There are three key products that will ensure you and your family are financially looked after if the unexpected does occur. These are income protection insurance, which provides an income if you’re unable to work as a result of an illness or injury; life insurance, which pays out if you die; and critical illness cover, which provides a lump sum if you are diagnosed with a serious illness such as cancer or heart disease.
Of the three, income protection should be your first consideration as Mike Gough, executive director of financial consultants Jelf Private Clients, explains: “Your income pays for everything so it makes sense to protect it. You’re more likely to be off work for six months or more as a result of illness than you are to die before you’re 65.”
The price of cover, which pays a maximum of two thirds of your gross salary tax–free, can be adjusted to fit your budget by increasing the waiting period or reducing the benefit. Income protection would cover you for stress and back pain – the two most common reasons people are off work.
Life insurance is an important consideration if you have any financial dependants. Ideally you’ll need enough to cover your debts plus sufficient to provide an income to support your family until your kids have left home or beyond. “Cover’s cheap,” says Gough, “especially if you buy it while you’re in your twenties or thirties”.
He also recommends going for guaranteed rates. “They can be more expensive to start with but you won’t get any surprises later on,” he explains.
Rather than paying a lump sum, you could take out cover that pays an income to the end of the term. This form of life insurance, known as family income benefit, can fit income requirements better than a lump sum and is also cheaper than the traditional product.
Critical illness cover
Paying a tax-free lump sum if you are diagnosed with a serious illness such as cancer, heart disease or a stroke, critical illness cover is often sold alongside life insurance. The average payout is £80,000, according to Aviva. To get the payout, policyholders will need to survive 28 days after diagnosis. “Premiums can be very expensive and, because more and more people are surviving these conditions, policies can be full of exclusions and policy rules,” says Gough.
However, while providers of critical illness have been criticised in the past for rejecting a large number of claims, the industry has recently tried to clean up its act and is now paying out 88% of claims.
If you don’t take out protection the state will step in, but it’s unlikely you’ll get the standard of living you would like. For example, get an illness that means you’re unable to work again and, once your employer’s sick pay is up, you’ll get employment and support allowance. This gives you a weekly benefit of £68.95 rising to £91.40 after a year. “It’s not much,” says Gough. “Taking out protection needn’t cost much and gives you the peace of mind your plans won’t be jeopardised if something unexpected does happen.”
Get an emergency fund
Don’t forget to put some savings aside for emergencies too. Anything from three months to one year’s salary in an easy access savings account or cash ISA will give you some financial breathing space. It can also help to reduce your income protection premium, as you’ll be able to increase the waiting period before any benefit is paid.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Income protection insurance
If you can’t work in the event of sickness or illness, income protection insurance aims to give you an income, with the amount of income set by you up to 75% of your gross (before tax) income with the premiums varying by how much of your salary you want to cover, as well as your age and health and when you want to start receive any payouts. Any payouts from income protection insurance are tax-free and usually continue until you recover, reach your selected pension age or the period of cover specified in the policy comes to an end. Income protection insurance does not cover redundancy but you can buy it as a bolt-on.