This is the question you are probably asking yourself if you have recently made some big life changes, like buying a home or starting a family. Some refer to these things as ‘adulting’. We’re often taught that when take on large amounts of debt to buy a home, we need to get life insurance to protect our family. But what does that actually mean, and how much cover do you need?
I like to think of Life insurance as the foundations of any wealth plan, and liken it to laying a slab before you build a house. Now, I’m pretty useless with my hands and certainly am no builder, but I know that pouring a slab is crucial to set solid foundations to build on.
When you set a slab, you want to ensure you that you have just enough or a little bit more than you need. What you don’t want, is to have the house overhanging the slab. This will no doubt cause structural faults in time and the house will start to lean, crack and fall apart.
At the same time, you probably don’t want to go overboard pouring concrete and have a slab that is way too big. Yes, more is better but you’ve probably overspent on concrete!
So you’re probably asking, how do I know how big my slab has to be?
Well, there is no one answer and everyone will be different. I will step you through the way we calculate cover at P3, and what each cover means and why you need it.
Income Protection
Income Protection is largely misunderstood and most Australians are underinsured in this area. Income protection pays you a monthly benefit, up to 75% of your pre-injury/sickness income. Unlike Life & total and Permanent disability insurances, IP will pay you while you recover and get back to work. This is why IP is such an important part of the slab.
You can have an excellent wealth plan – you own your home, multiple investment properties and you’ve built a nice share portfolio… But what happens if you can’t work and earn income? The wealth plan starts to crack and break, as you have to unwind your investments because you can’t afford the mortgage payments and need additional money to live on! The structural foundations of your house (wealth plan) starts to fall apart because the slab isn’t big enough.
Life Cover
In order to understand these types of cover and get a grasp on how much you need, you really need to get into the mindset of “what am I leaving to my spouse or kids if I die”. Not nice to think about, I know. But it must be done.
If you don’t have enough life insurance, it probably means you’re leaving your family with a lot of debt and some pretty sticky situations to deal with. If the family home isn’t paid off, it will have to be sold to pay down debt.
The first point of call then is obvious;
- Pay down any debts.
Life cover is paid out as a lump sum upon the death of the life insured. We usually say as a bare minimum, cover the debt of the family home so that if you were to die, your family can remain living there and not have to worry about repaying the loan.
It is important to then add on any credit card debt and personal loans.
Other things to consider are;
- Add in replacement Income (optional)
Again, put yourself in the shoes of your spouse and children. If you are the main breadwinner, is your family going to be left without income for a period of time?
There’s a couple of ways you can do this. Would you like to leave a lump sum so your partner can pay the bills until they’re 60, at which point they can access their super? Or would you like to cover them for 5 years to give them some room to get on their feet?
It will all come down to cost at the end of the day, and what is reasonable.
- Add in Funeral costs
This one is fairly simple, and in order to cover the cost of a funeral we usually add on $10-$15k. This is a popular one to do, as most people don’t want their spouse or parents thinking about how they’re going to fund the funeral when they die.
- Add lump sum for Children’s education
Another popular one is covering the costs of high-school education for your children. Private school fees are becoming more and more expensive, in Brisbane fees for a single year can range anywhere from $5,000 – $27,000. Covering 5 years of high school costs can give you peace of mind that your children have a good education, and your surviving spouse doesn’t have to work 3 jobs to afford it!
- Add lump sum for Children’s education
Another popular one is covering the costs of high-school education for your children. Private school fees are becoming more and more expensive, in Brisbane fees for a single year can range anywhere from $5,000 – $27,000. Covering 5 years of high school costs can give you peace of mind that your children have a good education, and your surviving spouse doesn’t have to work 3 jobs to afford it!
TPD Cover
Total and Permanent Disability (TPD) cover is also a lump sum payout, which is paid if you are permanently disabled or unfit for usual employment, or any other employment for which you are qualified based on your education, training and experience.
Much the same as Life cover, we will often cover for the same things. You’re still alive, but you will probably never work again. Therefore, it’s important to cover debts, add replacement income, children’s education costs and some emergency medical costs of $10-15k.
I’ve often heard of people adding in a benefit amount to ensure you can fit out the home however you need to, with wheelchair access, handles around the house etc.
