By Andrew from Vista Financial
Financial planning is about protecting your wealth as well as building your wealth.
It is easy to think that we won’t get sick or hurt and ignore the need to protect the very thing that generates our wealth, our own health and our ability to work. But if accident or serious illness does occur the impacts can be devastating.
It’s worth remembering that no matter how much expert advice you receive or how well you manage your finances there is always a risk that you could suffer an early death or serious illness or injury. Where that leaves you and your loved ones in the future depends on the wealth protection strategy you have in place.
Risks you could face in the future may include:
Emotional, physical or mental trauma
Death or serious illness
Loss of income due to temporary or permanent incapacity
Damage to your house or other personal assets
Theft and/or damage to business assets
Public liability and/or professional indemnity risks
Your financial plan should include a strategy to minimise risks that could jeopardise both your present and future plans. In simple terms, if you cannot afford to lose something then you should try to protect your exposure. Insurance can provide a cost-effective protection mechanism.
This may take a combination of personal, general and health insurance policies. There are many different aspects to insurance and it is best to tailor a package that suits your needs as well as your budget.
How the Strategy Works
Personal risk insurance protects your wealth accumulation strategy by providing money if you are no longer able to earn an income due to disability, trauma or death. The money received can help with medical bills, loan repayments and living expenses.
Many people often underestimate the importance of personal insurance which has led to a problem with underinsurance in Australia. It is important that you consider having enough cover to replace your income and cover expenses so that the personal tragedy does not create financial tragedy.
You can apply for insurance to cover you in the event of death, temporary or permanent disability, or trauma (critical illness). Outlined below is a brief outline of types of personal risk insurance.
The most common type of cover is life insurance (term life insurance). Life insurance will pay a lump sum to your estate or specific beneficiaries in the event of death or in some cases, terminal illness.
The advantage of life insurance is peace of mind that your death will minimise any financial hardship for your loved ones. Life insurance can be used to pay off debts, provide an income for dependents, cover funeral expenses and generally assist in maintaining your family’s lifestyle in the event of your death.
With this type of cover, your family would not be burdened by debt and may be protected from selling assets to pay debts or cover living expenses.
Total and Permanent Disability Insurance
Total and Permanent Disablement (TPD) can prevent you from working and require expensive medical treatment and ongoing care.
TPD insurance aims to provide a lump sum if you suffer an illness or injury and you:
Are permanently unable to work again or
Are unable to care for yourself independently, or
Suffer significant and permanent cognitive impairment.
TPD insurance pays a lump sum which can be used to pay for medical expenses, ongoing care costs and to meet living expenses for you and your family.
The definition of TPD can vary and may include options for a range of occupations, including homemakers. Options that you can choose from include:
Any Occupation TPD: The benefit will be paid if you are unlikely to be engaged in any gainful business, profession or occupation to which you are reasonable suited by your education, training or experience. This definition is generally less expensive than an Own Occupation definition but for some people may be harder to meet.
Own Occupation TPD: The benefit will be paid if you are unlikely to ever be engaged in your own occupation again. Own Occupation TPD provides a generous definition as it is specific to your occupation and is particularly suitable for specialist occupations. The premiums for this type of definition are more expensive than Any Occupation TPD.
You should discuss your circumstances with your financial planner.
A serious illness or injury can prevent you from working for a period of time and may require expensive medical treatment.
Trauma insurance (also known as critical illness, crisis or recovery insurance) aims to provide a lump sum upon the diagnosis of a specified illness or injury such as life threatening cancer, stroke or heart attack. Trauma insurance pays a lump sum which can be used to pay medical expenses and reduce any financial pressure while you focus on recovery. This payment is made regardless of whether you are able to return to work, and is designed to relieve financial pressure at a time when you are under great stress.
Child Trauma insurance can be added to your policy to cover a seriously ill or injured child. This provides a lump sum to help you cover medical treatment and eases financial worry for parents who may need to take time off work to provide care.
Income Protection Insurance
Income Protection insurance aims to minimise the financial impact of sickness or injury by replacing income lost during a prolonged absence from work. A monthly benefit will assist you to meet living expenses and debt repayments.
Income Protection policies will usually pay a benefit up to 75% of your gross income (some policies may pay higher) after a waiting period. Payments continue for a set term or until you return to work. Generally premiums for income protection are fully tax deductible.
Waiting period: This is the time period that you must be off work before an income benefit is payable. Waiting periods range from 14 days to two years. Generally, the longer the waiting period, the lower the cost of the income protection insurance.
Benefit period: Starting at the end of the waiting period, the benefit period is the maximum time the benefit is paid. Options range from two years, five years or until a specified age such as age 65.
Types of contracts include:
Agreed value: The monthly benefit is agreed at the time of application and will not reduce even if your income decreases after your policy commenced. This option provides certainty and peace of mind on how much income you will receive. If details of your income are provided at the time of application the benefit can be guaranteed so that no further financial assessment is required at the time of claim.
