Your Money For Your Life
The Age
Wednesday August 6, 2003
With high mortgages and rising debts, having enough insurance cover is more important than ever, writes Christine Long.
When it comes to life insurance, most of us buy it grudgingly and throw it into the bottom drawer, hoping it will never be needed. But taking a set-and-forget approach to life cover could leave people with a potential shortfall, particularly in times of rapidly rising debt.
With the average mortgage in NSW now $220,000, Mark Kachor, the managing director of DEXX&R, says under-insurance can be a problem.
If you need to upgrade your cover, there are alternatives. These days term insurance policies - which provide a lump sum in the event of death - are more popular than "whole of life" policies, where there is an investment component as well.
As the table shows, a 45-year-old non-smoking male wanting $500,000 of term insurance cover will pay an annual premium of between $475 and $1050 for a policy, with the average being $667.
Although these premiums have been gradually falling, many people now prefer to purchase cover with pretax dollars through their superannuation fund. Because these are group arrangements, the cover is usually cheaper than taking out a stand-alone policy.
Industry funds often automatically provide a basic level of life and total and permanent disability cover, while retail funds often give members the option of taking out such cover.
Ross Clare, the principal researcher at the Association of Superannuation Funds of Australia (ASFA), says that in group insurance arrangements, in general your dollar a week will buy you between $40,000 and $50,000 of cover at age 30. "By age 50 the premium will stay the same, but the cover will drop to about half the level," he says.
The other advantage of buying cover through a super fund is that there is generally no need for a health declaration or a medical examination if someone wants only basic cover.
Andrew Heaven, a principal at WealthPartners Financial Solutions, says this can be handy if someone has a pre-existing medical condition that could result in them being refused cover or charged a loading on the standard premium if they tried to buy a stand-alone policy.
Someone with diabetes, for instance, could be asked to pay a loading of up to 250 per cent on the standard premium, he says.
However, super fund members usually only have the option of taking out two or three units of cover on an "automatic acceptance" basis.
It may be possible to purchase up to six units of cover through a super fund, but someone buying additional units often has to fill in a health declaration and may have to undergo a medical examination.
Given current mortgage sizes, this still may not be sufficient cover, says Kachor. "In the vast majority of cases the amount of cover provided through superannuation is probably less than the debt people are carrying."
Purchasing life cover through a super fund can also trigger some transition issues if you go through a period of unemployment or change jobs. "Being in a job tends to be a precondition for death and total and permanent disability cover, but there often will be a continuation of cover for a [certain] period of unemployment," says Clare.
Michaela Anderson, the director of policy and research at ASFA, says people switching employers need to check when life cover applies, particularly if they are taking a holiday between jobs. "It can be when the employer makes the first [super] contribution for you rather than when you start the job."
Another alternative can be the cheap cover offered through credit card providers. However, people need to be aware this is often only accident cover, says Heaven. "It is no good having $500,000 of accident cover if you fall sick with cancer."
Advisers report stand-alone life cover may still be the best option for a self-employed person without a super fund or if someone is close to exceeding the pension reasonable benefit limit (see left for tax treatment).
"If you have a $400,000 super benefit and a $600,000 life policy written under super, that puts you at the pension RBL," says Heaven.
Someone buying a stand-alone policy needs to make sure they shop around on price, says Kachor. Also consider additional features. Most offer a terminal illness benefit and indexation, but some policies offer a financial planning benefit for the beneficiary.
The difference in cost can also be the result of the amount of commission payable to advisers. "The cheapest policies are often the ones without commission," he says.
HOW MUCH IS ENOUGH?
As a rough rule of thumb, financial planners recommend people take out life cover for seven times their annual salary. But the appropriate level of cover will depend on a combination of factors, including where you are at in your life cycle and whether your children are young.
Cover may need to be as high as 10 times annual salary if you have a sizeable mortgage and plan to educate your children privately.
Renee Hancock, the wealth protection manager at Count Wealth Accountants, says often people take out only enough cover to pay off their mortgage.
However, she says: "It should cover any outstanding debts - not just the big ones like the mortgage - but credit card debt, car loans and any money owed to the family."
People may also need to include a capital sum to replace their lost income stream for their dependents to live on.
Even where one person is a home-carer or working part-time, it may be necessary to take out insurance to cover the cost of a nanny.
The tax treatment of the life insurance benefit will vary depending whether the cover was bought with after-tax dollars outside of super, or whether it was bought with pre-tax dollars through super.
Elaine Keenan, the manager of adviser services at Count Wealth Accountants, says a payout from a stand-alone life insurance policy bought with after-tax dollars will be tax-free irrespective of who the beneficiary is.
However, a payout from life cover obtained through a super fund (and bought with pre-tax dollars) may be taxed depending on the beneficiary.
"If it goes to a dependent for super purposes, like a spouse or a child under the age of 18, they won't pay any tax on it."
However, she says, if it goes to a non-dependent they will generally have to pay tax at a rate of 16.5 per cent and it may be as high as 31.5 per cent.
There may also be tax payable if the insurance proceeds causes the fund to exceed the deceased person's pension reasonable benefit limit (RBL), currently $1,176,106. In that case the amounts over the pension RBL are taxed at the highest marginal tax rate.
As a result, she suggests: "It is a good strategy to have insurance through super if it is going to a spouse or a dependent and if it is going to be within the pension reasonable benefit limit.
"But if someone is insuring for amounts higher than that [limit] then they might have to look at life cover outside super."
© 2003 The Age