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

The Facts of Life (Insurance)

It seems to becoming more widely accepted and understood that we have an under-insurance problem in Australia. Although I am not talking about General Insurance (like home and contents), it is major events like the Victorian Bushfires of 2009 and the Queensland (and Victorian) Floods of 2011 (almost enough to make you want to move to NSW) that are starting to make people take notice on how they are insured, and are they protected like they think they are?

If you are unlucky enough to lose a car or your household contents, or even as far as the family home, that kind of financial setback can emotionally scar people and leave them struggling financially for decades, if not properly insured. Imagine the trauma and difficulty you might face if there was instead a death, or just serious injury, to a family member, particularly an income earner whom the rest of the family rely on.

This is a question for single people too, what would you do if you couldn’t work through illness or injury? Move back with Mum & Dad? Do they really have the capacity to look after you if it is a long term problem?

Are you approaching or in retirement? Adult kids independent and off your hands? Maybe some grand children starting to appear? How comfortable and peaceful will your retirement be if those same ‘independent’ children become injured or ill and move back home? What if they bring their whole family? Might be time to have a family chat.

I am saddened to hear that 90% of people will insure their cars, about 70% of people their homes, but when it comes to your single greatest asset (no, not your home – your ability to earn an income), only a third of people have adequate personal insurances.

Now I will give you some leniency, personal insurances can be terribly complicated and often deal with topics many of us would prefer to pretend don’t happen. I have lost count of the number of times people have told me they never did a Will because it seemed like ‘asking for something to happen’.

Although personal insurances can seem like a terrible spectre, and overly complicated, unlike General Insurances, there are dedicated professionals who can give you personalised, carefully customised, insurance advice to take the uncertainty out of the ‘Am I getting this right?’ question. I wish I could get the same when it came to reviewing my house and contents insurance last year, what a nightmare!

Now the rise of the online insurance broker is a bit of a worry to me, they lack the essential tailored advice you get from an insurance professional, but they are a significant improvement over the ‘just call now’ basic insurance cover also becoming popular. These ‘one size fits all’ infomercial-driven policies are severely lacking in depth and quality of cover. They are often significantly overpriced for those with relatively good health, as they must cover those who are not so healthy.

I mean, my local chemist is starting to sell life insurance! This is a product that may need to provide for my whole family, and cover many thousands of dollars, and you want me to buy it along side hair & skin products?

So if you are determined to go it alone, or if you simply want to know what all this jargon means when talking to an adviser, I will try to explain some of the basics over the next couple of weeks. If you have questions as we go along, just let us know and we will try to flesh out the areas you find of most interest. Remember, as with everything on this blog, this is only general advice, not personal, and you should always consult a professional (refer to our full disclaimer here).

However, if the idea of spending the hours necessary determining the right level, structure and types of insurances for your situation is just too depressing, don’t wait for the future articles and just give us a call. We are ready and happy to help.

Stephen Farrell

A ‘Yes’ vote to keep the financial planning profession ahead of the game

Daniel & I just voted ‘Yes’ to the Financial Planning Association’s (www.fpa.asn.au) constitutional change to radically overhaul the FPA and its membership. Should seriously lift the standard in years to come, lets hope it gets up!

Unfortunately it needs a 75% yes vote so it is not necesarily a done deal, even with such obviously strong merits. Significantly higher minimum education standards for advisers and less product owner and large dealer group representation.

It’s a very important initiative for the Financial Planning profession, I am not sure where things could head in the future if the change doesn’t get up. The FPA itself has stated ‘there is no Plan B’!

Either way Daniel and I will just continue to do the best we can, operating with ‘clients first’ regardless, not waiting for our primary professional body, nor the government, to catch up.

Stephen Farrell

“I don’t like Super”

I recently had a client call to discuss their financial future.  They wanted to know what they could do to make sure they had enough money in retirement but they “didn’t like super.”

It always surprises me the number of people who feel this way.  As someone who helps people retire early I actually really like super.  I recognise that the government changes the rules A LOT (just consider the changes for Financial Planners in the past two years) but superannuation continues to be the most effective tax vehicle available to almost all Australians.

The Australian federal government ‘tweaks’ superannuation every year and some years we see substantial change.  In the past 3 years super has become tax free when paid to over 60’s, contribution caps have been halved from $100,000 to $50,000 for over 50’s and from $50,000 to $25,000 for under 50’s and now they’re talking about increasing contributions from 9% to 12%. 

What doesn’t change is that the money is yours.  The government can restrict when you get access to it (and I have to be 60), they can adjust the tax that is paid on it (and most recently that worked in everyone’s favour) and they can change how much you are allowed to put in, but they can’t change the fact that it’s your money.

Many people have been “burnt by super.”  I get asked “but is it a good fund?” at least twice a month.  A lot of Australians make the mistake of comparing their fund (Asgard, Plum, MTAA, Australian Super or others) but fail to realise that in most funds they have some choice about how their money is invested. 

Did you know that in most super funds YOU get to choose whether you are invested in Australian shares, cash, fixed interest or some combination?  If you’re fund doesn’t have those options, you still have the option of a Self Managed Super Fund (SMSF) where you can choose exactly how the money is invested.  Did you want to own stamps, a property, art work, shares?  They are all available in an SMSF.

More and more Australians are trying to retire early or achieve their financial freedom.  I get asked all the time “what should I be invested in?”  That’s definitely important but could saving 15% of your salary every year be more important?  What if I could save you 22% or 31.5% of your salary EVERY YEAR?  Where do you think you could be with savings of that level?  Do you think if you could save up to 1/3 of your salary every year you might be able to retire that little bit sooner?

Yes, super has its draw backs.  There are problems with getting access to it when you are under 60, there can be problems with how it is invested and there can be issues with contributing too much.  However, the tax benefits available and your ability to choose how it’s invested can provide some serious benefits.  I don’t like super sometimes either but with at least 9% of your income going in there every year, you really should figure out how to make it work for you.

Daniel Hogben

3-2-1

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