By Mark O’Grady, Employee Financial Wellness
Who loves insurance and financial protection? No … no-one? No takers? OK, so this probably isn’t a subject I need to break out at parties to win the crowd over. But unfortunately, life isn’t all fun and games. Indeed, some of us are forced to leave the party sooner than expected. And this means that, however much we dislike insurance and financial protection policies, we need them in order to plan adequately for the future.
Getting to grips with life insurance, serious illness cover, income protection, health insurance, waiting periods, standalone or accelerated, joint or dual policies can be somewhat overwhelming. But understanding insurance and financial protection is a key part of being financially fit – it’s a bit like knowing the different muscle groups in the body and what exercises benefit them.
So, in this article, we’re going to go back to basics to explain in simple terms what you need to know. In just a few short minutes you’ll understand the different types of insurance and protection that are out there and be able to figure out what you need.
Why we need financial protection?
Imagine selling someone a product or service that they never want to use. Imagine every time they did use it you would charge them more and more. Genius, right?! Yes, insurances can be annoying, and they cost money, but they do play a pivotal role in getting us to retirement without any financial surprises or complications.
Think about that for a second. Knowing that no matter what happens to your health or physical abilities, there’ll always be enough money in the house. Money (or lack thereof) drives stress, after all. If we eliminate the possibility of not having enough money, then we also eliminate the associated stress. It might be pushing it to say that insurance makes us happy, but it certainly protects us from financial stress which contributes to unhappiness.
Income protection is largely considered the most important form of insurance, because it covers almost every eventuality, except unemployment. You guarantee your financial independence and ensure your mortgage will always be paid.
How does it work? You choose your optimal retirement age. In the event you could no longer work due to an illness or an accident, an income protection plan will ensure a monthly income of up to 75% of your salary all the way until your retirement age.
Serious illness cover
This is a tax-free lump sum payment if you are diagnosed with a specified serious illness. This lumps sum goes towards the high costs of medical treatments that your health insurance plan may not cover. You can get yourself the best treatment in the world without the worry of depleting your own savings.
You should keep something like this separate from your mortgage protection policy. Banks ultimately own your mortgage protection policy which means any pay-out from it goes directly towards paying off your mortgage instead of helping you beat the illness. If you have an income protection policy in place, it will cover off your monthly mortgage repayments, leaving the serious illness cover to deal with just that; serious illness.
TIP: 2 x net salary is adequate.
Most people jump onto the insurance bandwagon by taking out health insurance. It’s a confusing world as there are over 400 health insurance plans currently on the market in Ireland. So, how do you know which one is right for you? Simple, just ask! You should call your health insurance provider ever year on renewal to make sure you’re getting the best possible policy terms.
The www.hia.ie website is excellent for comparisons, but inevitably every year your provider will have released new, better, and cheaper plans that you’re perfectly entitled to switch to. There can sometimes be an unnecessary reluctance to switch plans, or even provider, where there really shouldn’t be. Legislation has been set in this country to allow you to switch plans and/or provider without having to serve any waiting periods on the cover you already have. So, you hear it all the time, but why not give it ago – don’t be afraid to shop around.
There are only 3 reasons to have life insurance:
- Inheritance tax.
If none of these apply to you there’s nothing to stop you from taking out insurance anyway for your own peace of mind but there’s a weak argument to say you need it.
Mortgage protection is always the cheapest form of life insurance, because it is set up on a decreasing term basis. As the years go by the amount left on your mortgage is lower and therefore so too is the amount left on your mortgage protection.
Where there are 2 people on a mortgage, these policies have always been set up as “joint”. This means 2 people are covered but there is only one payout i.e. the banks get paid, the mortgage is cleared, and the policy ends.
However, in 2018 Royal London introduced Dual cover mortgage protection for the same price as joint. What’s the difference? Dual cover will pay out twice! This means in the event of one death and the mortgage is cleared, cover continues on the second life for the remainder of the mortgage term. If there is a second death, there’s a 2nd pay-out to the estate. In simple terms, it’s twice the cover for the same price as joint.
Life insurance policies
It’s difficult to write about life insurance without sounding morbid so let’s take the sentimentality out of it. If there are people relying on your income such as a spouse/partner and/or children, would they be ok if your income was suddenly taken away from the household? Like most of us, probably not. Life insurance is there to make sure they’re ok. That, financially, at least, life will go on and the surviving spouse/partner will not be under pressure to work full-time to raise the children and put them through education.
Our rule of thumb is to have enough cover in place to replace your net income until your youngest child reaches the age of 25. Let’s take an example
- John and Mary both earn €50K per annum (36K after tax)
- They have 2 children aged 8 and 5
- They have a mortgage of €1,400 per month
- They have no death in service benefits at work
- If John dies the house will need to replace his 36K per annum until their youngest is 25 years of age i.e. 20 years x 36K = €720K
- The mortgage will be cleared because of mortgage protection so that is €16,800 per annum that won’t need replacing x 20 years = €336K
- Mary will also receive the Widower’s pension of €10K per annum x 20 years = €200K
- Therefore, John’s need for life insurance is €720K – €336K – €200K = €184K
- As Mary earns the same income her need is the same
- John and Mary should take out a dual cover life insurance policy for €184K each
You pay your taxes on the money you earn to buy the house you want, accumulate some wealth, and keep the Government happy all at the same time. Then when you want to pass on your wealth to your children there is another tax. Seems perfectly fair right? Hmmm.
It’s unfortunate that, in some cases, the children must sell the family home just to pay the inheritance tax bill and they are only given 6 months to do so! Situations like these should be avoided by knowing where to look.
Section 72 life insurance policies are much like any other life insurance policy with one exception, the benefit is paid tax-free so long as it is used to pay the inheritance tax bill. These policies are often good value for money because they are set up under a “whole of life” basis. So long as the premiums are paid, it will pay-out no matter what age the policy owner dies.
If, for example, you identify an inheritance tax bill of €200K and the premium for this amount of cover under a Section 72 policy is €300 per month, it would take over 55 years to break even on the contributions versus the pay-out!
Another scenario on the rise is unmarried couples sharing a mortgage. Now, we’re not suggesting everyone goes out and gets married to please the Revenue, but if this applies to you there’s some information you should know about. If you live with your partner and children for 10,15,20 years and never marry then you’re open to an inheritance tax bill on the death of your partner. For example, if the house is worth €400,000, the Revenue will view this as the surviving partner inheriting €200K from a total stranger whose inheritance limit is €16,250. That means there’s a tax bill of €60K to be paid within 6 months. Bottom-line, there are ways to avoid an unfortunate inheritance tax bill. Ask your broker about Section 72.
I hope this back to basics article has made insurance and financial protection a clearer, if not necessarily more exciting subject for you! My professional advice is to discuss all these options with your financial planner to make sure you are getting the right level of protection for you and your family. Do not discuss at parties.