2020 Guide to Income Protection
by Simon Marzell
The Need for Financial Protection
No-one knows what tomorrow will bring and clients need to be prepared for life’s uncertainties, especially those which will have a financial implication on their and their family’s lives. Advisers should be keen to guide their clients towards ensuring personal financial protection.
This provides family financial protection if the insured were to die, either within a specific time period or during their entire life. For many, a main consideration will be protecting a mortgage. But whatever need is identified, if the insured were to die (and the claim on the policy is valid) a tax-free lump sum will be paid as per the insured instructions. If it is used to pay off a debt it will ease that ongoing financial burden.
However, many will have more financial commitments than just a mortgage. Think about credit cards, loans, school fees and other regular payments a client may have. These will still remain for the family or others to manage and service when someone dies.
Life cover can be arranged in a number of flexible ways, such as:-
- Whole of Life
- Level Term
- Decreasing Term
- Family Income
The plans themselves can be written in a number of ways, such as single or joint life, first or second death, or escalating cover. Writing the policy into Trust will be a key consideration for the adviser – see later in this Guidance for further information.
Due to the options available, it means that for many, protection can be arranged in a competitively priced way whilst ensuring it meets a client’s ongoing needs.
Critical Illness Cover (CIC)
Critical Illness Cover pays a tax-free lump sum to the insured, as long as the illness meets the qualifying criteria, is on the pre-defined list of illnesses, and survives a minimum period.
Becoming seriously ill will always have financial implications on a family, often causing a loss of income, requiring lifestyle changes or even having to make necessary home improvements.
Alternatively, a lump sum can help to pay household bills and so rather than worrying about how these bills are going to be paid, the insured can focus on the most important thing – getting better.
The Association of British Insurers (ABI) has produced a set of standard definitions for a number of the core conditions covered by these plans to ensure consistency and aid client understanding. These include cancer, stroke, heart attack and multiple sclerosis.
However, anyone considering critical illness cover should be aware that not all conditions are covered and policies can vary widely in terms of when payments will be made. With this in mind, the cheapest premiums are unlikely to be attached to the most comprehensive cover.
Similar to Life policies, CIC plans can be written in a number of ways, such as single or joint life, first or second event, or escalating cover.
CIC is more expensive than Life Cover, but it is a protection plan from which the insured could benefit from themselves, helping them to withstand some financial pressures during difficult times.
It is worth noting that once a claim has been paid, the policy may often cease, creating the need for new protection cover to be arranged.
Anyone who is working should consider how they would manage financially if they were unable to work due to redundancy, illness or injury. Arranging a protection plan can provide a monthly income to help with paying the household bills.
Different types of plans are available, including:-
Income Protection (IP)
Pays a regular income for no maximum term, up until retirement. Some policies are written on an age banding basis. The most comprehensive plan for protecting income.
Accident, Sickness & Unemployment (ASU)
Pays a regular income for a defined period of time, usually 12 or 24 months, after which income will stop. Annually renewable. Lower monthly premiums than IP whilst still providing income cover.
Personal Accident & Sickness (PAS)
Similar to ASU, but without unemployment benefit, making it appropriate for the self-employed. Annually renewable. Suitable for providing income cover at a competitive price.
All types are limited to a percentage of earnings, which will need to be verified upon claim. This ensures a person is financially incentivised to return to work once they are better.
When arranging any type of income cover plan, it must fit in with any other personal or employment cover already in place. Plans can have various deferment periods before the income payment starts, which can range from immediate to 12 months or more. It can also be arranged on a stepped benefit, with it gradually increasing as other protection decreases.
Full analysis of income and expenditure, as well as what would happen if the insured is off work, is needed to ensure a suitable level of cover is in place.
Private Medical Insurance (PMI) and Health Cash Plans
PMI covers the cost of private medical treatment for ‘acute’ conditions – diseases, illnesses or injuries likely to respond quickly to treatment.
There are lots of different plans to choose from, ranging from basic policies which simply cover essential treatments to more comprehensive policies which could include specialist therapies and complementary medicines such as acupuncture or chiropody.
Typically, a patient with PMI would be able to choose the location of where treatment is provided, which can be helpful if family members live elsewhere and convalescence with them is needed.
Cover typically includes:-
- The cost of hospital admission
- Diagnostic tests, such as MRI and CT scans
- The costs of seeing a consultant
- Hospital accommodation and nursing care
- Cancer drugs - some policies will include drugs that are not available on the NHS
Cover may also include (or available as additional options):-
- Outpatient consultations
- Mental health treatment options
- Complementary therapies
- Physiotherapy and chiropody
Typically excluded are trips to A&E, injuries from dangerous hobbies and certain treatments as shown in the insurer’s policy document.
A Health Cash Plan can help to cover the cost of everyday healthcare, such as visits to the dentist, opticians or physiotherapy, by reimbursing some or all of the cost of routine and or unforeseen healthcare costs. Cash Plans are available for a monthly premium and are an affordable, simple and accessible way of helping to manage the cost of everyday healthcare.
Identifying Protection Needs
The four main factors which influence what an individual’s protection needs are:-
A young person may have few financial responsibilities and be living at home with their parents, limiting the necessity for financial protection. However, as a person relies more upon their income, purchases a house, gets married, has children, or experiences many of the key life events, the need for protection increases and considering the financial implications of these is important.
An individual may have children or adult dependents who rely on them financially. An assessment of how long this dependability lasts for or the flexibility of changing circumstances is vital as the financial impact on others is heightened.
