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.