Principles of Protection
We spend most of our lives trying to earn enough money to allow us to enjoy a comfortable standard of living whilst we are working, and also accumulate enough wealth on top to give us an enjoyable retirement.
The two major circumstances that will stop us doing this are premature death and long term sickness or disability, and although many of us insure the trappings of wealth (homes, cars, furniture, antiques, jewellery etc.) most people don’t insure the person that generates that wealth, i.e. YOU.
To summarise the main areas that should be protected and how that can be done, please check the headings below and then ask yourself how close to these recommendations are your own plans. If you feel that you are falling short in any areas, then we can advise you on how best to plug the gaps.
1) Mortgage Protection
There are three levels of Mortgage Protection:-
• Budget
• Fully Comprehensive
• Fully Comprehensive Plus
Budget
This is the basic level of protection and your outstanding loans should be covered against death, for both you and your spouse or partner, for the full term of the mortgage. In this event, the survivor will get a tax-free lump sum to pay off the mortgage, thus ensuring that at least they (and any children) will not have to worry about maintaining a roof over their heads.
Fully Comprehensive
If it is affordable, you should also cover the loan against contracting a critical illness (the main ones being heart attack, stroke and cancer, although up to 50 illnesses can generally be covered).
Critical Illness cover (CIC) will pay out a tax-free lump sum on diagnosis of a critical illness, which will allow the claimant to either pay off the mortgage or to carry out any modifications to the home that the illness may require (stair lifts, wet rooms, widening doorways, etc.). This cover can be included in the same plan as the life cover.
Fully Comprehensive Plus
You can also take out a stand-alone insurance called Accident, Sickness and Unemployment cover (ASU), which will cover your mortgage payments for up to twelve months, if you cannot work due to accident, sickness or unemployment.
It can, however, sometimes be included in the same plan as the life and CIC, depending on the insurance company, and it is then usually referred to as Mortgage Payment Protection Insurance (MPPI).
ASU/MPPI is not to be confused with Payment Protection Insurance (PPI), which has been the subject of mis-selling by the banks, and is not a product that we recommend.
Notes:
1. Some people have Death in Service (DIS) benefit with their employers, which could be anything between 1 and 4 times their salary, but this should never be used for mortgage protection, for two reasons.
Firstly, when you leave your employer, this benefit will cease, but your mortgage may last for 25 years or more.
Secondly, if, during this time, you become ill, you may become uninsurable, or monthly premiums may increase considerably.
DIS can be more suitably used to top up your family protection, although the same warnings apply.
2. To avoid any misunderstanding, none of the above insurances are mandatory when you take out a mortgage. However, it is both sensible and prudent to at least cover your mortgage in the event of premature death, and we strongly recommend that you take out life cover for the full amount of your mortgage.
Buildings & Contents Insurance
The only insurance that is mandatory when you take out a mortgage is Buildings insurance, and the lender will want details of this before they release the funds. They will often try and sell you this on the back of the mortgage, but you are not obliged to take this out with them, and you will always be better off getting an independent quote from the open market, using a broker.
This is very often combined with Contents insurance, and we can quote you on both of these, once you have settled on a property.
2) Family Protection
Once the mortgage is protected, the next thing to do is to make sure that your spouse or partner and your children will be able to enjoy the same standard of living as they had before your premature death. This can be covered by providing either a lump sum (single payment) or an income for a pre-determined period of time, and both of these are tax-free.
If a lump sum is chosen, the amount should be based upon that required to provide an income of 5% of the lump sum when invested. So, if £20,000 per annum is needed, then the sum assured should be £400,000.
If an income is preferred (and this is always the cheaper option), then you can elect to have the £20,000 paid from the time of death to a pre-determined time in the future (say, your retirement age). Both the lump sum and the income can be index linked to allow for inflation.
As with mortgage protection, if finances allow, CIC can be added so that the benefit will be paid out on the occurrence of either event.
To calculate the income required, take your net income (after tax and National Insurance), less your mortgage repayment (as this has now been paid off) and that will be the amount needed to maintain your existing standard of living.
