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, let’s consider Xolisa’s particular circumstances. Xolisa is a 43-year-old single mother to Anathi, aged 15. She is employed by True Products (Pty) Ltd and earns a gross income of R90 000 per month. Xolisa owns her primary residence and is currently servicing a bond of R3 000 000 towards which she pays an amount of R30 000 per month. She is also owes R250 000 on her VW Golf.
Xolisa is a member of True Products (Pty) Ltd’s umbrella retirement fund through which she enjoys group life cover equivalent to two times her annual income, which translates to R2 160 000. She has accumulated R1 000 000 in her retirement fund. In terms of disability cover, Xolisa has an income protection benefit which will pay out 75% of her current income in the event of disability. The group life cover is part of a tax-approved retirement fund which means that the death benefit together with the accumulated retirement savings will be subject to tax in the event of Xolisa’s death.
This means that on payout, assuming that Xolisa’s estate receives the full pay-out in cash (and no previous withdrawals from other pension or provident funds), it would receive an after-tax death benefit of R2 294 650, which is calculated as follows:
Fund credit: R1 000 000
Life Insurance: R2 160 000
Total benefit: R3 160 000
Taxed on retirement table: R143 550 + (36% x R2 005 000) = R865 350 tax liability
Therefore: R3 160 000 – R865 350 = R2 294 650
Xolisa’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 into account when determining her needs. While benefits paid from an approved retirement fund are exempt from estate duty, it is important to keep in mind that the distribution of ‘approved benefits’ are subject to Section 37C of the Pension Funds Act. The implications of this are that the death benefits may not necessarily be paid to the member’s nominated beneficiaries nor in the proportions indicated on the nomination form. The trustees of the umbrella fund have a legal obligation to determine who was financially dependent on the deceased member and, as such, the trustees have the ultimate say when allocating these funds to the deceased member’s dependants.
If Xolisa’s cover was provided by a group life policy held separately 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 meaning that the proceeds would be payable directly to the nominated beneficiaries in the event of the policyholder’s death. In essence, contributions towards unapproved cover are not tax deductible and, as a result, the death benefit is tax-free although it is important to note that the lump sum benefit will be estate dutiable. As is evident from the above, it is essential to know whether your group life cover is approved or unapproved before calculating any potential shortfalls that exist in your risk cover portfolio.
As a single mother, Xolisa 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 Xolisa’s financial objectives in the event of death, disability or severe illness. These objectives are:
- In the event of Xolisa’s passing, she would like to ensure that there is sufficient liquidity in her estate to settle her home loan of R3 million, pay off her VW Golf (R250 000) and cover her Executor’s Fees which are R150 000. Whilst she has appointed a guardian for Anathi, she would like to be able to provide her daughter with an ongoing income until she reaches age 23 for which she would need an amount of R2 million in today’s terms. Her advisor calculates that Xolisa will therefore need total life cover of R5 250 000 in order to achieve these goals.
Total life cover need: R5 400 000
- If Xolisa was to become permanently disabled, she would like to be in a financial position to pay off her debt which is combined at R3 250 000. She would also like to make provision for a lump sum of R500 000 to make any lifestyle changes or structural modifications to her home as a result of her disability.
Total lump sum disability need: R3 750 000
- 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 R90 000 x 75% = R67 500, limited to R58 000 per month.
Income protection need: R58 000 per month
- Lastly, if Xolisa 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
In line with her needs, Xolisa puts a 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||R3 160 000 before tax, R2 294 650 after tax
(incl. retirement credit)
|R3 105 350|
|Lump Sum Disability||R0||R3 750 000|
|Income Protection Benefit||R58 000 pm||R0|
|Severe Illness Cover||R0||R250 000|
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. As such, it is always advisable to consider who the fund trustees would consider to be financial dependents in the event of your death, bearing in mind that it could include children, an ex-spouse to whom you provide maintenance, aged parents, siblings or any person who is wholly or partially financially dependent on you at the time of death.
Another factor to consider is if you have group income protection benefits as well as an income protector in your personal capacity, it is unlikely that both policies will pay out in the event of a disability. 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, it is more cost-effective to use the income protection cover provided by a group life policy. 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.
Have a fabulous day.