Why your Financial Review Should lead with Protection
When having a comprehensive review carried out it should have at it’s core the protection component. It’s foolhardy making sure you have the best pension and investment products if there is no appropriate life and serious illness cover in place. What’s the use in a well-advised pension or investment portfolio that ensures you have a comfortable retirement if you suffer an illness that stops you earning and making that pension contribution. Worse still is if you die leaving a family behind without a lump sum to enable them to continue to maintain the lifestyle you strived to provide for them.
A proper plan will break your cover down to living benefits and death benefits further divided by those paid personally and those paid for by your business. This is important for tax reasons as you will see later.
Living benefits include serious illness cover and income protection. Serious illness cover is a long-term insurance policy designed to pay a lump sum on the diagnosis of certain life-threatening or debilitating (not fatal) conditions such as a heart attack, stroke, cancer, multiple sclerosis and loss of limbs. The age Group from 50 to 60 accounts for approx. 40% of claims and surprisingly the lower age group 30 to 40 accounts for approximately 30% of claims. The cost of arranging serious illness cover rises dramatically as one gets older so this something that should be addressed sooner rather than later to negate this. As you are aware the chances of getting a serious illness and surviving are much greater than dying due to medical advances. However, these illnesses can leave the sufferer out of work and unable to earn for a long period of time and these polices in conjunction with income protection can address that situation.
Income protection covers your most important asset which is your ability to earn. The potential to earn is a direct culmination of years of study, hard work and enterprise on your part. If you can no longer work this is taken away from you. This a benefit that pays up to 75% of your income if you cannot work after a deferred period typically 13-26 weeks up to your chosen retirement age from 55 to 68. The benefit is payable if you cannot perform your duties as a pharmacist. It does not matter if you could work elsewhere, its specific to your occupation. The premium on this qualifies for corporation tax relief if paid for by the business or 40% tax relief if paid personally. The maximum you can cover is 75% of salary less state disability benefit if you are entitled to it. As most pharmacists are owner directors with 50% or more of the shares in your company you are a Class S PRSI payer and as such would be you would not be entitled to disability benefit (€198.50 per week).
Company Paid or Personally Paid Cover:
A serious illness policy paid for by the business for the benefit of the owner needs to be set up correctly. The correct way to set this up is with the company as the proposer and the life insured as the owner. There will be a benefit in kind on the premium paid but the benefit paid will go directly to you and not to the company. If the policy is not set up this way and the policy pays out to the business this will be treated as non-trading income and taxed at 25% along with normal income tax, USC and PRSI on extraction. If you have a company paid serious illness policy and it’s not set up correctly a €100,000 lump sum initially reduces to €75,000 and then by nearly 50% with the tax on extraction. The means the benefit you think you have is reduced by over 60%. You could well be paying for cover you will never be able to benefit from.
With income protection, you can have the premium paid by your business or personally. Personally paid policies under claim pay out a taxable benefit that go to you while the company paid polices have the claim paid to the business and are taxed as normal on extraction. Crucially only policies paid for by your business give you the option to cover your pension premiums. This means not only are you protecting your income you can protect your retirement also and this is where this policy is invaluable in the lifetime of security it can provide.
This is simply a cover that pays out on the death of an individual. Typically people think this is something that will not happen to them and they discount the possibility. However, if you look at the probability figures from the most recent census statistics it shows the chances of one spouse in a couple dying before age 60 and 65 is as follows.
|Ages||Die Before 60||Die Before 65|
In this, you will see that with a 45-year-old couple there is a 10.69% chance one will die before age 60 and 18.41% chance of one dying before age 65. This changes a situation that you perceive as happening to other people to something that will happen to nearly one in five of us.
Trying to quantify an appropriate amount of cover always seems difficult for clients until you put maths and logic behind it. Then the calculation becomes surprisingly straight forward. Take the following scenario
A Married Couple both 40 with two incomes of €100,000 and €30,000 along with rental income of €8,000. They have two kids, two mortgages and living expenses of €50,000 per annum along with mortgage payments of €18,000. They wish to make sure that the family is protected in the event of the death of either spouse. Currently, they have mortgage protection on the home loan.
|Income||Current Cash Flow||Death Of Spouse 1||Death Of Spouse 2|
|Combined Salary (€100k and €30k)||€130,000||€30,000||€100,000|
|Widowers Pension||€ –||€13,177||€13,177|
|Children’s Benefit (2 Kids)||€3,360||€3,360||€3,360|
|Rental Income Investment Prop||€8,000||€8,000||€8,000|
|Tax and PRSI||€55,200||€10,235||€48,471|
|Mortgage Home||€12,000||€ –||€ –|
|Mortgage Investment Property||€6,000||€6,000||€6,000|
In this instance, you need to work out what impact the death of either spouse will have on the family in the long term and this is done by way of the calculation above.
