How to protect your family from financial disaster

According to the institute of Actuaries of Australia 2000, every working Australian has a 1 in 3 chance of becoming disabled through illness or injury for more than 3 months before turning age 65 (Interim report of the Disability Committee IA Aust: Sydney).

I know this is hard, but I want you to picture yourself off work due to a major illness or injury. Now picture your family. What are they feeling?  Would they be prepared or would their financial stress just add to their pain?

• Would debts get paid?
• Would the bills get paid?
• Would your spouse or kids be looked after

When disaster strikes the last thing you want to worry about is how you’re going to finance your misfortune. That’s why it’s important to make sure you have enough insurance to protect you and your family.

What are the MAIN types of insurance?

There are really two main categories of insurance

• Insurance that covers you for death, and
• Insurance that cover you for disabilities and illnesses.

1. Insurance that covers you for death

Life insurance (or ‘death insurance’) is fairly straight forward. Life insurance pays the lump sum your insured for on your death. This can be important if you have a family or dependents to help them pay off debts and provide further funds so the family can get by.

2. Insurance that covers you for disabilities and illnesses.

This category is a little more complicated because there are a few different types of cover that all work a little differently, but can also overlap each other. We’ve listed the main ones below:

a. Income Protection insurance

If you are unable to work due to prolonged illness or injury, Income Protection provides you with a monthly benefit usually up to 75% of your income. This is paid while you are unable to return to the workforce, potentially up to age 65 or 70.

Arguably the most important type of insurance because your income is what pays for everything.

b. Total & Permanent Disability (TPD)

This cover is a bit different to Income Protection in a few ways.

Firstly, this cover provides a lump sum, not an income stream like income protection does.

Secondly, it only pays in the event of permanent disability that prevents you from ever returning to work (unlike Income protection which can also be paid for temporary disabilities).

c. Trauma insurance

Trauma provides lump sum cover if you are diagnosed with a specified illness or injury (such as, but not limited to, stroke, heart attack and cancers). So getting paid is not based on how the illness effects your ability to work, it is paid purely based on you being diagnosed with an illness covered by the contract. This is one of the reasons why this type of cover can be fairly expensive, especially as you get older.

It is sometimes called ‘critical illness cover’ or ‘recovery insurance’.

What cover do I need?

Despite what the big insurance companies and fancy tv ads try to convince you of, the fact is, most people simply cannot afford to fully insure all aspects of their life.

You want to be able to take a holiday or enjoy yourself too, and that’s ok. It’s important to recognise this and accommodate it. They key word is “compromise”.

Here are a few ideas to help reduce those premiums so that you can get some cover that you can actually afford.

Remember, this is a guide only and ultimately you should seek advice that has been tailored to you. The amount YOU need depends on a number of factors such as your age, number of dependents, level of debt and level of wealth to name the name a few.

The minimum cover to aim for.

As a starting point I usually suggest people aim for at least some Life Insurance, TPD and Income Protection.

If you can then afford to add Trauma in go ahead.

Why Life, TPD, Income Protection and no Trauma?

With Life, Income Protection and TPD, you are covered for death, short term disabilities/illnesses as well as permanent disabilities/illnesses.

This means you are covered for a lot of things and therefore the need for Trauma is significantly reduced.

Yes, if you don’t have Trauma and have a stroke, you will miss out on a lump sum Trauma payment. But if you have an Income Protection policy at least you are getting paid a monthly income if you can’t work. And if your stroke turns out to stop you from working permanently, your TPD could kick in and you get paid a lump sum.

Furthermore, Life, income Protection and TPD can all be paid for with the help of you super (see below for more on this).

How much cover should I get?

Life Insurance

This is more important if you have dependents such as a spouse and/or children.

If so, as a minimum you would probably want an amount of cover that pays out all debts and provides another income at least until the kids are all grown up.

So let’s say you have a $300,000 mortgage and you would like to provide your dependents with another income of $20,000 a year for 10 years.

In this case you would need around $500,000 in cover (i.e. $300,000 to pay off the mortgage and $200,000 to provide an income of $20,000 a year for 10 years).

Income protection

Considering that your ability to earn an income is the most important asset you have, you should probably consider taking out maximum cover here.

Most income protection policies allow you to cover up to 75% of your gross income.

Total and permanent disability (TPD)

If you’ve taken out Income protection also, then the minimum level of TPD you may need is probably just enough to pay out the mortgage and maybe a little more to cover other things you may need such as medical bills and modifications to the home etc.

TPD can usually be taken out as an add-on to your life insurance for a reasonably low increase in premium.

Other tips to make your cover more affordable!

Using your super fund?

In most cases, Life, TPD and even Income Protection cover can be obtained from your superannuation fund.

You do need to be a little more careful when using your super fund for TPD and Income Protection though as there can be certain restrictions on holding this cover via super, so it’s important to do your research.

We sometimes recommend policies that are primarily funded by super, but partly funded outside of super because this can avoid some potentially major pitfalls of having your insurance fully funded by super.

However, the main advantages of using your super are that your premiums are effectively funded with your pre-tax dollars (meaning you are effectively getting a part tax-deduction for your premium) and it obviously won’t impact on your immediate cash-flow as premiums are funded by your super.

Take a 3 month waiting period if you can.

Try to take a 3 month waiting period on your income protection policy instead of a 2 week or 1 month waiting period. This means that if you make a successful claim, your insurer will not pay you for the first 3 months.

If affordability is an issue, we are always telling people to focus more on the disastrous stuff and forget about the ‘nice to haves’.

Not being able to work for 3 months is not great, but there are ways you might be able to consider to get by. For example, you could get through by having 3 months of savings, using up sick/annual leave, redraw on a home loan or getting help from family etc.

Not being able to work for years on end is the disaster that you really need to be covered for.

So, if you can find a way to get by for that initial 3 months, electing for a 3 month waiting period will drop your premium quite a bit.

Commission free broker

Getting insurance advice from a broker that charges or receives commissions could potentially add up to 30% to your annual insurance premiums. Over your life this can add up to quite a substantial amount. If you are looking at getting some help, you may want to consider getting help from someone who will rebate those commissions and charge a fee for service instead.

Not only could you save up to 30% in annual premiums, its also opens up the adviser to look at alternative providers that other brokers wouldn’t look at purely because they don’t pay commissions.

Get advice

As you can see, there’s a lot to getting the right insurances in place for you and your family and not all insurances are created equal.

So unless you know what you are doing, it’s a good idea to get some advice from someone who’s in the know.

If you’d like our help, you can arrange a free consultation with one of our experts by clicking here.