Thinking About Insurance

Building wealth is the sexy part of personal finance. It’s where you get to invest, take risks and watch your money grow. But there is a vital step to take first to make sure that your wealth can’t be swept away in a heartbeat thanks to an unforeseen event – life protection.

If we distil the essence of personal finance down to three steps, these are: spend less than you earn, insure against disaster and build wealth. We’ll look at this from the perspective of a new accumulator, someone looking ahead to build wealth for their future – someone like YOU!

Life Insurance

Life insurance pays out if you die. You take out a policy and if you die within the policy term, it will pay out whatever sum of money you have taken out the policy for. The term of the policy can either be fixed (between two dates), or for the rest of your life – ‘whole of life insurance’.

The sum of money itself (called the ‘sum assured’ or ‘sum insured’) can be level, decreasing the longer you live (perhaps to cover a mortgage as you pay it off), or can be paid out in the form of a tax-free income, called family income benefit.

It’s designed to meet your financial responsibilities if you die. Of course, you won’t be building wealth, but it means your dependents will be supported in some way, which you were planning for anyway.

Income Protection Insurance

This form of insurance pays out if you cannot work.  It pays you out a regular, tax-free income until you either return to work or to the end of the policy, whichever comes first. You can choose how long the policy waits before paying out, called the ‘deferred period’, so that you can tie into the benefits with those available from work.

You can choose to have the benefits – and the premium – rise by inflation every year, which is known as ‘indexed benefits’. If you’re in a risky occupation it’ll cost you more. Also, the definition of ‘being unable to work’ differs, usually based on the work you do. If you’re a desk-jockey like me, that’s low-risk, so you’ll get the most generous definition of being unable to work.

You can’t insure an income you don’t have, nor can you insure 100% of your income. Usually the maximum is 65-70% of your gross pre-illness income. But as income protection benefits are paid tax-free, you’ll likely find that this will add up to somewhere north of 90% of your net pre-illness income.

Your ability to earn an income is by far your biggest asset, so you need to protect it. Your number one tool for building wealth into the future is your income, so you need to make sure that if you can’t earn an income, there is still some money coming in. Income protection insurance is designed to do exactly that.

Critical Illness Insurance

Finally, there’s Critical Illness or CI cover. This pays out a lump sum if you are diagnosed with one of a list of serious conditions, and then survive, usually for 14 days after the diagnosis.

There’s a standard minimum list which includes heart attack, cancer, stroke etc., and then each insurer has its own definitions of what is covered. CI cover can be expensive but it is valuable in the right circumstances. Usually it comes last in terms of priority, but it does depend on your situation.

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