Insights 21.5.20 Author: Ian Rex-Hawkes

Financial Self Defence

Insights 21.05.2020 Author: Ian Rex-Hawkes

Many of us will have heard of self defence – the training and tactics used to make sure that we are able to protect ourselves from violent encounters. Contrary to popular belief, most of this training should revolve around avoidance of conflict rather than actual fighting, or in other words around good preparation.

You may be wondering what this has to do with financial planning. Admittedly it may be an overstretched metaphor, but within financial planning we have access to a suite of products designed to provide financial protection. Rather than leaving an individual or their family struggling to deal with debts and income deficit, financial protection is designed to allow you to ensure that, though prior preparation, money is the least of their worries in the event of death or illness.

In this article, we will look specifically at the financial protection available in the event of death. Keep a look out for future articles which will extend this subject to cover protection against illness.

Why Should I Consider Life Insurance?

For some people, typically those who are single and debt-free, life insurance is unnecessary.  For those who have dependants, though, it should be one of the top priorities to look into. If you aren’t sure which category you fall into, consider the following questions:

  • Does someone else rely on my income?
  • Do I have debt (e.g. mortgage) that would indirectly affect someone else if I wasn’t around any more?
  • Do I want to leave assets to someone (e.g. children) in excess of my current net worth?

If the answer to any of these is “yes” then you should consider life insurance. In the first instance, life insurance can provide a lump sum or income for life for your dependants should you no longer be around, while in the second a lump sum can be allocated specifically towards paying off debt.

In both of these cases, it is often possible to make sure that anyone left behind when you die is looked after financially. It is also possible to simply use insurance to leave behind a legacy.

For example, Ali and Charlie are married. Both work, but Ali’s income is £100,000 per annum while Charlie’s is £15,000. Between them, they conclude that – financially, at least – Ali’s death would be more impactful than Charlie’s. As a result, Ali takes out a life insurance policy with an annual benefit of £65,000, payable until retirement age. Should Ali die before reaching retirement, Charlie will receive that sum each year until the policy term expires.

Additionally, Ali and Charlie have an interest-only mortgage of £300,000, due to be repaid upon Ali’s retirement. After discussing their priorities, Ali and Charlie decide that they would like this repaid if Ali dies before retirement. Ali therefore also takes out a level term assurance policy which will pay out £300,000 if death occurs within the term of the policy.

Is Life Insurance Expensive?

By far the easiest way to answer this is with an example. If Ali is 40 and planning to retire at 60, then the insurance premiums would be¹:

  • £40 per month for an annual income of £65,000 payable to Charlie and a term of 20 years, and
  • £18 per month for a level insurance policy designed to pay off the £300,000 mortgage if Ali dies before reaching age 60.

At a total cost of £58 a month for all this cover, this represents some £2 a day, which is likely less than most of us spend on coffee. In this case, the cost of this cover is modest, compared to the peace of mind given to Ali and Charlie.

If Ali happens to own his own company, it is possible that some of this cost may also be offset against corporation tax. Such opportunities will be covered in a future article about Relevant Life Plans.

Are the Proceeds Taxable?

Most life insurance proceeds are exempt from tax on payment. If the payment is made into the deceased’s estate, it is possible that inheritance tax will be due on passing the proceeds to another individual. As a result, it is commonplace to write these policies into trust to ensure that the proceeds remain outside the owner’s estate.

What are the Risks?

Insurance contracts are fully protected from provider failure under the Financial Services Compensation Scheme, therefore the contracts are safe from provider failure.

The two main risks with insurance are:

  • Inflation, which can erode the value of established policies (though debts are also eroded, which offsets this risk somewhat), and
  • Underwriting

The latter risk here is the actual application process for insurance. If you do not have ideal health or lifestyle factors, it is possible that the insurance companies will want to apply a rating to your premium, making the policy more expensive than the initial quotes might suggest. In this case, it can make sense to apply with multiple providers to get the best possible rates. Luckily applying to multiple providers doesn’t increase the costs, as providers absorb the costs of the application processes.

What Should I Do Next?

If this article has raised any thoughts that you would like to talk about, whether you have any of these policies already in place or are thinking about these issues for the first time, please contact your usual CBW adviser. If you do not yet have one, please contact Ian Rex-Hawkes or Philip Harrison who will be happy to discuss your needs and the options further.

¹ Assuming good health and lifestyle, including non-smoker status.