If you are a member of your employer’s retirement fund, it is likely that you have group life cover in place. Many employees make the dangerous assumption that this cover is sufficient for their needs and adequately protects them in the event of death or disability. The reality, however, is that group life cover is very often insufficient for a person’s needs and should be considered as part of a broader personal financial plan.
As a case study, we have taken the situation of Sandra who is a 41-year old single mother of a son (age 12). She is employed by ABC (Pty) Ltd and earns an income of R80 000 per month. In terms of debt, she has a home loan of R2 000 000 towards which she pays R20 000 per month. She also owes R200 000 on her Audi.
As part of ABC (Pty) Ltd’s umbrella retirement fund, Sandra has group life cover equal to 2 x her annual salary i.e. R1 920 000 and has accumulated R750 000 as a retirement fund credit. She also has an income protection benefit which will pay out 75% of her current income should she become disabled. As the group life cover is provided as part of a tax-approved retirement fund, it is considered an approved benefit which means that the death benefit, together with her accumulated retirement savings within the fund, will be subject to tax. This means that on payout, should Sandra’s estate receive the full payout in cash, it would receive an after-tax death benefit of R1 956 300, which is calculated as follows:
Fund credit: R750 000
Life Insurance: R1 920 000
Total benefit: R2 670 000
Taxed on retirement table: R130 500 + (36% x R1 620 000) = R713 700 tax liability
Therefore: R2 670 000 – R713 700 = R1 956 300
Approved and unapproved death benefits
Sandra’s group life cover is provided under a tax-approved retirement fund and is referred to as approved cover. The policy is held by the retirement fund for Sandra’s benefit. Sandra’s contribution to her retirement fund is tax-deductible up to 27.5% of her income. However, in the event of her death, her death benefit would be subject to tax and it is important that her financial adviser takes this income account when determining her needs. Benefits from an approved retirement are exempt from estate duty. It is also important to note that approved benefits are subject to Section 37C of the Pension Fund Act. This means payments from the life insurance and retirement benefits will not necessarily be paid to the member’s nominated beneficiaries, nor paid in the proportions they have nominated. The trustees of the umbrella fund have a legal obligation to determine who was financially dependent on the deceased member. As such, the trustees have the ultimate say when allocating these funds to the deceased member’s dependants.
If the cover was provided by a separate group life policy which is separate from the retirement fund, it would be referred to as unapproved cover. Unapproved cover is held by the employer on the lives of its members and is not subject to Section 37C of the Pension Funds Act. In essence, contributions towards unapproved cover are not tax deductible and, as a result, the death benefit is tax-free. However, the lump sum benefit will be subject to estate duty. It is therefore essential to know whether your group life cover is approved or unapproved before calculating any potential shortfalls that exist in your risk cover portfolio.
Goals & Objectives
As a single mother, Sandra is worried that she may not have enough life and disability cover in place, so she seeks the advice of an independent financial adviser. Together, they list Sandra’s financial objectives in the event of death, disability or severe illness. These objectives are:
In the event of Sandra’s passing, she would like to ensure that there is sufficient liquidity in her estate to settle her home loan of R2 million, pay off her Audi (R200 000) and cover her Executor’s Fees which are R150 000. Whilst she has appointed a guardian for her son, she would like to be able to provide her son with an income of R20 000 per month increasing at a rate of 6% per year until he reaches age 23, for which she would need an amount of R2 million in today’s terms. Her advisor calculates that Sandra will therefore need total life cover of R4 350 000 in order to achieve these goals.
Total life cover need: R4 350 000
If Sandra was to become permanently disabled, she would like to be in a financial position to pay off her debt which is combined at R2 200 000. She would also like to make provision for a lump sum of R500 000 to make any lifestyle or structural modifications as a result of her disability.
Total lump sum disability need: R2 700 000
If disabled, she would also like to ensure that her current net (after-tax) income is protected and that this income keeps pace with inflation until her retirement age of 65.
Her company group benefit is calculated as 75% of her gross income, limited to her current net income, which would be calculated as R80 000 x 75% = R60 000, limited to R55 000 per month.
Income protection need: R55 000 per month
Lastly, if Sandra was to contract a dreaded disease, she would like cover of R250 000 to assist with medical costs and treatments.
Severe illness cover need: R250 000
Covering the shortfall
In line with her needs, Sandra puts personal insurance in place to cover the shortfalls on death, disability and dread disease. Together, her group cover and personal insurance address all her needs as follows:
|Provided by group cover||Provided by personal cover|
|Life Cover||R1 956 300 (incl. retirement credit)||R2 393 700|
|Lump Sum Disability||R0||R2 700 000|
|Income Protection Benefit||R55 000 per month||R0|
|Severe Illness Cover||R0||R250 000|
Life cover: As can be seen from the above case study, it is important to determine whether your group life cover is approved or unapproved because the tax consequences may affect the quantum of the final payout. In addition, do not assume that the death benefits will be paid as a lump sum, as they may be paid as a monthly annuity or a combination of both. Further, it is important to bear in mind that, while a member’s beneficiary nominations are taken into account by the trustees of the fund, it is the trustees who make the ultimate decision regarding distribution of the death benefits. It is therefore always advisable to seek professional financial planning advice.
Income protection: If you have group income protection benefits as well as an income protector in your personal capacity, bear in mind that it is unlikely that both policies will pay out if you are disabled. In most cases, your group and personal insurers will each agree to cover a portion of your total benefit. Therefore, it is advisable to check that you are not over-insured in respect of income protection, and that you are not paying for a benefit that will not pay out at claims stage. As a general rule, use your group income protection benefit as this is likely to be the most cost-effective cover. Thereafter, decide whether you need any additional cover. Note that there are a few insurers who do not amortise your insured benefit with other insurers, and you will therefore need to check the specific rules of each insurer.
Remember, the purpose of insurance is to protect yourself and your dependants from financial loss, and not to enrich yourself. Therefore, you should assess your needs and objectives at least annually and adjust your insurance cover accordingly to ensure you are not spending unnecessarily on insurance.
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