A subject which doesn’t often make the dinner party conversations is that of a Will, life insurance or critical illness cover. Funny that!
We are often asked how much cover/protection to have, and whilst it’s dependent on circumstances, there are parameters to consider.
It is, however, quite disturbing to find out that 8.5 million breadwinners in the UK have no life insurance at all. The association of British insurers calculates that households are £263 billion underinsured potentially leaving dependents to deal with extraordinary hardship on top of the pain and despair of losing someone they love. That’s a big gap. (1)
Life insurance is straight forward in that it pays out a lump sum on death (or an amount of income for a set period of time) and critical illness pays out a lump sum on the diagnosis of one of a range of illnesses such as a heart attack, stroke, cancer, Alzheimer’s, dementia, HIV infection, kidney or liver failure and Parkinson’s.
To calculate what cover you would need, consider first, who or what would be impacted on death or diagnosis of a critical illness. You would then calculate how they would be impacted financially and insure as close to that as is possible.
For life insurance, for example, it would be an absolute must to insure against all mortgages and debts so dependents are fully protected as well as leaving enough for funeral costs. Secondly, you may wish to leave a lump sum to dependents to provide them with some financial security/university fees etc and thirdly, there would be a loss of income so you could protect that in a number of ways:
Pay out a lump sum death benefit that gives an ‘income’ for life. This is a bit tricky in that the lump sum would have to be providing an income over and above inflation for an indefinite length of time (how long will the surviving spouse continue to live for?).
However, many households calculate that the lump sum will provide an income of about 4% over and above inflation over a longer period of time and so they simply multiply the income needed by twenty-five to calculate the amount of life cover needed. So a person with a take home pay of £20,000 per year might need £500,000 life cover.
Another option is to use a family income benefit plan. This is straightforward in that it provides an income on death for a set period of time and the survivors will know they will be receiving exactly that amount with no risk to the capital as in the lump sum option above.
Calculating the amount of critical illness cover is somewhat different and a little more complicated but equally as important.
We know that seven out of ten survive a stroke, that 50,000 men and 32,000 women this year will have a heart attack and that 1 in 3 people you know will be diagnosed with cancer at some point. (2)
Unlike life insurance which is pretty definite, many people who suffer from a critical illness will not be able to return to work again or be able to return to their choice of work again.
It seems sensible enough, therefore, with such a life changing experience, we should insure for critical illness to protect your debts as a minimum as well as a lump sum to provide a supplement to your income.
Many family income benefit plans as mentioned above allow for critical illness to be added so this could be a good option to protect any drop in income in the event of such an illness or diagnosis.
More than for life cover, it’s best to use a specialist as the range of conditions covered in a policy vary considerably and what might appear to be an obvious pay out for one company isn’t always the case with others.
Costs are varied for both life insurance and critical illness cover and an independent broker will be able to compare them in seconds as well as advising on whether to put the plan into trust to protect the lump sum from any inheritance tax.
Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.Last modified: June 10, 2021