13 – Life Insurance

Life InsuranceAs part of a review of all matters financial I initiated in the middle of 2014, one of the items I added to my list of things to mull over was life insurance. The matter surfaced for me when I realised I no longer had any insurance cover through my superannuation fund by virtue of not working (i.e. being a stay-at-home parent) and not contributing regularly to my super account.

I’m not planning to die or be critically injured any time soon but I remember when we took on the mortgage for our PPOR in 2006: the commitment felt almost too large handle. I used to commute into the city regularly by bicycle but, having recently moved to Perth from Adelaide—with a related increase in minor accidents, and as one of two income earners critical to our ability to repay the mortgage, I felt it was time to stop riding. With a few years of wisdom on my side, I don’t feel the same way this time around with the investment property but, conversely, I now have kids and want more than ever to protect my family from the risk of loosing an income/resource.

From personal experience again, my father died at the age of 56 and my grandfather at 65 so I joke that I’ll likely expire at 45. Specifically, my father had a life insurance policy worth $500k when he died and had only recently opted not to increase that policy to $1m. The $500k has served my mom well over the years as she retired and downsized the family home but she also weathered the 2001 tech bubble and then the GFC with most of that money in the stock market. With the payout she’s been comfortable; without it, I don’t know that her retirement years would have been as amenable as she was expecting had my dad lived to retire with her.

When we were working, my wife and I both had automatic life and salary continuance insurance (SCI) (also called income protection) through our super funds. We didn’t pay directly for these policies but they were funded through the fees we pay to each fund (a percentage of our super balances). Notably, the amounts insured were very small—a couple of hundred thousand each for life and SCI.

We had the option, of course, to increase the benefit amounts and do everything through super but I soon came to learn there is a better way—an approach that not only pays for some of the premiums from our otherwise inaccessible (preserved) super balances (we’re not running SMSFs) but also offers tax benefits.

By way of background, I’d scheduled a complimentary meeting with a financial advisor through our accountants at WSC Group (through Jigsaw Financial Planning—again no affiliation here). I took with me our written financial goals and described to Matthew Laird (the advisor) what we’re doing with real estate, where we are with super, and that I’m not looking at stocks or mutual funds. It soon became apparent we didn’t need much in terms of paid financial advice… yet. We did, however, talk about insurance and Matt promised to get some numbers together for us. Importantly, he highlighted the concept of a partial rollover from our super funds to pay some of the premium costs, reducing our out-of-pocket expenses and thereby removing what had been the single biggest blocker, to my mind, to insuring ourselves adequately: cost.

The first thing Matt’s team did was prepare a Personal Protection Plan document for us which summarised our current position in terms of income, assets, expenses, liabilities, goals, and existing insurance. This offered a framework for understanding our insurance shortfall and potential requirements into which the planner injects their recommendations for level of cover and ownership structure. There was no charge for this.

It’s worth quickly describing the different types of insurance because I found this enormously confusing at first. I like to categorise insurance into two simple groups: living benefit, which you receive if you’re not dead, and death benefit, which your estate or nominated beneficiary receives when you die.

Living Benefit

  • Total or Permanent Disability (TPD). A lump sum payout when you’re declared totally and permanently disabled—and can’t work. These policies might exclude heart attack, stroke, cancer and others. A very important distinction to be aware of between TPD policies is that of “Any Occupation” versus “Own Occupation”: with an Own Occupation policy, you’ll receive a payout if you can’t work in your own profession; with an Any Occupation you’ll only receive a payout if you can’t work in any occupation (as Matt says, “as long as you can lick stamps…”). The premium is not tax deductible and the payout is typically not taxed.
  • Trauma (also called Critical Illness or Living). A lump sum payout that covers heart attack, stroke, cancer, and other specific conditions. The sum insured is typically lower and this cover overlaps somewhat with income protection. The premium is not tax deductible and the payout is typically not taxed. For us, I felt this was very much an optional insurance given our SCI cover (see below) and we didn’t buy any trauma.
  • Salary Continuance (SCI) (also called Income Protection). Pays ~75% of your income on an on-going basis, after a waiting period, to the age of 65 if you can’t work. SCI covers heart attack, stroke, cancer, etc. The premium is tax deductible and can be paid through super but I’m told it’s best to pay this one yourself for maximum tax benefits. The benefit is classed as taxable income. With the wife’s insurer, the maximum monthly benefit they’ll underwrite is based on 75% of her highest income year in the last three years.