Trauma Cover
Trauma cover or ‘Critical Illness’ is another area where most Australians are underinsured. The reason for this, is that it can’t be held by your Super fund. Therefore, most people would not have it in their default super fund.
Trauma cover pays a lump sum amount if you suffer a critical illness or serious injury. Typical Trauma claims are for things like cancer, heart condition or stroke. Unlike TPD, you can usually return to work after a Trauma event.
Some people like to ensure they have enough Trauma cover to pay off their debts, and pay for out of pocket medical expenses. The problem that arises from this, is affordability. Trauma is the most expensive cover, because it is most often claimed on.
If affordability is a priority, we suggest covering a minimum of $100k-$150k based on an average out of pocket costs of a heart attack or cancer.
Needs Analysis
The most important step from here is doing an insurance needs analysis on yourself. Just like you would do if you’ve bought a new block and are surveying how large the slab needs to be for you home.
Below is a real-life example of a client we have worked with recently. This particular client has kids going through high-school, and both have around 8 years to retirement. They opted to replace income for 8 years, rather than having a lump sum for education costs – and for them this kills two birds with one stone.
Life Cover
| Client 1 | Client 2 | |
| Debt | ||
| Mortgage | $705,000 | $705,000 |
| Instalment Gearing Loans | $50,000 | $50,000 |
| Funeral Costs | $10,000 | $10,000 |
| Income Replacement capital – Lump Sum | $375,000* | $1,184,000* |
| Total Cover Required | $1,140,000 | $1,949,000 |
| Less: | ||
| Current Insurance in Place | $1,691,497 | $0 |
| Insurance (Shortfall)/Surplus | $561,497 | ($1,939,000) |
*This income replacement figure is based on take home pay (excluding tax) for 8 years, which gets them to age 60 where they are able to access super.
TPD Cover
| Client 1 | Client 2 | |
| Debt | ||
| Mortgage | $705,000 | $705,000 |
| Instalment Gearing Loans | $50,000 | $50,000 |
| Misc. Medical Costs | $10,000 | $10,000 |
| Income Replacement capital – Lump Sum | $375,000* | $1,184,000* |
| Total Cover Required | $1,140,000 | $1,949,000 |
| Less: | ||
| Current Insurance in Place | $1,691,497 | $0 |
| Insurance (Shortfall)/Surplus | $551,497 | ($1,949,000) |
*This income replacement figure is based on take home pay (excluding tax) for 8 years, which gets them to age 60 where they are able to access super.
To analyse this a little bit, we can actually see that Client one is $551,497 over insured and could therefore choose to reduce their cover and save on costs there. Client two on the other hand is not insured at all, and needs to apply for the full cover amount.
Trauma Cover
| Client 1 | Client 2 | |
| Debt | ||
| Medical Costs | $150,000 | $150,000 |
| Total Cover Required | $150,000 | $150,000 |
| Current Insurance in Place | $0.00 | $0.00 |
| Insurance (Shortfall)/Surplus | ($150,000) | ($150,000) |
For Trauma cover, they have opted to cover out of pocket medical costs only to reduce premium costs. They don’t currently have any Trauma cover, so they will apply for full amounts there.
Income Protection
| Client 1 | Client 2 | |
| Amount required (75% of $SALARY): | $56,250 per annum (30 day wait to age 65) | $150,000 per annum (30 day wait, to age 65 – Indemnity value) |
| You currently have: | Nil | Nil |
| Insurance (Shortfall)/Surplus | ($56,250 per annum (30 day wait to age 65)) | ($150,000 per annum (30 day wait, to age 65)) |
Income protection needs analysis also comes down to decisions on costs and some lifestyle decisions as well. For instance, client 1 is earning $75,000 per year and the couple feels that that could make do without her income if she couldn’t work. On the other hand, Client 2 has an income of $200,000 per year and they feel it is crucial to cover this in the event he can’t work. He currently does not have any income protection, and so will have to apply for full amounts.
To summarise, finding your required level of cover is all about taking a step back and making sure that you can continue your current lifestyle in the event that something goes wrong. It’s important to look at your goals and your own wealth plan, and customise your cover around that. If you would like any assistance running your own Needs analysis, or would like some help with pricing and quotes, please reach out. The team at P3 are happy to assist.
