The Most Important Asset of All: You
by Michael Williams, Managing Director
What is a life worth?
The value of your life is impossible to calculate. The value of your income is much easier to quantify. Although it’s difficult to try and place a dollar value on your own life or the life of your partner, it’s a reality you have to face if you’re to have a complete financial plan that allows for all contingencies. Like most challenges in life, a little knowledge and some preparation will go a long way towards achieving better outcomes should the unthinkable happen. In the short term, it will also provide you with some peace of mind.
Life insurance pays a lump sum benefit when the insured person dies. This lump sum can then be invested to produce an income, replacing that of the deceased. In other words, life insurance is about replacing income, and protecting your present lifestyle for the future.
So what is the right amount of life insurance for me?
The industry rule of thumb is that you should be able to pay off the family home, and also have around ten times the gross annual income that may need to be replaced. The logic behind this figure is that if the lump sum payout is invested and it earns around 8-10 per cent per annum, the beneficiaries will be able to draw on the equivalent of one year of the deceased’s income each year.
A more appropriate way to work out how much life cover you need might be to ask yourself the following questions: "If I died, what would be the financial consequences for those I left behind?" And: "What situation would I like to leave them in financially?"
If you have no financial dependants, no one who relies on you to pay the bills for them, you may not need life insurance at all. Ask yourself, how would your partner feel when faced with the prospect of having to pay off your home, put your children through school – possibly leave work in order to care for them – and save for retirement on a single income? Whether or not your investment plans could be maintained may seem like the least of your worries. More importantly, you may worry that your partner might become a burden to friends and family, or even to the welfare system.
Keep the financial plan alive – even if you’re not!
It may be tempting to assume that if you die, your partner could always sell your investments. That may be feasible if you’ve built up a large enough portfolio, but is that what you really want him or her to have to do? Remember the reasons you started the investment plan in the first place. If you want your partner to be able to achieve the goals you had in mind originally, then a carefully calculated sum of life insurance will ensure that your partner’s financial future is as comfortable as the one you’d planned for both of you.
Of course, these needs and wants for your family’s future have to be balanced against the cost of providing the cover. One way to make paying for life insurance a little easier is to have your superannuation fund own and pay for the policy.
A super way to pay for insurance.
In this scenario, premiums are deducted from your superannuation fund automatically, so you don’t have to worry about that. Obviously this decreases your superannuation fund balance slightly, but the fund’s returns and your contributions will usually more than cover the cost. This is often an attractive option as it leaves more cash available for paying off the mortgage, or funding a geared investment that could produce a greater return than your superannuation fund. Once again, every individual situation is different and needs to be considered carefully in order to work out which course of action is most appropriate.
Tax considerations
Also remember that life insurance premiums are not tax deductible if you personally own the policy, and the benefit isn’t taxed. However, life insurance premiums are deductible to a superannuation fund, so this means a 15 per cent discount on the premium, compared to owning the policy in your own name.
Another issue to be aware of is that if a superannuation fund owns the insurance policy, the superannuation fund gets the benefit payment. So getting the money out of your superannuation fund may incur a 15 per cent tax. Also, because superannuation doesn’t form part of your estate, your superannuation - including any life insurance benefit - will not automatically be distributed by your will. The superannuation fund’s trustees have the discretion to choose where your superannuation goes. They have general guidelines to follow, but are not obliged to follow your wishes unless, that is, you make a binding nomination. In some cases, these issues can be quite complicated, and may require professional advice to avoid costly mistakes. Be sure to see your adviser for guidance.
In summary, insurance is an essential cost in the business of running your life. There are several issues to be considered in order to determine the right cover and structure for your insurance, and there are some good strategies available to make insurance more affordable. The fact is, if you were to die, the people close to you would at some point recover from the emotional shock of losing you, however an appropriate amount of life insurance will help your dependants cope with the financial shock of losing your income.
Don’t get caught holding the baby!
It’s well worth asking yourself, "Is the risk management strategy I have in place right now good enough to adequately take care of those who depend on me?"
And just as important, "Is the risk management strategy of the people I depend on good enough to take care of me?"
To book an appointment with a John Hopkins Financial Adviser, please call our Client Liaison Officer on 1300 726 082 or click here.