The following guest post is by Mark Meldon, an independent financial advisor (and Monevator reader!) who we’ve noticed talking a lot of sense over the years. We thought we’d ask him to explain some of the more obscure or technical corners of personal finance.
A frustration I often face when talking to individuals is that they have usually first contacted an IFA1 like me because something ‘interesting’ is going on in their lives, such as pending retirement, investing a lump-sum, or some other relatively sexy financial planning matter.
That’s understandable, but not ideal. Rather than firefighting like this, I think it’s important to remember the basics. It’s all about the risk of something unexpected happening, such as illness, disability, or an early demise. These events can quickly wreck the best laid investment plans.
I’ll return to long-term ill-health and critical illness insurance another time. Today, I’ll explain what I think to be a good approach to life cover. (Or should that be death cover?)
Specifically, let’s consider a very useful but often overlooked kind of life policy called Family Income Benefit or FIB.
You’ve never heard of Family Income Benefit?
Perhaps the best way of explaining Family Income Benefit (FIB) is to call it installment term insurance.
Unlike all other kinds of term life insurance, FIB isn’t designed to pay out a lump-sum on death, although your beneficiaries will be given that option should a claim arise. (Hint: Try to avoid choosing this so-called ‘commutation’ option because you defeat the whole purpose of the policy).
FIB, rather, pays out a specific amount of cash every month or quarter following the death of the life insured under the policy. These payments continue from the date of death until the end of the term of the policy that was chosen at outset. The monthly installments are tax-free in the hands of the beneficiaries; these are normally spouses/civil partners and children.
One big benefit of FIB is it completely removes the hassle and risks associated with investing lump sums. You can think of FIB as a kind of temporary guaranteed pension.
For example, let’s say today your youngest child is two-years old. You hope that they will go on to higher education, so you are going to be on the hook financially for about 22-25 years. In this instance you could set up a FIB policy (in trust) with a 22-year term for, say, £2,000 per month benefit (flat rate or indexed policies are available – it’s best to chose indexed ones).
- If you die in year two, your beneficiary will be paid £2,000 per month for 20 years (£480,000).
- Should you die in year 20, your beneficiary would be paid £2,000 per month for two years (£48,000).
As the risk to your chosen insurer decreases with each year that passes, the cost of these policies is very low in comparison with large lump sum policies.
Remember though that lump sum polices will pay out the pre-selected sum insured right up until the penultimate day of the chosen cover period.
Family Income Benefit in action
Some years ago now I met a police sergeant and his wife. At the time their only child, a daughter, was about seven-years old. Whilst he had a very decent pension, they had a mortgage and I arranged a lump sum policy to cover that, and also FIB on both husband and wife as separate arrangements at the same time.
Whilst his wife and daughter would benefit from a decent police pension had he died, the idea behind arranging the FIB was to cover the school fees they were committed to paying.
His FIB was arranged to run over 18 years up until their daughter was about 25. Norwich Union (now Aviva) was the FIB provider. The sum insured was £12,000 a year, going up in payment by a fixed 5% p.a., compound (that’s important).
About three years after I arranged all of this, they bought a semi-derelict house and started renovation work whilst living in a caravan on site. Sadly he then got sick and died after some months of struggle
The lump sum policy paid off the mortgage and the police dependants’ pensions started shortly thereafter to help with his widow’s everyday living needs. The FIB also swung into action. That little policy paid out for 15 years and took their daughter through private school, university, a masters, and almost covered her time undertaking a PhD. Nearly every time I see the widow and her daughter, they mention that simple little FIB policy: “We didn’t have to think about investing the money, it just arrived every month”.
The FIB was written into a simple trust at the outset. The payments were all tax-free and paid very promptly. I recall that the monthly premium all those years ago was £6.02.
FIB ticks a lot of boxes and can be used for other things aside from family protection. I’ve used it for alimony insurance in divorces/separations, and as a kind of pension source for the spouses/partners of small business owners.
Where can I buy a FIB policy?
Whilst an IFA will look at a wide range of insurers – and be paid a modest commission for placing the policy – it is possible to buy a FIB policy directly from an insurance company.
At the moment, there are seven major providers offering competitive FIB policies: AEGON, AIG, Aviva, Legal & General, LV=, Royal London and Scottish Widows.
Whilst these policies all have the same underlying concept, they differ as far as the extra cost (but valuable) indexation, waiver of premium, and the much more expensive critical illness insurance riders are concerned.
