To guide and protect
Unprecedented? Radical? Life changing?
The outbreak of COVID-19 has impacted the lives of every person on the planet. News flows incessantly focused on the large global picture, comparing how economies are performing and different countries are coping with the outbreak, but often this is of peripheral relevance to us as individuals.
Following us going into lockdown, a meeting was called by my better half at the kitchen table. What happens if one of us is incapacitated? What if one of us doesn’t make it? How do we cope? What about our parents? Are our jobs secure? Personally, it challenged my sense of invincibility.
From conversations with clients I know we were not alone. In October, discussions centred on tax efficiency, investment return and meeting retirement goals. These are still important but people I have been working with for years and who had dismissed the protection element, wanted this at the top of the agenda.
As we emerge from the last quarter to a new normal of uncertainty there is still risk and concern. While preparing for the worst can be grim, we all have to do it. I have been to enough briefings to understand all IFA members must have a substitute in place.
So, what is the value of protection? It is peace of mind.
The hard facts
So, where are we at the moment:
- 70 per cent of the UK population does not have a valid will in place (https://wills.org.uk/national-will-statistics/ June 2019)
- Only 50 per cent of households with mortgages currently have life insurance (FT Adviser, May 2020)
- In 2019, 3 per cent of all individual claims were paid out (Association of British Insurers, May 2020)
Back to basics
Draw up a will. This is the ultimate guide of where your estate will be distributed. If you have a will, is it up to date? An individual’s life can change so quickly that what was written five years ago may no longer be relevant.
There are some common misconceptions. Doesn’t everything go to my spouse upon death anyway? If it is not clearly laid out in a valid will then no, and your estate will revert to the laws of intestacy, which is directed by the government and may not follow your wishes.
An example – A client, married with two children, has amassed wealth of £1 million in their home and assets but has died without a will in place.
Only £270,000 of the assets goes to their spouse directly. The remainder is split 50 per cent to the spouse and 50 per cent to the children.
What is the implication of this?
- Whilst assets left to the surviving spouse may be free from IHT, there may be IHT charges of up to 40 per cent to consider for any value passed directly to the children in excess of the nil rate band; and
- The children may now have ownership of the main residence, an interest in a business or a sum of cash that may be necessary to support the bereaved spouse.
In the right circumstances this may be what the client wants, but the last few months demonstrate that anything in life can change, and fast.
The intestacy rules are different for Scotland and Northern Ireland to England and Wales and therefore expert, local advice is essential.
Whom do we protect and why?
Protection is for an individual or circumstances that occur to an individual. It can provide a sum to compensate for a critical or debilitating illness or provide funds to meet liabilities upon death.
There is no right amount of protection as every individual has different circumstances. Yet there is often a disconnect and misunderstanding of how essential an individual is to their business, family and the livelihood of others all at the same time.
This can lead to a difficult calculation of cost versus benefit, but the ultimate benefit of protecting families and businesses often outweighs the monthly funding of premiums.
Protecting the business
For clients with their own businesses, employees, debt and assets, clarity on these is essential. Transition arrangements, should a director of a business die, can be laid out via the Will and shareholder agreements. This creates an insurable risk that can be protected.
Example: A two director firm with 50:50 ownership valued at circa £3 million. One of the directors passes away and via the will passes ownership for their share of the business to a surviving spouse. The spouse has little knowledge of the business and industry but is now a significant shareholder.
The risk is twofold. For the director’s family they are bereaved and need funds in order to support a now single earning household. The surviving director has double the workload and a business partner who can’t help but still needs an income stream in the form of dividends.
By putting in place a shareholder agreement and business protection insurance written into trust, to the value of £1.5 million on each director, the company can receive the necessary funds to buy the shareholding from the spouse upon death.
The level of cover needs to be reviewed regularly as the value of the company may change.
The company is now able to move forward under sole ownership without having to pay out dividends, and the surviving family has a significant cash sum that can take care of the household now and in the future.
Not just for the mortgage
Many people use life assurance to protect the value of their mortgage and this provides fantastic security. To keep costs low the level of cover reduces as the mortgage is paid off: called a ‘decreasing term’. Yet this may not be enough.
In a single income household, is there enough cash or assets to provide an income should the worst happen to the bread winner? In a case like this considering a cover that provides ongoing tax-efficient cover, such as family income benefit, comes into its own.
Taking care of staff
Many businesses have a staff base that they have put many years into cultivating and developing.
A group life plan, or death in service benefit, and income protection for staff provide a cost efficient solution. This is often set up to allow a member of staff to receive a multiple of salary as life assurance, or an ongoing level of income, should they be taken ill long term.
In some companies it could be that one member of staff is indispensable. Key person insurance can protect the business should that member of staff be lost, providing a cash sum to hire a replacement or to cover lost revenue and potential profits.
In cases where cash flow is tight for a company, it could be that these costs are a step too far, but would losing staff cost the company more in the long term?
The cat, the car and the carpet…
I would like to leave a final thought with you.
You are driving down the road in your car, and to your right a person walks out of the house with a carpet. They start beating it and the noise and cloud of dust causes the cat sat on the wall nearby to get spooked. The cat runs across the road causing you in the car to swerve and hit a tree.
The cat is insured, the car is insured, even the carpet is covered under home and contents, so why aren’t you?
Andrew Goulter, wealth management consultant from Mattioli Woods plc