The Facts of Life (Insurance) – part 2

Personal Insurances Types – Life, TPD, Trauma and Income Protection

There a four general ‘types’ of personal insurance available to Australians. When done properly they will work together to provide a complete ‘safety net’. Life, Total & Permanent Disability (TPD) & Trauma cover will each provide a once off lump sum payment when you make a claim, whereas Income Protection is an ongoing income replacement that starts when you can’t earn income, but stops when you recover. Today’s post will start with the ‘easy stuff’ – Life cover.

Life insurance – This is great because it is simple. You die, your estate gets paid a single lump sum. There are very little practical differences from one policy to the next. If you don’t have a stand-alone policy, get out your Superannuation statements, it is very possible that you have some there. Super is a good place for life insurance as it is often cheap and can be paid from the super fund rather than your pocket. Additionally, premiums are tax deductible to the super fund, so even though you can’t get a personal deduction, at least your super can.

Be aware though that although life insurance benefits are tax free when owned personally, if held in a super fund, some tax is likely to be payable by the fund on the final payout. This may even affect the tax on your super account (the investment component).

How much do you need? As a very general rule (and all advisers are a bit different with other methods or priorities) as a minimum starting point, you need enough to pay out all debts (e.g. home loan, car loan, investment loan).

Add another $50,000 to cover miscellaneous expenses such as medical, funeral and estate/legal costs. This amount is just a rough guide and you should calculate a more relevant figure for you personally.  You may also wish to allow for a few key expenses such as children’s private school fees.

Lastly, and this is the most difficult, you need to add an amount to replace the lost income of the individual (you or your partner), but adjusted for the debts you no longer need to pay. In the event that you don’t earn an income (i.e. homemaker) then you need to allow some funds for someone to do this in your place, either hired help, or the remaining spouse working less hours to now do these things.

As an alternative, I personally prefer a present day value, or multiple, of all lost income (salary, wages, etc. not investments). This is nice and neat because it assumes all future expenses don’t have to be guessed at in advance. We just assume that if you replace your lost income, you can afford the same level of spending in the future as if you were still here to generate that income.

To calculate the present day value of your income you need to allow for inflation, years to retirement, and an assumed investment return on the capital providing the new income. Once you know these assumptions, a simple present value calculation (in a spreadsheet formula as an example) will give you an insurance amount.

Remember, regardless of what calculation you make, any benefits actually received should be distributed using a set strategy that you stick to. It is no use saying here is the money for the next 50 years, good luck. You need to make it last the way it was intended to in the first place. This should definitely include a thorough review of your Estate Planning (Wills), but that is a whole other topic.

There are a couple of key overall insurance options that are available even with the most basic of our four insurance types (Life cover), the biggest one being ‘Stepped’ or ‘Level’ premiums. I will have to give that a closer look at in a future article as I think I have carried on for long enough.

Stephen Farrell