Insuring your retirement

It’s your retirement funds. Don’t let your children treat you as their life insurer.

Summary: Young adult children are liable to be un- or under-insured and your hard earned retirement savings are at risk if you don’t encourage them to address this. Insurance agents aren’t around to fix this, and automatic levels of insurance are likely inadequate.
Key take-out: Your retirement funding is at risk if you don’t encourage your children to have proper levels of insurance.
Key beneficiaries: Retirees and their children. Category: Risk management.

Not so long ago school kids around the world often found their English lessons occupied studying ‘Lord Chesterfield’s letters to his son’ on becoming a gentleman - held out as a model of perfect prose and a useful guide for wayward youth.

As far as I know Lord Chesterfield never talked about life insurance but he most certainly should have. Today I want to emulate his lordship and write you a letter you can pass on to your adult children to avoid them treating you as their life insurer and putting your retirement funds at risk … here goes.

Dear …

Sadly not everyone is invincible, and nor are you. Unfortunately life is not like an Xbox game where you get to hit Reset if things don’t go to plan.

Now that you’re older and more independent you need to think about having in place financial support in case illness gets in the way of you doing the things you want to in life, or if you’re not able to help those you love. In my day insurance agents roamed the Earth and it was hard not to have life insurance. Things have changed, and while it is possible you have a small amount of insurance through your workplace arranged super fund, it is highly unlikely the type and amount you have is right for you.  Here’s what you need to think about.

Why you need insurance

You need insurance, because not everyone enjoys good health and because of accidents. Selfishly, you need insurance to finance your living costs and care if you become ill. Selflessly, you need insurance for your family in case you die or become a burden on them.

Rather than simply lose in the illness and death lottery, you can “pool” your risk with others your age and buy insurance to protect against catastrophe. The cost of this is just the amount of benefit you need times the probability of that risk happening – plus about 25% to make this risk sharing system work. Because the cost of insurance cost is mostly a function of the risk, it is dumb to ask: “What are my chances?”. However, if you must know, read this dreary summary of incidence of diseases and death. It says the chance of you having a dreaded disease before age 55 is 10-20%, and dying about 5-10% depending on your age and sex. The only question worth asking is: if the event happened, could I afford it or not?

Protecting against death and worse, a living death

Dying or becoming totally and permanently disabled (tpd) is a catastrophe ready-made for insurance. The latter has bigger financial consequences. In Australia insurance companies and super funds often bundle these two risks into one combined policy. When you’re single, funding for permanent disability is your bigger need. However you should, and often have to, arrange both insurances. This is fine because there is a risk, when you get around to needing death insurance, that you may have suffered an illness that won’t be covered. 

It would be a miracle if the amount of insurance you have in your workplace super fund determined by a formula matches your need. The amount of insurance you need is the difference of:  

  1. How much annual living cost support you need (converted to a lump sum by multiplying by at least 25), debt you need to retire for others, education you want to fund (about $250,000 per private education) and anything else you want money for (noting that your death need not be a windfall for another); less
  2. How much savings you have outside and inside super and any other entitlements.

So if you want to fund a $40,000 annual expense, pay out a $500,000 mortgage and put two kids through private school you need a whopping $2 million. My guess is you don’t have near that much saved, and the automatic two units or three times your income existing cover is woefully inadequate. Don’t look to me/us as we can’t afford this either, and it would be selfish of you to expect us to postpone or ruin our retirement because you didn’t deal with this [Doug Turek’s words].

While you are under aged 45 the cost of life insurance is pretty stable. After that age it rises like a ski jump. Hopefully by then your future needs are less (1) and your existing resources (2) have increased, so you’ll be dialling down your cover on its way to nil. About $1 million of death and tpd life insurance costs a low-risk 30-year-old professional about $500 a year, if bought through their workplace super fund. It costs a 40-year-old about a quarter more, and a 50-year-old three times as much. When bought through workplace super it’s funded from pre-tax employer super contributions and not after-tax cash flow you’ll miss anyway.

In Australia the average death benefit paid from a super fund is well under a $100,000 and you can imagine that’s not enough to help a widow(er) and children. Don’t let this be you!

If you insure your car, then insure your income

When you’re young your biggest asset is not your good looks and humour, it’s your future income. Unfortunately only about 30% insure it against illness, versus 80% who insure their car. Income protection or salary continuance is a no brainer, especially as the cost is tax deductible – meaning you might get back nearly half the cost. As a general rule of thumb the cost of income protection is no more than 2% of your gross income. So choose between:

  • Living off 100% (not 110%!) of your income, but in the case of prolonged illness get nothing;
  • Live off 98% of your income, but while you can’t earn an income due to illness receive 75% of it until age 65 when you would retire anyway.

Your super fund might also provide this type of income, but many funds only pay a benefit for two years. This is a form of extended sick leave which you, rather than your employer, pay for. You don’t need this nearly as much as being paid to age 65 if you suffer a prolonged illness. If you have a two-year policy then you could replace it or get a second policy that kicks in after a two-year waiting period. It will be nearly half the cost of a usual 90-day wait policy. An insurance adviser can arrange this for you, which is probably done best outside super anyway. Discuss with them whether more “level” insurance premiums might be appropriate than “stepped”, as you might keep this going for a while.

If you or your spouse don’t have an income and if you will need money fast in the event of a traumatic illness, you can separately arrange trauma, sometimes called critical illness insurance. A few insurers also add this to their income protection policy, which may be a useful extra. This is illness bingo insurance, where you get your applied for lump sum back if your number comes up. Because these types of events happen frequently, it is expensive and it’s not tax deductible. Most apply for insurance equal to a half or two-year’s expenses; and over time it can be the easiest risk to self-insure.

What else to consider?

  • If you have a pre-existing condition you’ll have to advise that in the application – if anything, to avoid paying for insurance you wouldn’t get when your claim is checked. Insurers might charge you more for that risk, exclude paying out for it, or decline you outright. Getting insurance when you are young and healthy helps avoid this.
  • Be careful changing jobs and consolidating super funds, especially if you have insurance that you want to keep or can’t replace. Many workplace plans let you apply to take over the policy privately within 30 days of leaving.
  • Don’t forget your spouse. Many high-income earners insure themselves or their employer but forget their ability to earn that income depends on their spouse being around and healthy. He or she needs to be insured also.
  • If you run a business there are all sorts of life and illness insurance circumstances to contemplate – like funding or buying out a deceased partner’s share of the business so their family is looked after and out of the picture (paying for a replacement to the “key man” or “key woman”). See an expert and, if necessary, a lawyer.
  • Many die without a will, which means they leave a lot of work for others to clean up after them. If this is you, grow up and have one. Also buy the two-for-one special and get an enduring power of attorney so someone can pay your bills or turn off the machine. Ask your lawyer about “testamentary trusts” and consider afterwards whether your insurance and super should be paid to your estate once you own the perfect will.
Turning 18 or 21 is a rite of passage in our society. Consider buying your (grand) son or daughter insurance, including belatedly. If they are working and “they” make a tax-free, after-tax contribution to super the government might give them $1,000 of co-contribution benefit. This alone could fund $1 million of insurance for two years. Giving insurance for Christmas isn’t the same as giving a lump of coal. Show them you care!

Doug Turek is Managing Director of family wealth advisory firm Professional Wealth www.professionalwealth.com.au and is concerned about under insurance in Australia.