Building wealth: Long-term insurance has a vital role to play

Life seldom happens in a straight line and, as investors, we should expect to face a number of curveballs along our wealth creation journeys. While many potential risks may be unforeseeable, there are mechanisms available to mitigate these risks – in whole or in part – with long-term insurance being most notable amongst them. In this article, we explore how long-term insurance cover can be used effectively to fortify your investment plan and protect your future retirement.

During the accumulation phase of your journey, your ability to generate an income over multiple decades forms the basis of wealth creation. Any interruption to your earnings will compromise your ability to save and invest for the long term and, as such, this risk should be protected. One of the most effective ways of mitigating this risk is by taking out disability cover either in the form of income protection benefits, lump sum disability cover, or a combination of the two, depending on your circumstances and objectives. When applying for any form of disability cover you will be required to undergo medical underwriting which may result in the exclusion of certain conditions or in the loading of your premiums. On this note, keep in mind that many disabling illnesses are a function of aging, and it is therefore likely to be in your best interests to apply for cover early on in your career.

Income protection cover, which is occupation-based insurance, is an effective way to protect your future earnings in the event of temporary or permanent disability. While this type of cover can be expensive, it serves an important role in replacing any income lost as a result of illness or disability and ensuring that your future living costs can be covered. Generally speaking, when taking out an income protection benefit, you will have the option of protecting between 75% and 100% of your income, depending on your needs up until your desired retirement age, but generally not past age 70. However, if your occupation is considered high risk, it may be difficult to obtain income protection cover, although there are a handful of specialised insurers who cater to this market.

While an income protector is an effective way to protect your future living costs in the event of illness or disability, keep in mind that loss of income will also affect your ability to fund for your retirement, and this scenario should be accounted for in your financial plan. Ideally, your financial advisor should prepare a disability scenario in your retirement plan that demonstrates the capital amount you would need in today’s terms in order to secure a financially comfortable retirement. This lump sum can be effectively provided for by a capital disability benefit which is designed to pay out a lump sum amount in the event of permanent disability. That said, when determining the appropriate level of lump sum disability, ensure that the underlying assumptions used in capitalising your retirement income needs are realistic for your circumstances. Specifically, assumptions regarding anticipated investment returns, inflation, and life expectancy need to be carefully considered and stress-tested. Determining your future income needs, particularly if you are relatively young, can be particularly tricky, but it is always advisable to err on the side of caution when agreeing on the underlying assumptions. Note that while your premiums towards your capital disability cover are not tax deductible, you will not be taxed on the payout.

Importantly, be sure to make full disclosure when applying for cover to ensure that the insurance company has no grounds to reject your claim at claims stage. Remember, even a seemingly innocuous non-disclosure that has no relation to the condition being claimed can result in your claim being rejected on the basis that you did not provide the insurer with all the necessary information required to adequately assess the risk that you presented to them at the underwriting stage.

In the event that you become permanently disabled and claim from your capital disability benefit, the proceeds of the policy would need to be appropriately invested to provide for your future retirement needs. If you’re disabled early on in your career, you will naturally have a longer investment horizon which may allow you to take a more aggressive investment approach that reduces in risk as you approach retirement. On the other hand, if you become disabled closer to your planned retirement age, you may need to take a more conservative investment approach with your capital. Either way, continually reviewing your disability cover is key to ensuring that the quantum and type of cover you have in place remains appropriate to the life stage you are in. Before you have accumulated wealth, it is likely you will need a sizable quantum of disability cover, whereas as your net wealth increases you may be able to trim back your lump sum cover as your ability to self-fund your future income increases.

Whereas disability insurance can be used to protect your future retirement, life cover can be effectively used to protect your spouse’s retirement in the event of your premature death. While you and your spouse are still building up your retirement nest egg, it may be appropriate to take out sufficient cover on your life to ensure that your spouse can enjoy a comfortable retirement in the event of your passing. If you make your spouse the beneficiary of the policy, the proceeds will be paid directly to him/her in the event of your death, although the value of the proceeds will be considered deemed property in your estate and therefore subject to estate duty. In terms of section 4(q) of the Estate Duty Act, the value of all property that accrues to your surviving spouse is deductible from the gross estate of the deceased, and this includes the proceeds of any domestic life policy where the surviving spouse is the named beneficiary. The proceeds of such a policy are paid directly to the surviving spouse and therefore do not attract estate duty nor executor’s fees. Note that the definition of ‘spouse’ in the context of section 4(q) includes a permanent life partner, and not only a legal spouse in terms of the Marriage Act or the Civil Union Act.

Far from being a fear-based purchase, long-term insurance should be considered a strategic tool to minimise risk while you’re creating your wealth. Keep in mind that as your net worth increases over time, you may be able to reduce your insurance cover appropriately and re-direct any saved premiums towards achieving other financial goals.

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