These optional benefits can be well worth having. As with everything, the lowest priced contract isn’t necessarily the best value!
What might FIB cost?
Whilst all life insurance companies will carefully underwrite new policies based on your health and lifestyle, the majority of FIB applicants can expect to obtain standard terms. The younger you are, the less expensive it will be.
For example, a male non-smoker aged 38 choosing a FIB policy running for 22 years with an indexed sum insured of £2,000 per month might expect to pay between £18-21 per month for a plan (Source: The Exchange). The premium and sum insured in this example will go up each year in line with the indexation provision under the policy. This is often linked to the RPI2.
An IFA would be paid commission for arranging this insurance policy. (They are non-investment policies, so commission was retained after the RDR in order to try and maintain sales). The IFA would have the choice of an up-front payment or throughout a defined term of the policy.
In this example, the up-front commission would be about £400, or something like £11 per month for 48 months and 50p thereafter. My preference is to not take up-front commission.
Things to remember with Family Income Benefit
- It’s cheap, because the risk to the insurer reduces each year.
- If you chose the indexation option, you pretty much obtain a zero risk, guaranteed, secure, regular tax-free income stream for your beneficiaries from the date of death to the end of the chosen term.
- The marketplace in the UK is very competitive so premiums are very attractive, in my view.
- One of the main purposes of purchasing a life insurance policy is to provide a fund to replace the earnings you were contributing to the family pot. Rather than undertaking complex decisions at a time of grief on what to do with a large lump sum, your beneficiaries may well prefer a FIB to cover their everyday living experiences.
- It is much better to choose the indexation option at outset, in case living costs rise a lot in the future.
- Don’t over-insure; the policies you take should be appropriate to your current and future plans.
- I rarely arrange FIB on its own; the provision of an additional lump sum of a reasonable amount can provide a ‘dip-into’ fund for one-off costs and will help preserve the guaranteed income stream from the FIB policy.
- You will get asked lots of health and lifestyle questions when you apply. Your answers must be truthful. Most cases of refusing to pay out are due to non-disclosure.
- Notwithstanding that point, something like 98%-99% of all claims are met by the UK’s life offices.
- Shop around on-line, or hire an IFA to sort all of this out for you.
- Finally, don’t procrastinate if you have identified a risk you need to cover with insurance. Things change – and if you get sick then you might not qualify for cover at all.
Mark Meldon is an Independent Financial Advisor based in Cheddar, Somerset. If you need an IFA closer to home, try the directory at Unbiased. You can also read Mark’s other articles on Monevator.
Although not something for me, it sounds like an interesting product, the workings of which Mark has explained very clearly in this article, including details of commission paid to the IFA. This should hopefully be a useful reference for others who might feel they require insurance.
Sounds an interesting product but if someone is young and in good health, isn’t life insurance much cheaper? I do understand that produces a lump sum at a time when the surviving family member may not be best placed emotionally to deal with it but they can always let an IFA take the strain at that time.
I’ve never heard of this product before and I found the explanation very straightforward and comprehensible. Great article, look forward to hearing more from Mark in future.
What a great article, really clear and concise. So many people don’t have provision in place. We set up a lump sum policy to pay off the mortgage and also a FIB to provide a basic income whilst our children are still dependents. I do have one question though, what difference does it make if the policy isn’t written in trust?
Apologies for the rookie questions, but how would this be “written in trust”?
really useful article as I had never heard of FIB before. Looking forward to the next articles by Mark!
Good article. Thank you, MM.
For many people in DC schemes the FIB could serve in place of the dependants’ annuities that many DB schemes pay.
Another impressed reader. I’d not heard of these products either – this kind of article is a great addition to the blog.
A well written article – I wasn’t aware of FIB.
@Colin. I completely agree, life cover appears to be much better value than FIB.
Unless I’ve made some sort of mistake (entirely possible) I really do not think the FIB example provides value for money at all…..
Cavendish online is quoting me £22.73 per month as a premium, for level term life cover of £528K that is indexed, using a 38 year old male who is a non smoker, for a term of 22 years.
£528K = 22 years of £2,000 per month (e.g. the entire stream of payments under FIB example for 22 years, as a lump sum).
So the choice seems to be pay £22.73 per month and get the whole stream of 22 years of monthly payments in a lump sum on death (within the 22 year term), or pay £18-£21 per month and get a reduced stream of payments depending on when the death occurs.