The problem isn’t just about making sure working parents are insured either. Many stay-at-home parents are often left uninsured because they don’t directly contribute to the family finances. But hiring someone to replace the work that they do, for instance childcare, housekeeping, shopping can cost more than £70,000 per annum (www.salary.com).
3) Income Protection
This is the final piece of the jigsaw (and probably the most important, if you have a mortgage), which is designed to provide you with an income if you cannot work due to sickness or accident.
Statistics tell us that, before the age of 65, you are five times more likely to contract a critical illness or be off work for longer than 3 months than you are to die, so this is very important cover!
Income Protection Plans (IPPs) will provide you with a tax-free income after a waiting period (say 3 – 6 months), which will be paid to you until you return to work. If you are off work again for the same or even a different reason, as long as you have continued to pay the monthly premiums, you will still be covered. Premiums are paid by the insurance company whilst you are drawing benefits.
With the advent of the Mortgage Market Review (MMR), lenders are now responsible for ensuring that potential borrowers can not only afford to pay the mortgage now, but that they can afford to pay in the future (even when interest rates rise).
So what would happen if a borrower couldn’t work due to sickness, accident or redundancy? If this was long term, then the property would be repossessed by the lender, which is the last thing that lenders want to do.
To prevent this from happening, an IPP is the obvious answer, and it may not be too far in the future, before lenders start insisting that all mortgages are covered in this way.
So, if you don’t have either an IPP or ASU/MPPI, then it would be a good idea to discuss your options with us and make sure that, whatever happens, the roof over your head is secure, and your family are protected.
At the very least, you should check your contract of employment to see how long your employer would pay you for, if you were unable to work due to sickness or accident. You would then know for certain how long you have got before your mortgage payments become a problem.
People very often get confused between Critical Illness Cover, Income Protection Plans, Mortgage Payment Protection Insurance and Terminal Illness Benefit.
Critical Illness Cover (CIC)
The main criterion for benefit payment on CIC is that you have been diagnosed with a critical illness, and the benefit can be in the form of a lump sum or an income. You do not have to be off work and the illness does not have to be terminal.
Income Protection Plans (IPP)
The benefit is paid on an IPP if you cannot work due to sickness or accident and is designed to replace all of your net income.
The benefits are tax-free, up to a maximum of 60% of your taxable income, can be paid for as long as you are not working, and can go on until retirement age.
Mortgage Payment Protection Insurance (MPPI)
This is also known as ASU, and should not be confused with IPP.
MPPI pays out an income in the case of sickness or accident and can also cover unemployment, but only covers your mortgage payments and will only be paid for 12 months.
Terminal Illness Benefit (TIB)
TIB is a benefit added to life assurance plans (mortgage and family protection), whereby the benefit is paid immediately if the life assured is diagnosed with a terminal illness, and the life expectancy is less than 12 months.
In an ideal situation, everyone should be covered for all of the above, but unfortunately we don’t live in an ideal world, and so affordability is of paramount importance.
So, the question is, are you prepared to take the risk that one or more of these things will happen, or would you prefer to pay an insurance company to carry the risk? If it is the latter, then you need to decide how much of your income you are prepared to pay in monthly premiums to protect the rest.
The danger is that, because you may not be able to afford to do it all, you end up doing nothing, and this is a recipe for disaster! Much better to talk it through with us, and we will be able to look at your personal situation and suggest the appropriate level of protection, which is within your budget.
And finally .....
There is very little point in ensuring that you have adequate protection in place if, on your death, 40% of the benefit disappears in Inheritance Tax (IHT). So, where appropriate, you should write your policies in trust, and thus ensure that the benefit stays outside of your estate for IHT purposes, and immediately gets paid to your beneficiaries, without being delayed in Probate (which can take many months).
Also, you should ensure that you have up to date wills in place, which have appointed guardians for any minor children, and that adequate financial provision has been made for their upbringing. This can usually be done by writing life policies in trust for the children, with their guardians as trustees and, where appropriate, we can arrange to do this for you.
Appointing legal guardians is particularly important if the parents are not married, as the surviving parent may not be given custody of the children!