Everyone needs a financial Safety Net. The thought of spending a sizeable chunk of your income on things you can’t enjoy right now might make you wince, but think about what you’re protecting yourself against. Should the worst happen – ill health, death or redundancy – it won’t mean financial Armageddon for you and your family. Instead it will mean knowing that the mortgage will still be paid and you and your family will be able to maintain the standard of living you’re used to whatever happens. And for this a robust but manageable Safety Net plan is what’s needed – no ifs or buts.
I’m Young, Free and Single. Do I Really Need Insurance?
Unless you have lots of money in the bank and other assets to fall back on, the answer is YES. If you are self-employed, you need an income protection plan. This is an insurance policy that will pay out a tax-free income for as long as you’re unable to work. If you are employed, find out the terms of your company sick pay and whether they provide you with an income protection plan. If not you will need to arrange your own cover, ensuring it’s compatible with your work sick pay (eg. if your employer will pay you for 6 months while off sick, you need the plan to start at 26 weeks).
Next you need to consider critical illness cover. This is insurance that will pay out a tax- free lump sum (ie. £100,000) on diagnosis of a critical illness such as cancer or heart attack. A critical illness can be financially devastating at any age, so a large lump sum really will give you options and freedom not to rush back to work.
If you have a mortgage or other debts, you need to cover this with a critical illness plan to ensure your mortgage repayments continue to be made. If you can’t afford to cover your full mortgage, cover as much as you can.
What Are The Main Types Of Insurance I Should Consider?
If you have a family, the first thing you need is life cover to ensure your family would be provided for in the advent of your death. The amount needed follows this formula:
Income Need + Lump Sum – Work Cover.
First work out your lump sum need by adding together the total of all your debts minus mortgage/loans/credit cards etc.
Your income need is your monthly outgoings minus what your family spends each month. From this figure take off the cost of your mortgage, as this will be paid on death.
You then need to do a little sum:
Monthly outgoings x 12 x 20
The total is the amount of life cover you need, so have this information to hand when you arrange your life cover policy.
- If you have a partner/spouse who would continue to work after your death you can take their monthly take-home pay off the monthly outgoings. However you may need to allow for an increase in childcare costs (especially if your partner/spouse continues to work).
- Include tax in your calculations to make sure the figure is accurate
- When you apply for cover to support your income need, don’t forget to get the plan to increase with inflation (RPI) to ensure that a payout down the line still has the same buying power. Next you need to take off the cover you already have from work. The final figure is the amount you should apply for.
Critical Illness Cover
This is cover that will pay out a lump sum if you are diagnosed with a critical illness eg. stroke, heart attack or cancer. This is more expensive than life cover, because it is more likely to pay out. Choose a death or earlier critical illness plan. This would also pay out on death. Usually clients will opt to cover some or their entire mortgage. Whatever you decide to do, you can deduct this from the amount of life cover you need if you do take out a death or earlier critical illness policy.
This is insurance that pays you a monthly tax-free amount if you are unable to work due to illness or injury. Before you buy this insurance, you need to work out:
- A) How much you need as a minimum each month to get by.
- B) How long your employer will continue paying your salary if you are sick.
- C) Whether you have this type of cover already through work.
In the latter case it is likely that there is no need for further cover, unless you are really dependent upon your bonuses. This is because it is usually only your basic pay that is covered. When designing your plan you need the cover to last until you retire, and then need to decide the term of deferred pension you want – the choice is usually 4 weeks, 13 weeks, 26 weeks or 52 weeks. This is the length of time you need to be ill before the policy will pay out. The longer the term the cheaper the cost will be. Your choice of deferred period depends on your company sick pay and also the amount of savings you have – ideally 10 months’ worth of outgoings saved in cash.
Private Medical Insurance
This is a way of giving yourself a choice whether you take medical treatment privately or via the NHS. In my experience it can be invaluable for getting a second opinion.
While perhaps a good idea if you’re worried about being made redundant, due to an increase in payouts over the last few years policies are more expensive, and some more ‘At Risk’ jobs will not be offered cover.
How Much Should I Spend on my Safety Net?
Obviously what you spend will depend on what you need and what you can afford. As a general rule of thumb you should spend about 5% of your monthly take-home pay on your Safety Net.