KEY GUIDE
Financial protection for
you and your family
Introduction
Most of us believe that taking out life and other forms of protection insurance is a good thing to do. Protecting your family should underpin financial planning and it can also be a key business tool or estate planning mechanism.
Insurance can be viewed as complicated, yet understand the fundamentals and it becomes relatively straightforward. The problem is that not everyone bothers to explain how it works in the first place.
Why life insurance?
Life insurance provides money where there is a financial need resulting from a death, although there may be other reasons to buy cover.
l Paying off a mortgage (or other loan) if a borrower dies.
l Protecting a family against the early death of a spouse, partner or parent. Life insurance provides a lump sum or income to help compensate for the loss of someone’s salary. Where there are young children, any need is likely to be greater but decline as they become more independent.
l Paying for a funeral.
l Paying inheritance tax (IHT).
l Protecting a business against the financial consequences of the loss of a business owner or key employee.
You can have life insurance on the life of one person or on the joint lives of two.
More is possible, but is unusual except for group life insurance, usually bought by employers.
Who gets covered?
If your income will be lost if you die, you are the life to be insured. If you live with a spouse or partner, you can insure both lives. In that case, the policy will pay out if one of you dies.
You have the option to take out an insurance policy called a ‘whole of life’ policy. If you are a couple, you should usually take out a policy that pays out when the second partner dies. The policy is written under trust for your heirs (see above). The insurance company will provide the trust form.
The idea is to take out a policy that will pay out enough to cover the IHT bill. Because the policy is written under trust, it is paid out free of IHT and before probate is granted, so your heirs can pay the tax bill as soon as it’s due.
Whole life insurance policies can also be written on a joint life (so-called ‘second death’) basis and pay out when both parties are dead. The plan is set up in trust and this can be an efficient way of mitigating an IHT liability.
The payout on life insurance might be a lump sum or a regular income. If it is a
The payout on life
insurance might be a lump sum or a regular income.
If it is a regular income, a decision needs to be made on how long income is payable.
Focus point
You might want a lump sum to pay off a mortgage loan if you die. Minimum cover will be the outstanding mortgage, perhaps with the sum insured falling year by year if you have a repayment mortgage. But most people need more cover. Those who have, or are planning, a family may want ten times their salary cover or more.
Once any loans have been paid and the remainder invested it would still generate less than your salary. For young children, a regular income – perhaps until they leave education – may be more appropriate.
Ensuring the right people get the money
It makes sense to have a will, because if you die intestate the distribution of your estate is determined by the state.
And in matters of inheritance, it is always worth taking advice on areas such as whether it may be wise to take out a policy on someone else’s life, i.e. a spouse or partner, and on what writing in trust means.
Good advice can help avoid probate delays and uncertainties about beneficiaries and should also help with IHT planning.
Protecting against other events
There may be other events you wish to protect against, and health insurance could be useful to you here.
Private medical insurance
Private medical insurance (PMI) pays for private health treatment. Depending on your budget, you choose what you want covered – just in-patient or day-patient treatment, or out-patient consultations and tests too.
PMI pays for the treatment of acute conditions only, namely those that come on suddenly and can be cured. It does not cover chronic conditions and pre-existing conditions may also be excluded.
Health cash plans
Health cash plans pay for everyday health costs, typically 75%–100% of costs for dentistry, optical and consultation costs, plus a small sum for each day spent in hospital, subject to an annual limit. Other dental options include capitation and maintenance plans, which are agreed with your dentist and cover likely costs over the next year. Dental insurance is also available. Plans may be subject to an initial waiting period to stop people taking out cover for known treatment, then cancelling the policy.
Critical illness insurance
Critical illness insurance pays a lump sum on diagnosis of a specified illness. Over 30 conditions may be covered, including some forms of serious cancers, heart attack and stroke. It is often taken out to cover a mortgage and, because you are more likely to have a critical illness than die, it is more expensive than life insurance.
If you are not in paid work, you can get income protection on a limited basis.
