Sunday, May 6, 2007

How To Protect Your Family Finances With A Life Insurance Policy

How To Protect Your Family Finances With A Life Insurance Policy by Simon Christopher

A simple term life insurance policy is one of the most effective ways to protect your family and financial dependents against the premature death of the main breadwinner.

Like any insurance, price tends to drive the purchase of life cover before the quality of a policy and its ultimate suitability are considered. But focusing too much on the monthly cost is not always the best way to measure good value cover.

A good example of this is often found when buying term life insurance which provides a number of policy options including two types of premium, guaranteed or reviewable. Guaranteed premiums are, as the name suggests, fixed and guaranteed by the insurance company not to increase. Whereas, reviewable premiums are subject to regular reviews, usually every five years and can be increased at the insurer’s discretion. Yes, guaranteed premiums are more expensive than reviewable rates but they should be seriously considered, especially if you intend to take out a policy for ten years or more. This is because the amount of each potential premium review increase is likely to rise the older you get.

In reality, a more accurate guide to the best value cover is to match the right policy to your need for protection. Another good example is the popularity of lump sum cover when applying for a life insurance policy for family protection. A lump sum plan is fine if you need to provide large sums to pay off debts such as a mortgage. True family protection is more about ensuring that an income is provided to replace that lost on the death of the main income earner. When a lump sum policy is used for family protection the potential problem is how to generate the required income from the lump sum. Where should it be invested for maximum return and will the income generated be subject to tax? Plus will it be sufficient to meet the financial needs of the surviving dependants?

In many cases, a more suitable solution is protection that’s designed to pay a regular income to the end of the required term. Also known as Family Income Benefit this cover has many advantages over it's lump sum alternative. One of it's major pluses is that it’s usually cheaper than a like for like lump sum policy as the risk to the insurance company decreases over the policy term. For example, a 20 year level term assurance plan for £100,000 will cost the insurance company £100,000 if a claim is paid at any time up until the end of the policy term.

Compare this to a Family Income Benefit policy providing an annual income benefit of £10,000 over the same 20 year term which could potentially cost the insurer £200,000 if a claim was made shortly after inception. In practice this is unlikely so the risk to the insurer decreases with each year the policy remains in force. If a claim was made at year 10 the insurer would have to pay the annual income for the next 10 years at a lower cost of £100,000.

Another feature of Family Income Benefit is that the annual income can be paid on an increasing or indexed basis if selected from inception. The effect of this option is that the real value of the cover is maintained and not eroded by inflation over time.

So overall, Family Income Benefit can be an almost perfect solution to protecting your dependents financially from the premature death of a vital family breadwinner. Not only is it often the cheapest form of family protection but also currently provides the annual income benefit totally free of tax.

To Summarise:-

•If you can afford it, choose guaranteed premiums

•Consider if an income benefit would be more suitable

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