Only one financial topic is less sexy than taxes … and that’s death. It’s difficult to talk about and that may explain why 50% of Australians have at least $100,000 less life insurance than they need. Here’s the YMM guide to getting the right cover at the right price.
Most of the common misconceptions about life insurance date back to the 1960s and 1970s when policies were sold door-to-door by agents who promptly pocketed the money and disappeared leaving their ‘victims’ with less money and no life cover to show for it.
“It’s a rip off, too expensive and too difficult to understand” are three common opinions about life insurance. Modern term life policies, however, are affordable and easy to understand and they can offer peace of mind if the worst happens.
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Step 1: Decide whether or not you need life cover
According to the experts, the amount of life cover someone has seldom matches the cover they actually need. So how about you? Do you need life cover? To find the answer, first ask yourself the simple question ‘What do I want to happen in the event of my death?’, or ‘What financial situation do I want to leave my family with when I die?’.
Many people with families want to make sure they wouldn’t leave them in debt – saddled with a mortgage they couldn’t pay off, for example. Others want to leave a pool of capital to provide income to their dependents for a set period of time, or to pay for education or emergencies. Even people without dependents may want to leave money to a charity or close friend.
Step 2: Check your existing cover
If you decide to invest in life cover, the next step is to check your existing policies. Most super funds provide a minimum level of automatic life insurance to their members, so if you’re in a super fund chances are you already have some cover.
Call your super fund and check the terms and conditions of any life cover provided. When does the cover commence and cease? What exactly is covered and how much are you covered for? Are there any exclusions or limitations? What premiums are you paying? Gather this information in order to arrive at a decision about whether the cover within your super is adequate for your requirements or you need to purchase additional cover.
It’s also a good idea to check whether your employer makes any life cover available. Some employers provide life cover for staff as an employment benefit. If such a policy exists, gather the same information as you would for a super-based policy.
Step 3: Figure out how much cover you need
Now to figure out the amount of cover you’ll need. What lump sum will need to be paid out to cover your debts and support your family if you die? How much will it take to support your children until they are financially independent?
Consider other sources of financial support that would be available to your family if you died – superannuation, your current savings, other insurance policies, and any investments in shares, bonds, property and other assets that you might have. If the cash available from those sources would be adequate to maintain your dependents’ current lifestyle , you probably don’t need life insurance; if it wouldnt, consider taking out a life policy to cover the shortfall.
Of course, you’ll also need to take into account your current level of debt (mortgage, credit cards and loans) and predictable major expenses like school fees.
Step 4: Look at the fine print
Term life cover is not that difficult to understand. You pay premiums now and your beneficiaries receive a lump sum payout when you die. Policies don’t vary that widely, but it’s worth checking for hidden clauses and the finer points of detail.
Is it term life or an imposter? Make sure you buy a fully underwritten term life policy with a straightforward explanation of the circumstances under which a death benefit will be paid to your dependents.
Are there any exclusions? Under what circumstances (eg. suicide or within a waiting period) will the insurer refuse to pay the death benefit?
How long does the insurance last for? You usually have to pay extra to ensure the policy continues for your entire life or up to a certain age.
How are premiums calculated? They’re usually stepped, which means they increase as you get older.
Step 5: Decide how to buy and compare prices
If you’ve decided you want additional life cover you can usually add it to an existing super policy or buy it outside of your super either direct from an insurer or through a financial adviser.
Policies purchased direct or through a financial adviser can be 40% to 85% more expensive than getting the cover through your super fund.
Many experts advise that if your situation is complicated and you’re categorised as “high risk” due to health conditions or the nature of your occupation, it is worth seeking advice and opting for a fully featured policy through an adviser. This would be more expensive than other options.
Did you know?
Parents with average levels of life insurance as part of their superannuation have less than 20% of the cover they need
It costs a middle-income family about $537,000 to raise two children to the age of 21
Today more than 45% of young adults aged 20-24 years still live in the family home and their parents continue to bear the associated financial costs
Upcoming trend: ‘life settlement’
“Life settlement” is already established in the US and is starting to gain legs in Australia. Using life settlement, if you no longer want to continue your life insurance policy, you can sell it.
Normally if you discontinue your life cover, you surrender it to the insurance company. Life settlement, however, involves a third party buying the life policy off you once you reach a life stage, such as retirement, where you no longer have any dependents or debts and don’t wish to keep paying the premiums. In the event of your death, the third party collects the death benefit instead of your beneficiaries.
In the US, policyholders often sell their life cover when diagnosed with a terminal illness to get access to cash before they die. Australian term life policies usually have a terminal illness clause that allow you to get the death benefit as soon as you are diagnosed with a terminal illness (such as cancer) and found to have a short life expectancy.
Buying life insurance – top tips
Get quotes from different insurers and compare what they offer – don't be afraid to ask lots of questions
Write a list of the things you need and pick a policy that meets all your needs
Work out how much cover you need to avoid being underinsured – insurance company websites have tools to help you work this out
Be honest with the insurer – your 'duty of disclosure' means future claims may be denied if you leave details out
Check the costs – you’ll always pay a regular fee (the premium) for cover, but you may also need to pay an 'excess' on any claim
Check exclusions – always ask what is and isn't covered
Rule of thumb
Ten times your annual earnings is the standard rule of thumb used by the insurance industry to calculate how much life insurance you’ll need. So if you earn $70,000 gross a year, you’d need $700,000 of cover. Note, however, that this rule of thumb is very general, and that every person’s circumstances and needs are different.
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