Expect the best, prepare for the worst

Posted on: 24 June 2020 by Peter McGahan

The COVID lockdown has prompted many people to re-evaluate life insurance policies and how best to protect their family. Peter McGahan answers some common concerns.

life insurance

Lockdown has given us all the chance to sort out many unsorted items. Buying another jet washer to wash your jet washer was a step too far, perhaps!

We have had many calls asking about life insurance and protecting families over the last two months, so I’ll endeavor to answer those questions here.

How much life insurance do we actually need?

I asked a friend how he calculated his. He is a bright guy and he’ll be reading this!

His answer could be summarised by the words ‘finger’ and ‘wind’. Whilst we laughed, it is a scenario advisers have experienced on many occasions, when, after the event, the family can do nothing about it, because they are not protected adequately or efficiently.

A simple thought process of ‘If you won the lottery how much would you need to give up work” might be a good starting point.

Whatever that number is, it reflects the capital you perceive you would need to repay your debts, and provide you with an income that would have you comfortable.

However, from a more mathematical perspective, you might consider this approach:

What is your take home pay?

How much of that do you use to live i.e. how much have you left at the end of the month? What you use is clearly, what you need. If there was a death, how much of that expense would disappear, i.e. car, food, pensions costs, mortgage, insurances etc.?

What benefits would the surviving spouse/partner have in this scenario? Subtract that, and the disappearing expense from the amount you currently use above and that is the amount you need to insure.

Naturally if some big expenses are due to end later, such as educational costs for children, that can be decreased later.

How long should the cover run for?

Normally the cover runs alongside the need, so if retirement, Inheritance, or an earlier mortgage repayment for example occurs, the cover could cease then.

It is no surprise therefore, that most cover is set to run to age 65.

Do I protect with a lump sum or with a family income benefit plan (pays out per year)? Neither is the ‘correct’ answer, but one may suit more than the other.

A lump sum is not an exact science so you would work with your adviser to ascertain the correct figure based on your tolerances with the variables.

If you had a lump sum life insurance paid out, it would have to provide an income. You have to make assumptions around inflation and income to calculate that. So if you have a need of say £15,000 per year, a lump sum of £500,000 could provide you with the ability to take 3% income from that capital, whilst allowing growth in the remaining capital to cover inflation and future rising income needs, depending on where and what you invested it into.

If you were comfortable that you could achieve 4%, the lump sum needed is reduced to £375,000.

Alternatively, you could use a Family Income Benefit Plan (FIBP), which is set up specifically to give you an exact income for a set length of time. The upside is you are paying for what you need when you need it. The downside is that the closer you are to the end of the term, the less your surviving spouse would receive i.e. in the last year, you would receive £15,000 v £500,000.

Costs? A FIBP for a 40-year-old couple for 25 years is £24.61 whilst the lump sum option with the most competitive company is £60.19. If you have cover and budget is important, the FIBP may be more preferable.

If you already have cover, have a look at your value for money. The difference between the top provider and the 14th (LV) is nearly £177 per year. Over 25 years that is £4,419.

You could have that premium reduced, or use the same premium to gain more cover, in this instance, nearly £138,000 more in your pocket than the insurance provider.

About the author

Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.

For a complimentary Life cover audit, please call 01872 222422 or visit us at WWFP.net.

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