#3 Income & Expenditure
The objective is to determine the amount of income needed if an individual becomes ill or dies. Establishing the current household income and what will continue in the event of illness or death is critical, along with what the continuing household expenditure will be. Any gaps need to be insured against.
#4 Financial Liabilities
Along with mortgages, all capital debts need to be considered, such as loans and credit cards. Prioritisation of what should be repaid first may need to be made if there are pressures on the budget.
Other factors may apply and every person must be considered on an individual basis.
Consideration for Protection Plans
What should advisers be considering as they arrange protection for their client? The following 5 areas are fundamental in the advice process.
#1 What is the client needing to protect?
#2 How much protection is needed?
- Is it demonstrable
- Employer benefits
- State benefits
#3 For how long is the protection needed?
- Period of dependency
- Mortgage term
#4 Who is to benefit from the policy?
- Spouse or Partner
#5 Where is the money to be paid?
- Direct to client
- Another individual
- To Trust
How to Choose the Insurer
There are many insurers all vying for protection business, some offering eye-catching rates. So what should you consider in selecting the insurer?
This is by far the main consideration in determining which insurer to select. However, care is needed as there are often reasons for why one plan is cheaper than another.
- What illnesses are covered?
- What are the policy exclusions?
- Underwriting requirements
- Policy excesses
- Occupation definitions
- Any other specific product features
Some may have an emotional connection for (or against) a particular insurer and be willing to pay a premium for this.
Quality of service
This is an important consideration, especially for advisers.
- How easy is it to speak to the insurer?
- Is the administration burdensome?
- What are the insurer’s claims statistics?
- If the setting up of the policy is difficult, how will the client be treated if they need to claim on the policy?
Many insurers are on the market, both new and institutional. Many people prefer to select an insurer they have heard of before. However, for those on a tight monthly budget, this may be a luxury rather than a need.
Depending on the type of policy arranged, it may be in place for a very long time, potentially even decades. The insured must be confident that if a claim needs to be made well into the future, that the insurer is still in existence and be able to meet their claim.
Why Use a Trust
There are 3 main reasons why Trusts may be advantageous to clients.
#1 Getting access to the plan proceeds when they’re needed most
If a life assurance plan is held in Trust, when a claim is made the amount insured will be paid to the Trust and will not be included as part of the insured’s estate. This can save a huge amount of time as settling the estate can take many months to complete. The funds can then be used by the beneficiaries much quicker.
#2 Nominating beneficiaries on death
Clients can ensure the correct beneficiaries receive the proceeds from their protection plan in one of two ways.
Firstly, they can state in their Will who they wish to benefit. However, choosing this route doesn’t avoid probate and a Will may be contested.
An alternative is to write the plan in Trust where the insured can nominate who they wish to benefit and in what proportion. The plan benefits may also be protected from creditors or anyone with a claim on the estate. In this way, clients can ensure that the people they want to receive the benefits actually do.
#3 Tax planning
Trusts can also be used for inheritance tax (IHT) planning purposes.
IHT is payable at a rate of 40% on estates over the standard nil rate band of £325,000 (2019/20) although this excludes any amounts left to a UK domiciled spouse or civil partner.
Married couples or civil partners can combine their IHT thresholds when the second person dies if the first person to die didn’t take full advantage of their own threshold, for example, if the estate was left to their surviving spouse. Any chargeable transfers made in the seven years prior to death must be added to the value of the estate.
The payment from any protection plan not held in Trust must also be added. To avoid a possible charge to IHT, the plan may be written in Trust.
Insight Private Finance Ltd always recommends that individuals take personal legal advice prior to establish both a Will and a Trust to ensure it is suitable for them and meets their requirements.
Parties to a Trust
Three groups of people are involved in a Trust.
The person or people who establishes the Trust, sets up the Trust Deed, and puts their policy into it. The Settlor also chooses who the Trustees and Beneficiaries are to be. Anyone who is aged over 18 and mentally capable can be a settlor.
The people responsible for looking after a policy once it is put into Trust and become the legal owners of it. They must be at least 18 years old and of sound mind. Settlors are often also Trustees, although this is not a legal requirement. It would usually be good practice to appoint additional Trustees in addition to the Settlors.
Trustees should have good financial knowledge and be someone whom the Settlor can trust. It may not be a good idea for a Beneficiary to be a Trustee as this could lead to a conflict of interests, particularly on Discretionary Trusts where the Trustees have the power to determine for themselves who benefits from the Trust.
The people who the Settlor wishes to get the money from the Trust.
In this way, the Trust holds the policy, the Trustees look after it, until it is paid to the Beneficiaries.
Types of Trust
There are lots of different Trusts available, with most of them being called differently depending on the provider selected. The most commonly used Trusts and their features are discussed below.
- When setting up the Trust, the Settlor must name the Beneficiaries of the Trust
- They also need to decide how the proceeds of the plan will be split between the Beneficiaries
- Once a Beneficiary is 18, they are legally entitled to own the contents of the Trust. This means they can force the Trustees to transfer the ownership of the Trust contents (for example the pay out from a life policy) to them, if they want to
- Once the Beneficiaries are chosen, and how much each will receive from the proceeds of a policy, they can’t be changed later on. In other words the decisions made when setting up the Trust are fixed
- Once a plan is in a Bare Trust, the Settlor can’t benefit from it. This means such a Trust wouldn’t be suitable for a plan which could pay a benefit while the Settlor is still alive, such as a life plan which includes critical illness