This is not an exciting article about a fund tip or a secret share that will double overnight — but reading it might turn out to be the best tax-free return you, or someone you love, will ever receive.
When I first joined the wealth management industry, we used to draw diagrams showing the pillars and roof of financial advice. This was comprised of investments and savings (the pillars) and pensions (the roof). However, I was always taught that the most important part of financial advice was the foundation, and ensuring you have adequate protection laid down.
Despite this critical element of financial planning, I still speak to many people who have not ensured that their financial foundations are built on solid ground. This strikes me as rather peculiar.
The reason I am writing about protection (and I hope I haven’t lost half the readers at this point) is that I have reached my 40s and my friends are beginning to not only lose their parents, but suffer illnesses themselves. In the past month alone, two of my friends have had life changing medical issues.
These events rock the foundations.
When it comes to finances, people often think: we need to invest some money; let’s review our pension provision; let’s go and look at a buy-to-let property. But very few people wake up and think, “I’m going to buy some life cover today.” It’s not an exciting Saturday task. But it is a crucial one for you and your family.
The economist Daniel Kahneman has previously claimed that the annual income required for happiness is £57,000. Let’s assume for a moment that all FT readers are happy. This means at the age of 20, if you earned the magic £57,000 each year, with 2.5 per cent inflation, you would have earned just over £5m by the time you retire.
If you had something in your house worth £5m, you would certainly insure it. So why do so many people take the risk of not insuring themselves?
The latest figures from the Association of British Insurers show that 19.6m households had home contents cover, but only 6m had some type of protection cover. Put another way, two-thirds of households appear to value objects such as their furniture, gadgets and stamp collections over themselves. I hope they have a lot of Penny Blacks.
As talking about protection can be such a yawn-inducing conversation, it’s little surprise that not everyone is fully clued up about the different types of protection available in the market. This week, for instance, I was asked: “What is the difference between assurance and insurance?”
Insurance is something you take out to make sure you will be OK if an event happens. That event may never happen. For example, car insurance (you may never crash your car), home insurance (you might never be robbed) or even celebrity body part insurance (Ronaldo may never break his legs).
But assurance is assured to happen. You take out life assurance to cover the whole of your life, and it is assured to pay out, because we will all definitely die. So make sure you get as much cover as you can as young as you can, because it will typically be cheaper. You are never going to be younger or healthier than you are now, and you never know what could happen next — so now is the time.
Of course, it’s important to understand that with these policies you are effectively placing a bet with an insurance company, and one which you hope you lose (because all will have gone well with your life). But the truth is that with this type of cover, you will never be happy. If you make a claim, something terrible has happened. If you do not, you may feel you have wasted your money. Nonetheless, the peace of mind of having that safety net in place can be hugely valuable.
For example, I have had several clients claim on their critical illness cover, including an accountant and a lawyer who had only been paying their policies for just over a year and received £500,000 and £600,000 respectively. Both payouts were tax-free.
In the accountant’s case, after the doctor told him he could claim on his critical illness cover, he was back to work in just eight weeks. I personally believe that having the cover in place, and knowing that he and his family would be financially secure no matter what happened, aided his recovery.
The reason these policy payouts are tax free is that they are paid for with money from which tax has already been taken. If, however, you have cover through your business or work it is likely there has been tax relief on the premiums. As such, those benefits would normally be taxed. It is therefore very important to know whether your benefit is taxed or not.
Another issue people tie themselves in knots about when it comes to protection is whether they are a smoker or not. However, it’s really quite simple. A non-smoker does not smoke. If you have the odd fag, you are smoker. Intending to give up also makes you a smoker and if you are in the process of giving up, then yes, you guessed it, you are still a smoker.
So what type of protection should you be looking at?
If you work, be sure to get yourself some income protection. This pays you a monthly income if you are unable to work due to sickness or injury, usually until age 65.
If you have a mortgage, cover yourself for life and critical illness. This means that if you die or suffer a stroke or have a heart attack, your mortgage is repaid.
If you have a family, cover yourself so your dependants can continue the financial life you wish for them.
I know that some will see this article as a sales pitch for the insurance industry. It is true that financial advisers typically receive commission on protection policies (this has to be declared upfront, but considering the complexity of these policies and the small size of the commission, many advisers feel it is not worth their while to make a recommendation).
But I am happy to take any criticism for raising the issues here. As an adviser, the most important part of my job is making sure your financial plans continue, even if you don’t.
Michael Martin is a private client manager at Seven Investment Management. The views are personal. Twitter: @7IM_MichaelM