Focus point
Income protection
Income protection – sometimes called permanent health insurance – pays a weekly or monthly income if you cannot work because of illness or disability. You can insure up to around half your income. It pays after a waiting period on each claim, and can pay up to retirement age. It covers more conditions than critical illness insurance, but only if the condition stops you working. If you are not in paid work, you can get income protection on a limited basis.
Accident, sickness and unemployment insurance
Accident, sickness and unemployment (ASU) insurance is known as payment protection insurance (PPI) if used to cover credit or a loan, or mortgage payment protection insurance (MPPI) to cover your mortgage.
It pays monthly income for up to one or two years only if you cannot work because of illness, disability or unemployment. Some policies pay off any loan if you die. Policies usually last for the term of the loan or up to retirement age. Cover from lenders can be substantially more expensive.
In recent times, PPI has been widely criticised because it was mis-sold, particularly with loans and credit cards. While there remains a legitimate need for the cover, sales processes have been tightened up and new products that are more transparent are being launched.
Long-term care
By age 80, there is about a 1 in 5 chance of needing long-term care, which costs an average of £26,000 a year in a nursing home. Situations vary and planning can be complex, but some people could qualify for some state/local authority help, which is means-tested. It is possible to buy insurance in advance of needing care. Alternatively, you can wait and see if care becomes needed.
The right life insurance policies for you
When it comes to life insurance, there are three main types.
l Term insurance – pays if you die only during the term of the policy.
l Whole of life insurance – pays whenever you die.
l Endowment insurance – pays if you die during the term of the policy or at the end.
Term insurance
Level term – pays a fixed sum if you die during the term of the policy. Policies may be renewable (can be extended at the end of the term) or convertible (to a whole of life or endowment policy), or both.
Decreasing term – as level term, but the sum insured falls each year.
By age 80, there is about a 1 in 5 chance of needing care. You could qualify for some state/local authority help, but this is means- tested. It is possible to buy insurance in advance of needing care.
Focus point
Mortgage protection – as decreasing term, but the fall is in line with the outstanding capital on a repayment (or capital and interest) mortgage. The higher your mortgage interest rate, the slower the outstanding mortgage capital falls each year. When choosing this, make sure the interest rate matches your mortgage (and will go on doing so if the rate rises in future), or that the rate is higher than the interest rate you expect at any time during your mortgage.
Family income benefit – pays an annual sum if you die during the term of the policy and until the end of the term. If you died in year one of a 20-year policy, the annual sum would be paid 20 times; if you died in the last year, it would only be paid once.
This can provide the highest initial cover for the lowest cost.
Whole of life insurance
Premiums are usually more expensive than for term insurance because of payment certainty. To help keep costs low, insurers often offer:
Reviewable premiums – may be fixed for 5 or 10 years only.
Extra cover – premiums are artificially low initially but rise later. The increase, usually after 5 or 10 years, can be significant. Maxi cover policy offers the highest sum insured for the lowest initial premium but the biggest rise later (perhaps suitable if income is low but will rise swiftly in future).
No surrender values – because whole life policies pay out eventually, if you stop a policy early, the insurer may pay a surrender vale (or cash value) or convert the policy to paid up (the sum insured continues but is lower and you stop paying premiums completely). To offer lower premiums, some insurers no longer include surrender values. Stopping premiums ends the policy.
Low start premiums – start off artificially low, then increase, usually every year.
Insurers may also offer:
With-profits – insurers declare a bonus dividend every year, added to the sum insured.
Policies are more expensive, but in effect the sum insured rises each year (though not guaranteed and depends on how well the insurer performs).
Unit-linking – similar to with-profits, but premiums are invested into insurance funds, which go up and down in line with investments held.
Premiums limited to a particular age – for example, 85 or 100. Afterwards, cover continues but no more premiums are paid.
Endowments
Traditionally, endowments were used to build a cash sum at the end of the policy term, often to pay off a mortgage. They also pay out on death during the term.
