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What is life insurance and why you need it?

The best way to understand life insurance, and how important it is, is to imagine what would happen to your family and their finances in the event that you or your partner were to die unexpectedly or become disabled and unable to work.

Think about all of the financial commitments you have in your life. Like many of our clients, there a probably a few large expenses that spring to your mind! Mortgage repayments, car or personal loan repayments, credit card debts. And then there are your dependents. You might have your children’s care and education costs to consider or your parent’s aged-care living expenses. And on top of that, you probably have a few long-term financial goals, like a retirement fund you and your partner are saving towards.

If you were suddenly out of the picture what would happen to all of these financial commitments and goals?

Who would be able to pay all of your debts?

What would your family have to sacrifice?

Although it’s not a scenario that many of us like to think about (and for good reason) being adequately prepared for the worst can save your family from years of financial hardship in the long run. That’s why life insurance is something that everyone should think seriously about.

This article is designed to explain everything you need to know about life insurance.

Specifically, we’ll discuss:

The different types of life insurance available
How to work out how much cover you need
What to consider when applying for life insurance and
How life insurance premiums work

So what is life insurance?

Life insurance is an umbrella term that’s used to describe a range of products that can provide financial support and cover for your family in the instance of your death, disability, serious illness or injury. The amount of cover and the nature of this financial assistance can vary greatly depending on the type and level of insurance cover you have.

Many people take out life insurance to provide security for large expenses such as their mortgage repayments, but life insurance can also be used to protect your family’s quality of life by covering smaller, ongoing expenses such as bills, general living costs and even costs associated with your death that your family may incur, such as the cost of the funeral.

Life insurance can also be used to ensure that your family will continue to receive adequate income in the event that you are seriously injured or ill and are unable to continue to work.

Types of cover

There are several different types of life insurance available, and it’s important to understand what each offers. Often these different products are packaged together, so you should always check what is included in your life insurance when applying.

  • Life cover
    There are several different types of life insurance available, and it’s important to understand what each offers. Often these different products are packaged together, so you should always check what is included in your life insurance when applying.
  • Total and Permanent Disability (TPD) Insurance
    TPD insurance is very often paired with life cover, but instead of covering you in the event of death, it offers cover in case you are seriously and permanently disabled and no longer able to continue to work and support your family. Different insurers have different definitions of what constitutes a ‘total and permanent disability’ so it’s important that you read and understand the terms and conditions that your insurance provider offers.Generally, there are two different options. For some products, TPD insurance can only be claimed if you can no longer work at all in any occupation. For other products, TPD is claimable if you can no longer work in the specific occupation that you did previously. This will be established when you take out your insurance.
  • Income protection
    Income protection (or salary continuance) is a way of ensuring that you and your family will be financially covered in the event that you are seriously ill or injured and unable to work for any period of time. Like TPD cover, insurance providers have different definitions of what is considered a disability to work, so you need to check carefully what they will and will not cover.Unlike TPD insurance, however, income protection can be claimed even if you are only unable to work for a limited period (such as 6 months or a year), and you do not need to be permanently unable to work to claim. Income protection is a way to ensure that you continue to receive ongoing income to cover your ongoing expenses, even if you are not working. For this reason, income protection is highly recommended for small business owners, and self-employed people, but it is useful for anyone who relies on an income.
  • Trauma cover
    Trauma cover (sometimes called ‘critical illness’ cover) is used to cover you in case you develop a specific illness or condition (such as a stroke, or cancer). In the event that you do develop this illness or condition, you will likely find it difficult or impossible to keep working. Trauma insurance will pay a set amount to help you and your family through this time.

How much cover do you need?

Working out how much life insurance cover you need is a complicated task, and it requires a lot of research, and personal consideration to determine the best options for your circumstances.

As a very simple equation, you need to try to answer the following two questions:

How much money would my family have access to if I were out of the picture?
How much money would they need?

The gap between these two amounts is a good approximation of how much life insurance cover you would ideally need. But you also need to think about what you can afford.

Working out the answers to both of these questions is not easy, though, and you need to consider many other factors to have an accurate idea of your financial position.

