Question: I will be retiring next year and my pension will be less than what I am currently earning. I am currently paying quite a large premium towards a life insurance policy and am thinking of cancelling it to improve my cash flow. Would you recommend this course of action?
Answer: Any element of your financial plan needs to be there for a reason. Life insurance needs to be there to cover a risk. If that risk changes, then your life insurance should change. The trouble is that we seldom review our risks and end up paying for unnecessary cover.
The first step towards financial wellness is to protect your income stream.
This will ensure that your life will remain on the same financial trajectory should anything happen to you. I am, therefore, an advocate of having life and disability cover during your working years. As you get older, the size of the risk that you need to cover with insurance decreases.
While working, you need life insurance to cover your debts. This would typically be your home loan or a car loan. You also need insurance to ensure that your family will be taken care of if your salary is no longer coming into the household. As your children get older, the size of this need will decline.
When you retire, many of these risks should be gone. Under normal circumstances, all your debt should be gone. Your income stream is now a pension, which is often in the form of capital drawdowns from a living annuity, so the need to insure that income also disappears.
Before you cancel your life insurance when you retire, there are a couple of things that you should consider:
If your pension is one of those schemes where the pension your spouse receives halves when you pass away, you may want to consider keeping the life insurance. Your spouse can use the life insurance proceeds to purchase an annuity that will compensate for the reduction in income.
You may still have children who are dependent on you. Having some life cover would ensure that they are taken care of.
This is a very important factor for you to consider and is one of the reasons I advocate keeping some life assurance when you retire.
When you pass away, three high costs are incurred:
Capital gains tax
This is the one cost of dying that is usually grossly underestimated. When you die, it is deemed a capital gain event, and capital gains tax will be levied on the value of your home and non-retirement assets. The amounts here can be very large.
While there is a roll over until the death of the last spouse, you do not necessarily want to have your family sell assets to meet these costs.
These are typically around R40,000 for each R1-million in your estate. So a R5-million estate will incur around R200,000 in executor fees. Life assurance will prevent the forced sale of any assets.
This will be at least 20% of the value of your estate after certain deductions and abatements. Again, having life assurance will provide the estate with the necessary liquidity to meet these costs.
It is vital that you understand what these costs will be. This will enable you to keep the right level of life insurance in place when you retire. You do not want to have too little, and don’t want to waste money on unnecessary cover.
A skilled financial planner can calculate these costs for you by running a dummy estate liquidation and distribution calculation.
This exercise will also highlight the areas where your affairs could be better structured to prevent unnecessary leakage in the form of taxes and costs should you or your spouse die.
This is usually money that is well spent as the savings can be significant.
I often come across retired people paying really high premiums for their life insurance. The cause usually lies in the premium pattern that was selected when the policy was taken out.
These policies often start with low initial premiums, which rapidly increase as you get older, making the policy unaffordable for retired people. Remember to take a close look at the premium pattern when you take out life assurance.
Life insurance is there to remove financial risks. These risks change as you grow older and new risks appear. It is important that you understand these risks and have the right cover to remove them.