Death of Spouse 1: In this case €100,000 of income is lost but this will be offset by two primary factors. The home mortgage payment of €12,000 per annum is no longer payable as the mortgage protection policy kicked in and the surviving spouse became entitled to the widow’s pension of €13,177 per annum including dependants pension. Even with this and a reduction in living expenses the annual surplus of €18,160 reduces to €3,301. This is a drop in income of €14,859 per annum. With this figure quantified we can then look at a recommendation that makes sense rather than an arbitrary figure. With 28 years to retirement at age 68, a fair assumption would be 28* €14,859 giving a life cover requirement of €416,052 to maintain the lifestyle that is in place.
However, you can also factor in clients wishes that an extra amount is included to cover the costs of third level education which most financial advisers will be able to give you an approximation of. The above methodology appeals to some while others will say they want the above amount and more to leave the family in a stronger positon. That comes down to your own personal preferences and life cover premiums are currently at the lowest point they have ever been mainly due to price competition in the market place and the drive for market share by the insurers.
Death of Spouse 2: With this instance and it’s not unusual to see if the second income earner dies the cashflow situation can improve. This is down to the saving on the mortgage, the addition of the widow’s pension and the reduction in living expenses.
A common issue encountered in reviews for clients is where they were sold the wrong type of cover for their loans. This happens most often when the bank arranged the cover for them and at the time most people were just grateful for the loan and did not look too closely at the cover required or provided. The most cost-effective way to cover loans is with a mortgage protection policy which is the cheapest form of life cover available as the amount covered decreases with the loan. Any other form of cover is not necessary unless you are on an interest-only loan and should be changed. The savings here can lead into thousands depending on the term and premiums involved.
Inheritance Tax Planning and Life Cover:
In the past when you were looking at a large inheritance tax bill you had the option of taking out a Section 72 policy the proceeds of which were exempt from tax if used solely for the purpose of settling the inheritance tax bill. These whole of life policies with reviewable premiums(upwards) which combine life cover and savings were typically very expensive and the promised level of return on the savings element never materialised. Given they quoted estimated growth rates that were 6% plus per annum which no managed fund can do with any regularity this outcome was not surprising. However, there is a new option on the market place which can address for somewhat can be a very significant figure and a source of worry. The policy enacted under section 72 of the tax code can cover your liability in the event of death but crucially will refund you 70% of your premiums after 15 years if you do not make a claim. This is a policy that will refund a large portion of your premiums if it’s not used. As a concept, it goes against the grain of how life companies operate and we cannot be sure how long it will be on offer for but it’s available today. This is an excellent option that allows you over time to engage with more advanced tax planning to pass on your estate efficiently and means you do not have to worry in the interim.
Life and Serious illness cover are too important to you and your family to leave it to a loosely assembled bunch of policies with no plan in place. The cost of cover has reduced due to market pressures in the last 5 years and any policy taken out before this time can likely be replaced for a lower premium. Speak with a Certified Financial PlannerTM , who can guide you in this matter. It’s important you deal with someone who is independent because if you, for example, go to a bank they can only offer a quote from one provider out of a market of 7 providers. It’s no different than going to the Ford garage and saying what’s the best car, you will only get one answer and experience tells me it won’t be in your best interest.
Colm Moore Grad Dip, SIA, QFA, CFP® Colm Moore CFP® is a Certified Financial Planner and principle with Moore Wealth Management. He has been advising pharmacists for 10 years and is very aware of this market and its issues. CFP® is the highest level of education available in Financial services and is recognised worldwide. There are only 210 independent CFPs regulated to operate in Ireland and if you would like to talk to someone about the issues raised above this is the level of qualification your adviser should have.
This article first appeared in the IPN News in March 2017