How much protection do I need?
I'm not sure if I need more life assurance or other protection. And if I did, I don't know how much I would need.
This is a question that always comes up in a financial consultation. Whether we are talking about life assurance, serious illness protection or income protection, clients wonder how much protection they will need. Or when we are doing a financial plan with a client, we often find a need for protection. Then the question is again : how much cover does the client need?
AM Financial has the tools to analyse this. In this blog, we introduce you to some of the thinking behind these tools.
Why do I need any protection?
This is the first important question we need to answer. Perhaps there is no need for protection! In general, it is a requirement to have a mortgage protection policy in place on our family home. This means that in the event of the death of either of the policyholders, the mortgage is repaid in its entirety. So, what else needs to be covered ?
There are five potential areas to look at:
Loss of salary upon death or illness
Loss on death of a carer.
Loan repayment cover
Inheritance tax cover
The first three of these needs are likely to be temporary. Salary stops coming in at the age of 65 so obviously it does not need to be protected beyond that. Children will not need support funds for carers beyond a certain age, for example when they begin secondary school. For these needs, temporary assurance may be all that is needed and that saves on costs.
The remaining two needs are related to inheritance and so, Whole of Life Assurance is most appropriate, if it can be afforded.
Doesn't the State offer protection against these things?
Yes, the State is the first layer of protection. There are some conditions but for example, for the loss of income, the maximum current rate of the State Widow's, Widower's or Surviving Civil Partner's Contributory Pension is €208.50 per week. There is an increase of €34pw for each child under the age of 12. And €37pm for each child older then 12, up to the age of 22 if they remain in full-time education.
For example, for a family with three children, this comes out at €1,350 per month or €16,200 per year. This pension is not means-tested but it is subject to income tax. It continues until the remaining spouse remarries.
Ok, and my employer provides me protection. At least I think they do.
Yes, employers can often provide protection. A typical example is a lump sum to dependents upon the death of an employee. This is typically some multiple of the salary at the time of death. Some employers also provide an ongoing pension to the dependent up until the retirement age that had been scheduled for the employee who passed away.
Finally some employers also provide permanent health insurance.
So, how do I figure out how much protection I need?
With all these inputs we are getting closer to making a calculation. For example, assume we are looking to protect against a situation where the main breadwinner dies. We will have an income loss mitigated by some income gain.
Show me an example
Here is an example for a 40 year old employee, normal retirement age 65, the main breadwinner on €100k gross salary with mortgage payments of €1,800 per month, in a family with three children who passes away. The pension scheme at work pays a lump sum of three times salary to the dependents.
We take a very simple example where we do not take account of inflation or salary changes. We convert everything to annual figures.
Deceased's gross earned income: (€100k)
State Widow's. Widower's or Surviving Civil Partner's Contributory Pension (€16k)
Pension from employer pension scheme of which the deceased was a member (€18k)
Savings in future loan repayments where loans are paid off in full at death (€21.6k)
Savings in future living expenses in respect of deceased (food, clothes, car etc... ) (€20k)
The interesting aspect in this example is that although the salary is €100k per annum, the amount that requires protection is only €24k or €2k per month. This amount needs to be protected for the next 25 years.
At the time of writing a policy can be bought to pay €2,000 monthly upon the death for a cost of €53.34 per month.
Should I get a lump sum or an income stream?
Typically life assurance payments come as a lump sum. This is often suitable - for example, for a mortgage protection policy. Or to pay off a loan upon death. But to replace a salary, it may be preferable to have an income stream. This is what we have done in the above example.
How does this apply to me?
Contact us at AM Financial for your bespoke financial consultation. We will put together a financial plan that helps you meet your needs.