If I take the premium for FIB to be £18 (rather than £21), then £22.73 is 26% higher, but it doesn’t take that long until the payout from level term is 26% higher than FIB, the crossover point is around 55 months into the term, or 4 years and 7 months (and it is paid out in full on death, rather than monthly). On that basis, for this specific example, the FIB seems poor value in comparison. If it is £21 as a premium for FIB, the level term assurance is only 8.2% higher in terms of premium and the crossover point is reached after just 20 months, the FIB seems terrible value in comparison.
Maybe the indexation is different in that once the benefit starts being paid it is indexed each month or year to increase. I have no issue with the concept of FIB, but I do think it is worth comparing and contrasting for value for money.
In this example, I think the level term cover is far better, even if it is paid as a lump sum into a segregated bank account and then £2,000 per month standing order is setup from that segregated bank account to the everyday current account. You don’t need to invest the £528K lump sum, I think you’d still be way ahead in nearly all cases (especially on weighted outcomes) if it stayed as cash.
When I was looking a few years ago I found it was far cheaper to over insure on life term cover now and then not index, than it was to get a policy with indexation for life term cover. When I was looking the indexation of the premium and lump sum were different. It was something like a 3% increase in the level term cover provided, but a 5% increase in monthly premium. If you compound that over 20 years, the lump sum increases by 80% and the monthly premium by 265%. I think it is much better to just over insure on level term cover at the outset and allow inflation to decrease the benefit over time.
I’d agree life cover is very cheap. In fact, too cheap. I worry for the solvency of the insurers. I can only assume they rely heavily on long term policies being forfeited as well as modelling the life expectancy.
By way of clarification about “written in trust”, may I just say that FIB, being a kind of life insurance, is no good to the policyholder if it becomes a claim (‘cos you are dead). So, you have bought it for some-one else, usually a spouse or co-parent. If you just buy the policy and forget about it and then die, the cash can end up in your estate and, depending on your other assets, might end up being taxed.
When you set up a life policy, of whatever kind, you can complete a trust form and this lets you specify who should benefit from the policy and appoint trustees to deal with the claim, etc. Doing this means that the payments are outside your estate and can be settled very quickly.
All of the life offices named in the article supply trust forms free of charge and several have really good guides to completing them. Some let you complete trust forms on-line, which is really progressive.
Keep it simple, I act as trustee on my wife’s life policies and vice-versa.
Just briefly, there is no argument from me about the fact the FIB should rarely be set up on its own. Remember, though, that the payments of “income” from a FIB are tax-free in the hands of the beneficiaries as they are treated as a return of capital by HMRC and that it is likely that, once invested/saved a large lump-sum payout may well bear some taxation and/or complex investment choices.
Over the years I have dealt with many death claims, unfortunately, and it is my experience that lump-sums don’t last very long in the hands of many – it’s too tempting, perhaps. When I used to administer “final salary” pension schemes, it was nearly always that case that the death-in-service lump-sum vanished in a year or two, for a whole host of reasons. That couldn’t and didn’t happen with dependant’s pensions!
If one accepts the premise that “The purpose of making an investment is the purchase of an income” (which I most certainly do) then the combination of a decent risk and tax-free indexed FIB with a reasonable sprinkling of lump-sum cover sounds like a recipe for long-term success in protecting one’s loved ones!
I have got this policy since 2006 from pgmutual.I am not sure whether they are cheaper than other insurers but they cover only professional job occupations .
Hi Mark,
Sounds similar to something my workplace cover, I think my wife/kid would get the choice of upfront payment or monthly instalments for a fairly decent number of years. Always seemed like a really good benefit to me and that’s why so far I’ve not bothered buying any additional life insurance. I should probably go back and double check all the figures to see they would definitely be covered though now I understand a bit more about personal finances!
Looking forward to the articles on illness cover as I am pretty sure this is something I’m not covered for at this point in time.
Thanks!
@Mark Meldon – Your insight, in so much as the real danger of a lump sum versus a monthly benefit is many will fritter away a lump sum is a very useful one for me.
Whereas I can happily look at the cashflow and pricing of the insurance on offer for a lump sum vs monthly benefit, it’s how the recipient would look at it and act that is probably more important should death occur and the policy payout.
In that sense, something like a £528K lump sum for say a dependent who isn’t very financially literate – particularly say someone who is late teens or early twenties – may in fact be far worse than the £2K per month, even though there is less money being paid out by the insurer.
