Life isn’t about waiting for the storm to pass it’s about dancing in the rain
We can never predict how hard those proverbial thunder storms can hit, and the kindest thing we can do for our own peace of mind is to make sure that the rainstorms we dance in are the singing in the rain kind. This is the purpose of insurance. To give ourselves a safety net for the life events that keep us awake at night.
Why insurance is important to your financial plan
A strong financial plan is built on a robust foundation. One of the building blocks in this foundation is insurance, especially in the years when we are building wealth. It protects us and our loved ones in the event that anything negative impacts our wealth building plan, death, critical illness or disability, it reimburses us for loss of assets and it enables us to drive our vehicles legally.
There is virtually a form of insurance for anything that may impact our lives. Most recently I saw an insurance policy being advertised for the Game of Thrones finale. The policy covered any loss a UK policyholder suffered as a result of being exposed to a spoiler between the airing in the US and the UK. The policy was purported to pay up to £100 for proven unhappiness suffered.
Insurance is very personal and driven to a large extent by our individual risk tolerance and the amount of wealth we have accumulated. It is a part of our wealth building foundation that we should take time to evaluate and objectively consider the impact an event could have on our lives if we weren’t insured against it. The key areas of insurance we should focus on first are Income protection, Life Insurance and coverage for our possessions.
We are more likely to become disabled than die. Not a thought we often want to entertain, and hopefully one that never becomes a reality. But if it were to happen how would you cover your living expenses? Disability insurance, otherwise known as Income Protection Insurance, is designed to protect our biggest asset. Our ability to earn income. As there are various forms of disability cover it is important to understand exactly under what conditions the policy will pay out. Some policies are designed to pay if you can no longer carry out any work, not just the primary occupation you are engaged in. Others will pay when you can no longer carry out your primary occupation. The payments, which are a maximum percentage of your current income, continue until you earn alternative income or for the maximum defined period in the policy. This may be retirement if this is the policy coverage you have selected. If the premiums were paid by you, as opposed to your employer, the policy pay outs are not taxed. It is important to note these policies do not pay out immediately on becoming disabled. There may be a waiting period from 4 weeks up to a much longer period depending on the policy. The implication of this is that you will need to have an income buffer during this time.
Critical Illness cover differs from disability cover in that payment is a lump sum which is usually tax free and is paid on diagnosis of a defined critical illness. The lump sum payment is unrelated to your ability to work. This means your illness permitting you can continue to work after the policy has been paid out. This cover could be used to pay off a mortgage, for medical treatment or to ultimately provide a benefit to your surviving family. The key with this type of policy is to shop around and compare offerings, fully understand what is covered and more importantly what isn’t. These tend to be expensive policies and it is worthwhile making sure you understand every aspect of the terms and conditions.
The chief beneficiary of life insurance policies for single people with no dependents is the life insurance sales person. If you don’t have dependents you do not need a life insurance policy.
Life insurance is intended to provide cash support to your dependents on the event of your death. The amount of life insurance you require is driven by the unencumbered assets you will leave to your dependents.
The cheapest way to financially protect your loved ones is level term life insurance. You select a term of cover, ideally enough time to enable you to build up your assets to a level sufficient to support your dependents or alternatively to last until your children have completed full time education, and a level of cover which will repay any outstanding debt, such as a mortgage, and provide income to support your dependents.
The rule of thumb that experts advise is 10 times the main breadwinner’s income.
Experts further advice that your life insurance policy be written into a trust for your depennts when you take it out to avoid it falling into your estate for inheritance tax as well as avoiding potential delays on it paying out due to extended period of probate.
At this point in the article you must be feeling some resistance to considering any further insurance costs, however, consider the loss of your most valuable assets and the impact this can have on your wealth building. Building wealth is all about risk mitigation, we invest to mitigate against inflation reducing the purchasing power of our pounds, we diversify our investments to mitigate against the poor performance of one particular asset class or sector and we insure to hedge ourselves against the occurrence of costly event impacting or impeding our wealth building plans.
In the UK if you own a car, you are legally required to have motor insurance. At a minimum you require third party insurance which covers the damage or injury any other person may suffer if you have an accident. It does not cover any costs of repair or replacement on your vehicle. If your car is an integral part of your ability to earn income or an important aspect of your lifestyle it is worthwhile to extend coverage to your vehicle.
If you own a property, it is likely to be one of the most expensive assets you own. Loss through a natural disaster could be financially devastating. Insurance is a valuable hedge for this. And whether you are an owner or a renter, you may be surprised at the value of the contents you have accumulated. Your computers, IPADs, mobile phones, jewellery and appliances add up to a pretty large sum and not something you want to have to replace because of theft or damage. A well considered insurance policy may be the buffer between draining your savings and impacting your budget and your ultimate financial wellbeing.
Insurance may not be the first thing you consider when you think wealth building, but a well considered and successful wealth plan could be totally derailed by a devastating life event. Insurance is a key pillar to your risk mitigation strategies.