  • What you should consider
    You need to think realistically about your family’s financial situation, and how it would change if you were suddenly out of the picture.

    How much money do I currently have in savings? (Include superannuation, shares and any investments).

    How much cash would my family need to continue living at the same quality of life? (think about mortgage repayments, childcare costs, your other bills)

    How much income would continue to come into my family without my contribution?

    What additional expenses could arise as a result of my death or disability? (Think about funeral costs or the prospect of ongoing medical bills and palliative care.)

    Would other family members be able to help support your family financially?

    Do you have paid leave entitlements at work that would be paid out on your death?

    What other forms of financial support might be available to you or your family? Remember that you may be entitled to worker’s compensation or government payments if you become disabled or seriously injured. Accidental death insurance, which is a life insurance product may also be paid to your family if you die in an accident.Many insurance providers offer insurance cover calculators to help you work out how much cover you need. Or you can always discuss you options with one of our consultants who will talk you through the whole process.

  • Who needs to be covered?
    Another important thing to consider is who needs to be covered in your family. Although it may seem like only the main income earner needs to be protected, you need to carefully consider whether this is the case.Consider a situation like that of Mark and Sara. Mark works full-time and Sara works part-time while also looking after their 3 children for most of the week. Even though Mark is the main income earner, if something were to happen to Sara, Mark’s income alone would not be enough to cover their mortgage repayments, as well as the additional cost of full-time childcare. They decide they both need life insurance to protect their family.
  • Superannuation and life insurance
    Once you’ve worked out the appropriate level of life insurance you need, it’s worth taking a look at your current superannuation. Many super funds include life insurance, so it’s worth checking what you are already covered for.
  • Review your life insurance regularly
    For many people, the amount of life insurance they need will change a lot over their lifetime. If you take out a new mortgage or have children the amount of cover you need will increase quite a bit! Similarly, if you have just paid off your mortgage, or your dependents move out of the home, you might find you can reduce the amount of cover you need.It’s important that you have your life insurance cover assessed regularly so that your policy can be changed and updated to match your changing circumstances.

Applying for life insurance

Once you’ve decided on the type and level of life insurance you would like, you can apply for a product that meets your needs.

Applying for life insurance cover is a simple and straightforward process. However, it’s important to know that when applying for any life insurance product, you will need to provide the insurance provider with some personal information on your health and lifestyle. If you have a serious, or terminal pre-existing medical condition, you may not be able to apply for life insurance. Some insurance companies will need you to undertake a medical examination before you take out a policy.

Premiums

For any life insurance product, you’ll be paying premiums. Most insurance providers will allow you to pay your premiums monthly or annually so talk to one of our consultants to find out what will work best for you and your budget.

Usually, life insurance premiums will become more expensive the older you get. This is a matter of statistics, as insurance companies expect elderly people to be more likely to make a claim on their life insurance than young people.

Because of this, when applying for life insurance, you’ll often be given the choice of stepped or level premiums, so what is the difference?

  • Level premiums:
    Level premiums are set at a fixed rate that will not increase as you get older, although they may still increase with inflation and additional insurance provider’s fees. Level premiums will normally be more expensive than stepped premiums, at least when you first take out insurance, but because they do not increase with your age, it’s easier to plan for your future and control how much you’ll be spending later. Often level premiums will work out cheaper in the long run.
  • Stepped premiums:
    Stepped premiums will go up each year as you get older (like steps) but because of this, they will usually be cheaper than level premiums, at least in the beginning. If you are thinking of choosing this option, you need to think realistically about how long you are likely to be paying your premiums. You might save money for a little while, but if you’re stepped premiums end up much higher than a level premium it might have been wiser to have selected a level premium all along.

Conclusion

It’s easy to see why for many clients, life insurance is one of the most important aspects of financial planning. No one wants to imagine a situation where their family is left in debt or financial hardship. Life insurance offers peace of mind that if the worst were to happen, your family would not have to worry about money or their financial future. With the appropriate life insurance cover, your family will be financially secure no matter what.

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