Endowments are primarily savings plans, but include life insurance. They are now rarely used to fund mortgages.
It is important to look at your options – what do you need most now? How much cover do you need? Can you defer some cover until a future date?
Focus point
Add-ons
Insurers may also offer life insurance linked in with other types of protection, such as term insurance that includes critical illness insurance or income protection.
Waiver of premium – if you are unable to work because of illness or disability, the insurer pays the premiums. There is an initial waiting or deferred period of three to six months after such an event occurs, and an extra premium is charged.
Many insurers will offer free trust wordings to enable you to leave the policy to beneficiaries on your death. We can advise you on this.
How we can help
Insurers are constantly looking at new ways to meet people’s needs, such as through life insurance that includes critical illness and/or income protection insurance, which may be cheaper. It is important to look at your options – what do you need most now? How much cover do you need? Can you defer some cover until a future date?
We can help you to select the right policy in the most economical way.
Our role is to do three things:
1 To know enough about you to make the right recommendations. We do a factfind – taking account of facts, your preferences and views. We don’t expect you to be an expert on life insurance, but we need to know your attitude to risk.
Whether, for example, you accept premiums may rise – or want a guaranteed solution.
2 To help you to identify priorities. If you were insured against absolutely
everything, like most people you may find premiums unaffordable. Working out how things might change in future and prioritising matters could be a sensible thing to do.
3 Recommend solutions to meet your needs. The right policy is important, but a will or writing policies in trust could be too.
Useful terms
Assurance or insurance? Insurance covers things that might happen (e.g. dying in the next 20 years), whereas assurance covers something that will happen (such as dying eventually). We use the term ‘insurance’ to cover both.
Reviewable or guaranteed rates – guaranteed premium rates are fixed for the whole term. Reviewable rates (which are cheaper) can be changed by the insurer, based on factors such as life expectancy, investment returns and expenses. Reviewable rates may remain cheaper, but may go up in the future. If that happens, you may have the option of reducing the sum insured.
Increasable, escalating or index- linked – the sum insured rises each year (or every three or five years) by a fixed amount, or in line with an index. Common indices are the retail prices index (RPI) or the average weekly earnings (AWE) index. AWE usually
rises faster than RPI, although this has not been the case recently. Increasable policies can help offset the effects of inflation. Where cover rises, the premium will usually rise, because you will then be older.
Guaranteed insurability – gives the option to increase cover in future, up to a pre-set limit, without new underwriting. Typically, it allows you to increase cover by up to 50% on marriage, moving home, birth or adoption of a child, promotion at work or receiving a legacy – although rules vary.
Inter-vivos – a decreasing term insurance that lasts for seven years and is used in IHT planning.
Term 100 – an alternative to whole life insurance, running to age 100.
This publication is for general information only and is not intended to be advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking any action on the basis of the contents of this publication. The Financial Conduct Authority (FCA) does not regulate tax advice, so it is outside the investment protection rules of the Financial Services and Markets Act and the Financial Services Compensation Scheme. This publication represents our understanding of law and HM Revenue & Customs practice as at 3 April 2013.
Kelvin Financial Planning Ltd
1st Floor, Front Suite, 180 West Regent Street, Glasgow G2 4RW Authorised and regulated by the Financial Conduct Authority
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financial advice and planning
Kelvin Financial Planning provides high quality, professional financial planning advice. We offer a transparent and fairly priced service. We specialise in investment services, pension planning and mortgage advice for clients across Scotland. We only work on a fee basis and our clients benefit from knowing that there is no conflict of interest in our advice process. If you wish to receive professional, unbiased service then contact us to take advantage of our offer for Scotsman readers.
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Kelvin Financial Planning provides high quality, professional financial planning advice.
We offer a transparent and fairly priced service. We specialise in investment services, pension planning and mortgage advice for clients throughout the UK. We only work on a fee basis and our clients benefit from knowing that there is no conflict of interest in our advice process.
