Critical Protection Issues - How To Get The Right Level of Personal Protection
This is the second of a three part mini-series on protecting your family from the effects of death and illness. A morbid subject perhaps, but a crucial one that you shouldn't ignore.
How to get the right level of protectionUsing our example again, Dr Cureall has a clear idea now on the quality of protection he wants, and now needs to make a decision regarding the level of cover he requires.
He is a family man in his late thirties, his wife, 3 years younger, is not working, and they have two children, Mat and Laura aged four and two.
We suggested to him that he should follow a simple process to work out how much cover he should buy:
- Find out what income they need to create- Work out what they already have- Decide on the time period to be coveredWe asked Dr Cureall to fill in a detailed spending plan of what his wife would need if he had died yesterday – and vice versa.
This is to ensure that they would have enough income between now and retirement and into old age, should either of them die prematurely.
The SolutionMortgage – it is decided to fully cover the interest only £200,000 mortgage with level term assurance over the 20 years of the loan. Since it is only slightly more in premiums, Dr Cureall decides on two single life policies instead of one joint life plan. This would mean on either death, the surviving partner would still have their cover intact.
Since the strategy we have created for him involves overpaying on the mortgage (he has a flexible mortgage) we could have used decreasing term assurance to mirror the reducing debt. However, Dr Cureall feels he may not reduce the debt all the time, and will reduce the sum assured on the level term assurance when he feels it is appropriate.
Dr Cureall already has sufficient critical illness cover therefore no additional cover was required.
So, on either death, the surviving partner would be free of debt.
What's next?Living expenses – this is where the spending plan comes in. This, together with a forecastig tool we use, Dr Cureall is able to see how the next 50 years will look on the scenario of either/both deaths.
Clearly their main priority is to provide for the children. This means being able to give them the life they would have had if the grim reaper had not called. So any school and university fees are built in as well as holidays and general living expenses.
Due to the children's ages and university costs being anticipated, the Curealls look at their projections (‘financial map') and decide on 22 years as the optimum time period. This also would give Mrs Cureall enough to live on into her old age.
The projection takes into account all NHS benefits, which are considerable now that Dr Cureall has 14 years service, including spouse and child payments. (In addition we recommend that the NHS death in service benefit is placed into trust which will potentially save the family £60,000 in Inheritance Tax).
Because we have built in these NHS payments, the amount of cover required on Dr Curealls life is nowhere near what he expected. They decide on more lump sum cover, with the balance to be provided by Family Income Benefit (pays out an annual income).
This time instead of level protection, the Curealls decide on indexed cover to protect against inflation. After all we can't plan when we are going to die, and in payment the amounts would increase as well.
We recommend all these policies are written in trust to minimise Inheritance Tax, as well as ensure the monies are paid to the right people quickly on death.
Other pointsTheir strategy could also include:
- downsizing the home, or selling a business or property- Mrs Cureall going back to workYou also need to be aware of:
- From April, Pension Term Assurance changed and we recommend you review your protection. Up to 40% tax relief will be available on premiums.
UPDATE: ON 6 DECEMBER 2006 THE GOVERNMENT ANNOUNCED THAT TAX RELIEF ON PREMIUMS MAY BE REMOVED, NO FINAL DECISION HAS BEEN MADE AT THE TIME OF WRITING.
- Beware Dentists! If you have or are considering leaving or reducing your NHS work, your NHS cover will reduce.
In SummarySo what have we achieved?
Well, the Curealls now have the correct amount and quality of cover. It is over the appropriate time period, and has the right mix of level and indexed protection. It is written in trust, and the Curealls ensure they pick the right trustees.
The Financial Tips Bottom LineMake sure you consider ALL your options before you buy any type of life assurance, critical illness or income protection. Just buying a policy may not be enough. Seriously consider whether you should place it under trust, which will potentially save you Inheritance Tax.
In the next article we'll look at the actual claims experience of insurance companies and the reasons why people are claiming on critical illness and income protection. It makes interesting reading!
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ABOUT THE AUTHOR
Ray Prince is an Independent Financial Planner with Rutherford Wilkinson plc, and helps UK Resident Doctors and Dentists get the best deals on mortgages, protection and investments, as well as helping them achieve their financial objectives. Click here for Financial Advice for UK Doctors and Dentists and to get your free retirement guide, How To Avoid The 7 Most Common Retirement Planning Mistakes. Rutherford Wilkinson plc is authorised and regulated by the Financial Services Authority.