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PERSONAL FINANCE

Life insurance cover — how to work out the amount you really need

Life insurance cover — how to work out the amount you really need

Life insurance, contrary to popular belief, is not intended to make the people you leave behind rich, but to fill the financial gap you leave behind.

Though many consumers use life insurance as a means to create generational wealth, there are financial costs that life insurance is meant to cover when you die.

Clyde Parsons, the chief innovation officer at BrightRock, said there are two things to consider. “The first is ensuring your income is protected in the case of an illness, injury or death. Second, you need to make sure your assets, such as your home and your savings, are protected.”

Lizl Budhram, the head of advice at Old Mutual, broke it down further. “Apart from the monetary consideration or your affordability in respect of the premium payable, you need to look at reasons or considerations that will determine the amount of life cover required,” she said.

These considerations include:

  • The financial void you leave behind: This is the capital required to replace the income you contribute to the household. This is especially important if you are the breadwinner. Ideally, you want to know that if the life insurance payout is invested, it can provide an income that will allow your family to maintain their current lifestyle.
  • Debts: If you have major debt, such as a home loan or vehicle finance, these debts need to be settled when you die. Including funds to cover your debts in your life insurance cover means that your loved ones won’t be forced to sell your car, or worse, their family home, to settle a debt.
  • Education costs: In the absence of an educational policy for your children, life cover can provide the capital to fund their education.
  • Estate expenses: This refers to funds that will be needed to cover estate expenses, duties and taxes payable on death, such as executor’s fees, estate duty tax and capital gains tax.
  • Funeral expenses: Funeral costs can vary widely, depending on how lavish you want the service to be and whether you choose burial or cremation.

Now that you’ve figured out how much life cover you need, you may choose to take out one policy to cover all these needs or several policies for different purposes.

“Using a single policy is possible, but it can become complicated when there are many different needs to address and many potential beneficiaries to provide for,” said George Kolbe, head of marketing at Momentum Life Insurance.

“Often it is simpler to dedicate specific products for specific purposes; for example, a policy to provide bond protection cover, a policy to provide funds for your children’s education, a funeral policy to quickly provide money for funeral expenses or a policy to fund the buyout of business interests.”

However, he cautioned that the disadvantage to this approach is that you are likely to pick up more costs in the form of policy fees for the administration of each one.

“The benefit of using one policy for the purpose of estate costs as well as various beneficiaries is the ease of administration, having to manage only one policy with one premium,” Budhram said.

When you take out a life insurance policy, look at the premiums and the level of cover that you are being offered. Some policies include increasing life cover and increasing premiums to match the increasing cover. Other policies may offer you a flat premium (that does not increase), but this is likely to mean that your cover won’t increase either. Unfortunately, it means that by the time your beneficiaries receive the payout, the money you thought you were leaving them will be worth much less because of inflation.

“If you die in retirement, it may be that the only costs to cover are your funeral costs,” Parsons said.

“However, if you were to die in your thirties, for example, your financial needs would be the highest they’ll ever be, because you’ll have the highest number of pay cheques yet to be earned, more years of school fees left to pay and more bond repayments.”

Having said that, there is a case to be made for decreasing your life cover as you get older. The general guideline is that the older you get, the less life cover you need because as time passes your debt reduces, your dependent children grow up and become independent, and your retirement savings replace your income needs when you retire. DM

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R29.

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