Should I invest or should I insure?

We all intuitively understand that we need to ‘squirrel’ money away today to
use for a purpose in the future. From a young age, it becomes deep-set knowledge
that a portion of today’s earnings need to be saved so that it can grow, and be
used at some point down the line.

This is the bare basics of having a financial plan. It does not mean that we
all follow through with this saving, but most people do understand the basic
concept.

Life cover, on the other hand, is not understood intuitively, and is usually
a ‘grudge purchase’. Depending on the individual and at what stage of life they
are in, the relevance of life cover could outweigh the relevance of investing.

Let’s consider four different clients:

1. The New Graduate:
The biggest asset for this young individual is their ability to earn an income.
The likelihood of this client having financial dependents is low and there
probably won’t be too much debt. So, life cover is not a major need.

The main risk is that they become disabled to the point of not being able to
earn an income; income protection and disability cover are a must! Without these
benefits, the individual would become a financial burden.

If you have a student child, rather consider purchasing disability cover
instead of saving a nominal amount for them for their retirement.

2. The Young Working Mother:
She works hard to provide financial stability for her family. If she were to
suffer a serious injury or illness that would preclude her from earning an
income, or if she passed away, there would be a big gap in earnings to provide
for the same lifestyle. As important as it is for her to save for the period of
her life when she no longer earns an income, so too is there a need to protect
her income in the event of death or disability.

She has people dependent on her income, and the chances are there would be
debt to settle.

The cost of education is high and rising, particularly if your child attends
a private school. It’s estimated that the cost of educating your child from
Grade 1 through to Matric is R2 million in school fees alone. Without life
cover, the young mother’s kids may have to change schools and the accumulated
debt would be passed on to her dependents.

Thus, life and disability cover are highly relevant for this young mom.

3. The ‘Sandwich Generation’:
This income earner has the obligation to financially support his kids
as well as his ageing parents who may not have made enough provision for their
retirement, and therefore need his financial assistance in today’s world of
rising costs.

The impact on the extended family unit were he to die would be hard felt.
Careful consideration would need to be made when calculating the monthly cash
flow needed to keep the kids on their path to success as well as the money
needed to assist the aging parents.

Life cover is essential for this multi-generational provider.

4. The Established Income Earner:
This client is well established in his career and provides a good
standard of living for his family. Annual December holidays and Thursday
takeaway meals are just some of the luxuries his family enjoys. His kids are
beginning to become more independent and he may need to take on a bit more debt
to help them along. The cost of education and medical aid are a big part of the
budget.

In the event of his death, this man would leave his wife with a big financial
burden to maintain the lifestyle and clear all debt.

Life cover can be used here to cover any liquidity, tax or expenses payable
by the deceased’s estate. Instead of having to sell assets under duress, life
cover provides immediate liquidity to cover these expenses. It would be somewhat
irresponsible for this client not to have a policy that would provide for his
family.

live local, Insure Global

Traditionally, one would take out life cover in the country in which one
resides. Most South Africans will take a policy with insurers like Sanlam,
Liberty, or Old Mutual. The policy is funded from a South African bank account,
and when a claim is made, the proceeds are paid in Rands into a South African
bank account.

This makes sense because we live, earn and spend in Rands.

If one’s spouse is the beneficiary of the policy, the proceeds will be exempt
from estate duty. However, if one’s children or parents, or anyone else for that
matter is the beneficiary of the life policy, the proceeds will attract estate
duty.

Certain policies can be structured where no estate duty is levied, but that
is a subject for another article.

In today’s South African environment, and with the world becoming a global
village, it may be time to consider a life insurance policy that allows one to
insure in US Dollars – i.e hard currency.

The mechanics of this global insurance policy works in the following way:

• The premiums reflect in Dollars but are paid in Rands from a South
  African bank account.
• The proceeds, however, are paid out in US Dollars.

One can have it paid into a South African bank; however, one foregoes an
advantage of this policy which is that the proceeds do not have to be brought
back into the country.

The beneficiary can be an individual, a foreign trust or a foreign company.
The biggest advantage, if structured correctly, is that the proceeds are estate
duty-free.

A parent who has life cover can nominate their children as the beneficiaries
and the proceeds would not attract estate duty. Thus, one would be paying a
similar premium as to a local product. However, there would be a saving of
20-25% of the proceeds by avoiding the tax that would normally be attached to a
local policy.

A few more advantages to insuring in a global currency are:

• The Rand is a highly volatile currency and you can protect your family
  in a currency that is more likely to retain its value.
• To emigrate as the only income earner without a spouse is quite a
  burden-filled journey. By insuring in Dollars in the event of death or
  disability, the proceeds would be available out of the country.
• If you have ambitions for your children to attend university in another
  country, you can ensure that in the event of your death or disability, the
  tuition fees would still be affordable.
• If you have children that have already emigrated or are thinking of
  emigrating, this is an easy way to leave a legacy that would be paid to a
  bank account in their new home country; a local policy would pay to a South
  African account. If your child has formally emigrated, then they will need
  to set up a blocked Rand account in South Africa from which to transfer
  money out of the country. This is admin intensive, time consuming and costly
  because of tax.

Can you invest via a life Policy?

I wish to compare two scenarios – both of which involve a 40-year-old male.
For ease of reference, let’s call him James.

In the first scenario, James takes out a life policy through the global
insurer that would pay his family $500 000 on his death. The premium for the
first 12 months is $96 per month. This monthly contribution would increase by
approximately 6% per annum.

The second scenario is where James puts same $96 per month, increasing at 6%
per annum, into a savings account.

The question is: How long will it take James in scenario 2 to have the same
$500 000 available to his family? We know that in scenario 1 the money is
available from inception of the policy.

In the second scenario it would take James just on 39 years to be able to
save the $500 000 – that’s assuming the investment can provide a steady return
of 7% per annum.

Should James pass away at any stage before his 80th birthday, his family
would have been better off if he were paying to the life policy as described in
scenario 1.

To clarify, I am not encouraging people to stop saving and to stop building
assets for their future.

There is a negative stigma around life cover. One only needs to be injured,
suffer a serious illness or die for the benefits to be realised. It’s important
to reframe the narrative around life cover; protecting yourself and your family
in the event of injury, illness or death isn’t a bad thing!