Indemnity value: The monthly benefit paid depends on your earnings at the time of a claim rather than at the time of application. If your income at the time of claim is lower than it was when the policy started, the monthly benefit may be reduced accordingly. Details and proof of income will be required at the time of claim.
You can generally claim a tax deduction for the premiums paid on an income protection policy to reduce the effective cost but any income payments received are considered taxable income.
Business Expense Insurance
Business expense insurance can help to keep your business running if you are unable to work due to temporary illness or injury. This may be particularly appropriate for a sole trader.
This type of insurance will usually cover up to 100% of your eligible business expenses, for example rent/lease payments, interest costs, accountant’s fees, telephone, electricity, etc. However, not all expenses are covered so you should check the policy wording before taking out a policy.
Alternatively, if you run a larger business you may need to consider life, trauma, TPD or income protection insurance to cover ‘key’ employees or your business partners in case they die or become disabled and are unable to work. This type of insurance protects your business in the event of the loss of a person who makes a significant contribution towards the profitability or stability of the business. As an example, ‘key person’ insurance may provide the business with a lump sum that could be used to either hire a temporary replacement, cover costs of training a new staff member or just compensate the business for any reduction to profit.
The premiums may be deductible as a business expense depending on the insurance purpose and the proceeds may also be considered taxable income.
Premiums for all types of personal insurance will vary with age, gender and smoking status. Occupation and medical history may also affect the cost of premiums.
Premium options include:
Level premiums: The premium rate is fixed when you start the policy and does not change as you get older except in line with CPI indexation. Level premiums are initially higher (than stepped premiums) but will be more stable over time. This can help with affordability and reduce the risk that premiums will become unaffordable as you get older.
Stepped premiums: The premium rate increases each year according to your age. Stepped premiums are initially more affordable than level premiums but over time may become more expensive. However, this option can provide you with flexibility as your needs change over time.
Your financial adviser can assist in determining which premium option is most appropriate for you.
Life, TPD and income protection policies can be owned personally or through a superannuation fund. Trauma insurance can be owned personally.
When held within a superannuation fund, the policy is owned by the trustees usually for the benefit of the member.
When making a choice of how to own the policy you need to consider the advantages and disadvantages of each option.
In Personal Name
· Premiums are paid using contributions into the fund (e.g. employer contributions) or your superannuation savings – this can help to ease your cash flow.
· Tax concessions on contributions may reduce the effective cost of the premiums (e.g. salary sacrifice to cover the cost of premiums)
· In some funds you may be eligible for automatic acceptance (for some cover) which means you will not have to provide evidence of health or income
· The claim proceeds are usually tax-free
· Claim proceeds will be paid directly to you, your estate or nominated beneficiary as appropriate. This ensures the money is available when you and your family need it
· A wider range of benefits and features may be available
· Income protection premiums are generally tax deductible
· The policies may have less benefits and features than those offered outside superannuation due to legislation restrictions
· Tax may be payable on claim proceeds, depending on circumstances and rules at the time
· Your disposable income will be reduced as you need to pay premiums from your after-tax income
· Premiums need to be paid from after-tax money and so may be a higher cost to you than premiums inside superannuation
How insurance premiums and claim proceeds are taxed will depend on the type of insurance policy and beneficiary, but will also depend on whether you choose to hold the policy inside or outside of superannuation. You should seek specialist taxation advice to check the taxation applicable to your circumstances.
In Personal Name
· Premiums are deductible to the fund
· Not deductible except for income protection policies
· Life policy – the proceeds are taxable only if paid to a non-tax dependant
· TPD – if you are under age 60 when you take this money out of superannuation tax may be payable
· Income protection – the benefits are assessable income to you and are taxed at your marginal tax rate
· The proceeds from a life, TPD or trauma policy are generally tax-free. However, the benefits from an income protection policy are assessable income and taxed at your marginal tax rate
Application and Underwriting
When applying for insurance you will need to complete an application form providing both personal and medical information so that the underwriter can assess the application. Some applicants may also need to undergo a medical examination and/or blood tests or a report may be requested from their usual doctor to determine whether to accept or decline the cover.
Depending on your circumstances and health you may be asked to pay an additional premium, known as a loading, if you have an unfavourable medical history or display higher risk factors for developing chronic illness such as being overweight or high blood pressure. In some cases, the life insurance company may apply an exclusion to your policy. For example, a decision may be made to not cover your for high risk activities and sports or a pre-existing injury/illness. This means that if an event occurs that is excluded, the benefit under the policy will not be paid.
Many policies are guaranteed renewable. This means that as long as you pay the premium you will continue to receive cover regardless of any changes in your circumstances or health.
If you do not pay your premiums, your insurance will lapse. Some life companies may provide a short window of opportunity to pay your overdue premiums to maintain the cover if you have missed the due date. If your policy lapses and your health or circumstances have changed it may impact on your ability to get the same cover at the same premium.
It is important to understand the benefits included in your policy, and optional extras. Benefits included are at no extra cost however optional extras may increase your premium. Your financial adviser can discuss the features of the recommended policy with you.