For the financially literate, the lump sum is a massive win – given the relative value on offer from the insurance in the example provided. You can drip feed maximum ISA and pension contributions and really manage your cashflow to your advantage.
This discussion has parallels with the considerations around cashing in a final salary pension scheme and converting it to a SIPP. In the case of cashing in the final salary pension, tax mitigation is a big part of the picture, for two reasons. Firstly, when you draw a final salary pension, you can’t determine the level of income and hence tax you pay, whereas in a SIPP when you go into drawdown you can. Secondly, you can pass on your SIPP to your beneficiaries in a very tax efficient manner.
@JohnWB – I’m not sure your analogy with DB transfers quite fits this situation. The point of life assurance/insurance is not to provide a lottery-sized windfall gain in the unfortunate event of an early death; it’s to help your survivors maintain an approximation of their current lifestyle without financial worry. Sums insured need to be carefully calculated on an individual basis and, as you point out, not many people are used to dealing with sometimes difficult financial decisions, particularly at a time of grief.
In the old days, the life insurers had big salesforces (The Man from The Pru) who, in the main, did a great job in selling – and that is the right word – life cover to “ordinary folk”. On average 3% or so of those policies became claims, and those claims were almost always paid. Back then, the usual approach was to arrange a “whole life assurance”, often on a “with profits” basis, with FIB as a “rider” over an appropriate period to provide a guaranteed, secure, income for dependants like children. Oddly enough, I believe there is still merit in that kind of approach.
Sure, you need capital to pay off debts such as a mortgage and/or to provide a long-term “nest egg” for future “dip into” purposes – but the FIB would provide something that, in my experience, bereaved individuals crave – security of income, perhaps right up to retirement age.
Many “Monevator” readers, I’m sure, would be very content to deal with how to invest large lumps of capital, but that does not ring true for most of the population. Hence my preference for the simple solution of FIB in combination with either a “permanent” or “temporary” lump-sum policy with the latter, like you say, offering choices and flexibility.
I know this approach works – not so long ago a client suddenly died aged 41 leaving a widower and two children under ten. Because of her income and financial asset situation, she carried a lot of lump sum cover. This paid out a great deal; there was also a FIB paying an indexed £2,500 a month tax-free. The last thing her widower needed to do at a time of intense grief was to sit down with me and agree an investment strategy for the capital, so this was “parked” in “safe harbour” accounts (NS&I Income Bonds and that sort of thing) until he felt ready to deal with this – that was some six or seven months later.
While that natural deferment of deciding what to do was going on, the little FIB policy started paying tax-free income into his bank account, paying the bills and putting food on the table. He was able to spend time with the children without needing to even think about stock markets, ISAs, pensions, lump-sum investments and so on – very valuable time and he has been such a brilliant Dad – he had the “luxury” of worry-free income.
Time heals, and the capital has long ago been invested in various ways, but the FIB keeps on paying each month into the bank account (it was indexed, so it’s gone up) and will continue to do so for another 9 years (about the time that the youngest child is likely to finish full-time education). The widower is a very bright individual and he often mentions that the “riskless” nature of that little FIB policy was a godsend for him and the children.
Peace of mind, especially for those suffering grief, is a most valuable commodity and is, in effect, “priceless”. An IFA can only help to a limited extent with the emotional stuff – although we all try, I’m sure – but the practical financial stuff that insurance can offer should be our “bread & butter” forte – where else can you pay little bits of money (the insurance premiums) that, should disaster strike, can be exchanged for a secure income stream and/or a cash lump sum?
It sounds kind of horrible, but I felt that my job was done well.
I’ve often wondered at people’s attitude to insurance: no health insurance, for instance, for themselves, but they’ve bought it for their pets.
Does someone know how to handle all these insurance issues if you’re an expat who frequently changes countries? Where would you buy this kind of insurance? Or could someone please point me to a blog that looks at this from an expat’s point of view? Thanks.
For anyone who has a Legal and General policy, they have an excellent “trust hub” on their website. I have just very easily completed the paperwork to put my existing FIB into trust so that in the unfortunate event that both myself and my husband die, my family can still easily access and use, without being obscenely taxed, the FIB to support my children. This article prompted me to look in to doing something I have been meaning to for ages, many thanks.
@Rosie, You are quite right about L&G’s excellent trust facility and thank you for mentioning it. Others still rely on paper forms, which is OK, but compared with just a year or two ago, it’s very easy to write new or existing policies into trust as you have found.