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20/10/2021

Making Cents: How much cover do you need?

Making Cents: How much cover do you need?

Think of insurance as a life ring

WE often plan for our financial futures assuming we will remain healthy and alive which allow us to continue to earn an income. We focus on saving as much as we can, we pay down debt aggressively etc. and we tend to largely ignore protecting ourselves against events that can throw our plans into disarray.

And when it comes to protecting our financial future, there are three major risks that we have, to insure against, and they are:

Early death

Diagnosis and survival of a serious illness

Inability to work because of injury or accident

Because premature death is probably the most traumatic of the three events and probably the one least talked about, I’m going to focus exclusively on it in this article, and I’ll post other articles about income protection and serious illness in the weeks ahead.

The primary reason to get a life policy in place is to secure the lifestyle your family once had, by replacing your income, in the event of your passing. So, if someone was financially impacted by your death, you need a life policy in place and if nobody is, then you don’t.

And how much cover you need will depend on your circumstances, which is why the first thing you need to do, before you even propose for life cover, is establish the financial loss, because this will determine the level of cover required.

First look at the income paid in death which might come in the form of a personal pension, the amount paid by the state, rental income etc. and the amount that is no longer required i.e., mortgage repayments (paid off from a mortgage protection policy), insurance premiums, and the amount the deceased spent on themselves.

Then add and subtract these various amounts from the deceased’s monthly income and that’s the amount you need to cover.

Once you know this number, apply a multiple of say 15 or 20 or 25 to any monthly shortfall amount which will cover you for that length of time. And don’t forget to deduct from this number, the amount available in savings, pension funds, death in service payments etc.

You might choose 20 years’ because your need to bridge the income after that time reduces because children are no longer financially dependent on their parents anymore.

Okay, there are four types of life assurance policies:

Term Assurance

As the name would you lead you to believe, it’s a policy set for a fixed term. The policy will pay out a sum assured in the insured dies within the term agreed. And if they survive the term, nothing is paid out or back.

Decreasing Term (otherwise known as Mortgage Protection)

The cover in this instance reduces throughout the term and this type of policy is most often used to protect the repayment of a mortgage, where the level of cover reduces in line with the debt outstanding.

Life Cover Income Benefit

This type of cover is a kind of reducing term assurance policy but rather than paying out a lump sum, it will pay a regular amount each month. It can be overwhelming for some people receiving a large amount and wondering what they should do with it, whereas getting smaller amounts each month, can be more manageable for some.

Whole of Life

This is a policy that as the name suggests, lasts for as long as the life insured is alive. The watch out for this type of policy is that the premiums can start off low, but as you get older the premium is reviewed typically every five years and can increase significantly to the point where it becomes offensively high resulting in people either cancelling the policy or reducing their level of cover.

Deciding what level of cover, you require, if any, is largely down, I think to your life-stage, and here are my suggestions in this regard:

Young and Single

If you fall into this category and have no dependents, there’s a strong argument that you don’t need any cover. The only reason I could think of is (a) you have debt that isn’t covered by a life policy e.g. a term or car loan and rather than your family inheriting this debt you want to have it paid off from the proceeds of a life policy and (b) you want to cover off the possible future loss of a death in service benefit.

Life insurance is cheaper the younger and healthier you are. This is because as you age, health problems are more likely to crop up that could increase the cost of coverage or even make you uninsurable. Is that enough reason to get a policy in your 20s or 30’s? Maybe.

Most suitable policy: Term assurance.

Double Income, No Kids Yet (DINKY)

You need to cover any shortfall for the surviving person in the event of death. And the amount of cover will depend on the earnings of each partner i.e., if one partner earns significantly more than the other, then the level of cover each person should have, should be weighted accordingly.

At the very least, the level of cover should pay off, any non-mortgage related debt (any mortgage will be repaid by a mortgage protection policy) and a term assurance policy or income benefit type policy would be the best type of policy for this person.

Most suitable policy: Term assurance/income benefit.

Young Family

If you have young kids, you should consider all the same things as DINKY’s have to, but I would suggest adding in additional amounts to cover the cost of future education, and you may want to add in an extra amount that can be given to them when they reach adulthood that could be used towards a deposit on a house etc.

Most suitable policy: Term assurance/income benefit.

Empty Nest

At this stage in life, your kids may not be financially dependent on you anymore, your mortgage is over or nearing an end, and your financial situation as a result might be better than what it once was.

As a result, your need for life assurance is not what it used to, be and you should only consider life cover to redress any imbalance between now and when you retire. You could also include a provision to cover your partner and the income they perhaps lost if they took a career break to raise children or look after elderly parents.

Most suitable policy: Term assurance.

Summary

The decision to buy life insurance is personal, since so many of the calculations depend on your circumstances, financial situation, and future plans. Putting together a robust protection plan is about deciding on what your priorities are right now, and then figuring out what cover is the right amount for you. And as your income, debt levels, family situation, change over time, so should your level of cover. And remember there is no optimum amount of life cover you should take out, because it’s very much dependent on everyone’s individual circumstances.

Thinking through the potential financial issues that could arise after death, can help answer those questions of, if, when, and how much do you need when it comes to buying life insurance.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie

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