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How to make protection fit your profile

I have just read a report that said 61 per cent of families do not have enough financial protection ? I am married with two young children and self-employed. How do I decide what type of protection I need and how much?

You have to be brutally honest with yourselves and consider the financial consequences of four scenarios – death, serious illness, inability to work due to illness and the desire for private medical insurance to complement the NHS.

First, assume no state assistance. We have good state support in this country but it is fair to conclude that, as a result of the Government’s austerity measures, we are going to see a drastic reduction in state benefits.

Second, we need to make a distinction between insurance to cover debt and insurance to support lifestyle.

Ensure all debts, including a mortgage, can either be repaid in full or repayments can be maintained in the above scenarios and then consider the ability to maintain lifestyle in any of the above scenarios.

Remember to contrast this against any existing provisions, including any employer benefits. Although you are self-employed, if your spouse of partner is employed any benefits need to be taken into account.

It is important to identify the shortfalls first and then see whether your existing provisions address them adequately rather than make it fit the other way round.

This is because existing policies are sometimes no longer fit for purpose, either because there is more comprehensive cover available or the objectives have changed over time. It is very common to find that protection needs are addressed when the first child is born, there is a bit of a gap until the second child is born and then all the terms and levels of cover are wrong.

Also, be wary when using employer benefits when addressing shortfalls, as an employer may make a financial decision to reduce or even remove employee benefits. Benefits are reduced pro-rata if working hours are reduced, for example, if returning to work following maternity leave on reduced hours. Benefits can also be lost if you change employer.

To identify any shortfall in cover, your starting point is always to produce a comprehensive budget planner, not so much to assess your affordability but to get a sense of what your outgoings are. Then imagine either you or your partner were to die and consider what outgoings would remain. For example, if you run two cars, would this reduce to just one car?

Then consider what income would be available in either scenario and there is your monthly shortfall for life cover.

Multiply this shortfall by 12 and then multiply that by the number of years until you expect your children to be financially independent. For example, for a £1,000 a month shortfall is £12,000 a year over 20 years, you need £240,000 worth of life cover.

Consider the merits of putting life insurance in trust, as it ensures the benefits go to the right person and will not just form part of your estate. It also ensures speed of payment as you do not have to wait for probate to be granted on an estate.

Do this calculation for both partners individually because you will possibly get a different outcome. It is good value to have two individual life policies rather than a joint one. It also does not follow that just because one partner has died, cover is no longer needed.

When looking at income protection, you need to do a similar exercise to discover the shortfall but ensure that the cover will provide an index-linked benefit for at least until debt (mainly the mortgage) is covered and ideally until retirement.

For criticaillness insurance, consider the difference between a traditional policy and a severity-based policy and understand the differences between to two to decide what your preferences would be. Index-link the benefits if possible and the minimum term would be until your children are financially independent and ideally until retirement.

Cheapest is not necessarily best and consider the importance of flexible plans, as it is unlikely that any policies put in place now will meet requirements forever, and additional services such as counselling services in the event of a claim. These do not necessarily cost more, or may add a few pence but can be very valuable if needed.

Peter Chadborn is director of Plan Money

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