17 January 2012
We have previously commented on various aspects of the 'protection gap'; the difference between the amount of life assurance and income protection people have and the amount that they actually need.
Many leave the provision of life assurance and pensions to their employers, although unfortunately they do not consider whether, in the event of a claim, the benefits provided would be sufficient to allow a reasonably comfortable lifestyle to be maintained.
Most people in employment or self employment have life assurance that will provide a lump sum (typically 2 – 4 x their annual income) in the event of their death before retirement. Insurance industry statistics indicate that there is a much higher probability of an individual having an accident or suffering ill health that leads to long term absence from work. Insuring against the resultant loss of income from this is much less common.
Adequacy of cover - assets and insurance
In the event of death, the value of any life assurance policies can be added to the value of any pension funds, savings and investments. It is currently considered that drawing an annual income equivalent to 4 – 5% of the aggregate value of pension/ savings/ investments should be sustainable over the medium to long term.
Simply put, if your life assurance/ pensions/ savings are worth £500,000, your next of kin can look forward to an ongoing annual income of £20 – 25,000. This income may or may not be taxable depending on how the funds are invested.
In the event of absence from work most employers would continue to pay salaries for a reasonable period. If the period of absence was prolonged, then once employer support ended residual income would comprise state benefits plus any pension and investment income. Again, the 4 – 5 % income guideline would apply.
Affected individuals who are well funded could opt for an earlier than expected retirement. Those perhaps further away from retirement, with fewer resources or with significant ongoing commitments, may find themselves in difficulty.
Insurance options
Additional life assurance can be sought, which can provide an additional lump sum or a tax free income in the event of death.
It is possible to insure your income: income replacement insurance (also known as permanent health insurance or PHI) can provide a tax free income benefit of up to 50% of your full salary/ income in the event that you are unable to work for a prolonged period due to accident or illness. The benefit is paid following a waiting period until the first of either recovery and return to work, retirement or death. This is considered a very valuable type of cover as it provides long term income security.
Critical illness cover can also be useful. It provides a tax free lump sum in the event that you survive for a period following the diagnosis of one from a list of specific 'critical' medical conditions, eg. cancer, stroke, heart attack etc.
The types of insurance described above are unnecessary if you have sufficient accessible assets to effectively self insure. If you have insufficient accessible assets however, then insuring the shortfall is the practical option.
The costs of providing appropriate levels of cover vary widely depending on age, health, lifestyle and the sum assured.
Family protection is hugely important, but it is not straight forward. There are numerous options and it is very important that you seek professional advice to determine the correct type and levels of cover to suit your circumstances.
If you would like to discuss your protection requirements then please contact UHY Financial Planning who will be pleased to help.
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