.
If you are thinking about having children, now may be a good time to buy insurance, as the premiums are lower when you are young. Moreover, by buying insurance at an earlier age you guarantee your insurability. However, ultimately insurance premiums are set according to your age, gender and risk classification.
Similarly, if you have any property investments that are partially debt funded, an income protection policy might be a savvy move to cover your investments if you become ill or lose your job.
If you are older with no dependents, and you have saved sufficient to provide for your family’s needs, you may no longer need for life insurance or income protection.
2. Decide How Much Life Insurance You Need
The general consensus is there are two methods you can use to how much insurance you need:
- Income replacement: This model takes into considers your earnings and your age. It typically calculates a higher number than the needs-based model. Starting with your age you determine how many years of income you would need to replace in the event of your death. Sole, if you are 40, you might decide to buy insurance that would pay 15 or 20 times your yearly income. Some predictive models also factor in your projected after-tax earnings over your working years, together with inflation and discount the results to arrive at a net present value. The fundamental problem with this model is that it’s not customised
- Needs-Based Model: This calculation considers your personal financial situation and assesses the impact your death would have on your dependents financially. Factors to consider in this model include whether your spouse or partner is or will continue to work, the number of children you have, whether you have a mortgage to pay off and the cost of educating your children.
Of the two, the needs-based approach tends to arrive at a more customized position that reflects your personal situation and needs. However, it does require more time and more information to get right.
Determine The Form Of Insurance You Need
The two common forms of insurance are term and universal life insurance. Term insurance is a flat premium fee and has no investment element. You simply determine what coverage you require and how long you want that policy to be in effect for. You then buy a term insurance policy with a set premium over the policy term. Term insurance generally comes at a lower premium than cash-value insurance.
Guarantee Life Insurance has a provision, that if you pass away within two years of taking out the policy, the company will refund the premium you have paid to date. However, the death benefits attached to these types of polices tend to be low, while the premiums can be expensive.
Universal life insurance comes with higher premiums but with the added benefit that the life insurance company will take your additional premium contributions and invest them for you. Unfortunately, these types of insurance have proven to be quite expensive. The investments can struggle to increase in value as the expense load on the policy consumes your interest.
For those people with a young family, term insurance will provide the most coverage for the lowest premium. Shopping for term insurance is simple using comparison websites or insurance company websites.
What Is Income Protection Insurance?
Despite all the variations in legal terminology, the basic aim of most income protection policies is much the same: to ensure you won’t be out of pocket if an unexpected illness or accident leaves you unable to earn your regular wage.
Broadly speaking, there are two types of income protection policy:
- Agreed value pays a fixed amount regardless of what your actual income is
- Indemnity value policies verify your income at the time of a claim. The latter is usually cheaper and many are offered via a superannuation fund.
There are also two payment types:
- Level premiums: These remain the same throughout the life of the policy
- Stepped premiums increase over time.
Level premiums will usually prove cheaper in the long run but can prove to be more expensive initially. Rates vary based on your gender and occupation. Unsurprisingly, smokers will pay higher premiums.
Under these types of policies, you receive a regular income until you are able to return to work or retire.
In most cases, a waiting period applies before income protection payments begin. Typically you trigger income protection payments to kick in after your sick leave provision ends, or after other insurance ceases its coverage. The longer the waiting period, the lower your monthly premiums usually are.
Income protection will cover a broad range of short or long-term illnesses that leave you unable to work, depending on the policy type and how it defines incapacity. You can claim against your policy as often as you need to, while the policy is in effect.
Key Questions About Income Protection
- Is the amount paid a fixed sum, or based on your earnings during the previous year?
- Are there any exclusions or circumstances where the policy won’t pay out?
- How long will you wait before the policy pays out?
Finally, there are the tax advantages of income protection. Generally, you can claim “income protection, sickness and accident insurance premiums” against your taxable income. That doesn’t make them free; but it does reduce your overall taxable income, thus reducing your overall tax bill.
Life insurance and income protection are a very personal decision. Only you can decide if the cost represents value to you and your family in the form of greater peace of mind. The alternative is to place the amount you would have been paying in premiums into an alternative form of investment, say a savings plan. If readers have strong views one way or the other, we’d love to hear your feedback in the comments.