Very few people enjoy thinking about the inevitability of death. Fewer yet take pleasure in the possibility of an accidental death. Yet a study conducted in 2016 by the Association for Savings and Investments South Africa included this terrifying statistic:
“The life insurance shortfall for income earners in South Africa aged 15–65 is R28-trillion.”
If you’re currently employed in South Africa, and have life insurance, there’s a good chance you’re among the underinsured. Although life insurance is a basic human need, not want, most people treat it with dissent. An irritating afterthought, a grudge purchase. Insurance though, is the one thing you don’t need, until you need it.
I’ll be the first to admit that buying life insurance doesn’t make sense for everyone. If you have no dependents and enough assets to cover your debts and the cost of dying (funeral, estate lawyer’s fees), then insurance is an unnecessary cost for you. If you do have dependents and you have enough assets to provide for them after your death (investments, trusts), then you do not need life insurance. Basically, if you’re wealthy and financially independent, you don’t need insurance. Since that is a marginal minority when discussing the South African population, this article is for the rest of us still in the rat race, otherwise known as the general public.
The thing is, while R1 million may sound like an impressive sum of money when you’re considering taking out life insurance, the question you should probably be asking is whether it will be enough to take care of your family’s needs over 20–30 years (it won’t). If there are people who depend on you and your income (especially if you are the primary provider), or have significant debts that outweigh your assets, you need life insurance. Life insurance – put simply – concerns liquidity. It is about providing cash for the unavoidable expenses associated with wrapping up an estate and replacing the net income a family stands to lose over the longer term. In this article, we’ll look at how to evaluate how much life insurance you need.
What factors do I need to consider?
When calculating your life cover requirements, you will need to take a few things into account: Your assets, your liabilities, estate costs, number of dependents and how much you want each dependent to receive (it is during this exercise that most parent tend to realise they have a favourite child). So, given these factors, how should you choose your life insurance? In my humble opinion, the starting point should be centred around loss of primary income.
One of the biggest factors for life insurance is for income replacement, covering the loss of income to your family because of your death. If you are the sole bread-winner, the amount of life-cover you choose should be enough to at least fulfil this requirement, ease your family’s immediate financial burden, cover essential future life expenses such as your children’s education and guard against inflation. To err on the safe side, assume that the lump sum pay-out of your policy is invested at 8%. If you do not trust your dependents to invest or use the lump-sum properly (or in accordance with your wishes), you can opt for the life insurance to be paid as a monthly income, as opposed to a once-off lump-sum, to your beneficiaries.
This is an option (monthly annuity) that is growing in popularity as by receiving a monthly payment rather than a lump sum, the dependants do not need to be burdened with the financial responsibility of investing and managing a lump sum. The dependants don’t have to consider the uncertainty of future interest rates, or inflation, whilst providing the peace of mind that the provision will not run out. Furthermore, such annuity benefits pay out tax-free. An annuity income removes the ambiguity of how a lump-sum will be invested, at what costs, by whom and if it’ll generate a sufficient income to serve its purpose. Important to note though is that the income payments are payable until the life insured would have turned a certain age, which is selected upfront, and not indefinitely. This age can be selected to be as low as 55 or as high as 90.
You must look at your own situation. Insurance cover is not static. Your changing personal circumstances, as well as external factors will impact the sufficiency of your cover. Revisit your life insurance needs analysis at least every two years, select an insurance policy that will afford you the flexibility to amend your cover as and when you need to. As with investing, educating yourself is essential to making the right choice.