Death Benefit

  • Term Life. A lump sum payout at death or when you are declared terminally ill (i.e. before you die but with less than 12 months to live). You’ll likely purchase “term” life insurance, in which your premiums cover you for death up to a certain age. You might also be able to purchase permanent life insurance, although I’m not sure this is available in Australia. The premium is not tax deductible and the payout is typically not taxed (but it may be if paid via a super fund or if paid to someone who isn’t a financial dependent—i.e. not your spouse or children).

Note that life insurance tends to get more expensive the older you get—I suppose because you’re more likely, statistically, to receive a payout. I was specifically told by Matt insurance gets a lot more expensive past the age of 47.

The other problem you might face the older you are relates to your medical history. In my (young) case, I broke my back in a snowboarding accident at the age of 21. So my insurance policy includes a blanket exclusion on spinal cover—with no reduction in premium, of course. Basically if my back suddenly gives way tomorrow I’m not covered but if I’m in a car accident and break my back I would be covered. Of course, some insurers may offer you a policy with increased premiums to cover the additional risk. My suggestion therefore is to get yourself insured as soon as you can, as a young person, so you at least have something in place even if health problems do present as you get older which might preclude you from becoming insured.

In the same vein, you’ll also want to be careful what you tell your GP—and what they record in your patient file (the insurer will request your patient file from your GP as part of the assessment process). One thing in particular to be mindful of is mental health—depression, anxiety, etc. If you’re having a bad week at work and mention that when you visit your GP for an unrelated reason—and let’s say your GP recommends you see a counsellor, the insurer may take that into consideration when assessing your application.

With some insurance products like SCI you can insure at indemnity value or agreed value. Indemnity value means the benefit is paid as a percentage of your earnings (i.e. 75%) whereas agreed value means your benefit is whatever fixed amount the insurer has agreed to cover.

Your premiums will also increase annually (these are called “stepped” premiums)—beyond the rate of inflation. You may have the option to pay a higher, “levelled” premium that remains constant throughout the course of your policy. If you can afford to, a levelled premium seems like the way to go to me—assuming premiums will increase beyond the levelled premium and you’ll save money. That said, part of me thinks “the house always wins”.

Our risk of death increase as we age but we conversely approach the end of our careers and our income generating potential. In other words, we should theoretically have a lessened need for insurance as we get older. My aim therefore is to wind back insurance over the next twenty years, with the assumption that we’ll be further progressed in our financial lives and less dependent on income or a large payout to set us in good stead. I’ve therefore opted for stepped premiums.

With other products you can purchase a lower-cost “rider” policy. For example, if you have a trauma rider to your life policy and claim against the trauma policy, your life policy benefit will be reduced by the amount you claim for trauma.

With the concepts out of the way, we started by defining our insurance goals, i.e. what costs would need to be paid for if one or both of us could no longer work. With my wife as the only income earner, we would firstly want to reduce debt and replace her income. With me providing child care, we would also want to cover the cost of child care if I couldn’t provide that function. Pretty simple. Anything else is a bonus—i.e. paying down property debt. In short, we calculated benefits from income, factoring in living expenses and debt. As with most things we do, we insured for modest amounts. Since income protection would be paid at 75%, I opted to go for the maximum amount we could purchase however.

From there, we were able to structure the insurance so the premiums are partly held through a superannuation account. This is accomplished through a partial rollover from our own super funds to the insurer’s zero-balance fund for the amount of the annual premium. In other words, that percentage of the premium for the policy held in the super fund is paid with super dollars that I otherwise cannot touch until I reach preservation age or retire. Yes, that money is no longer earning money for me in my super account but at least I’m not having to pay out of pocket for something as mundane as insurance (and in all honesty I consider the balance of my super as dead money… I’ll look at an SMSF one day).

In my particular case since I’m not working, I wasn’t eligible for an Own Occupation policy or SCI and all of my premiums were covered by the partial rollover. My policy covers me for life and TPD.

In the wife’s case—interestingly—the advisor recommended a different insurer and she’s covered for life, TPD, and SCI. Premiums are again paid through a combination of a partial rollover and a personal contribution. Interestingly, dear wife is with an untaxed super fund so there’s the little catch that rolling over from an untaxed fund to a taxed fund will likely result in tax being payable on the rolled over amount. This is still being resolved but it sounds like a tweak to the ownership structure will sort it out.

Finally, I should mention buying this insurance didn’t cost us anything in broker fees. The broker received a commission from the insurer which is detailed to us. I didn’t think insurance was sold this way so that was a nice cost savings and, since I know nothing about these types of insurance companies, saved me a lot of research. Yes, brokers are selling products that make them a commission which may vary from product to product but WSC Group (through their subsidiary Jigsaw Financial Planning) seemed very professional and above board in their dealings with us.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

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