It's human nature to avoid thinking about what might happen in the event of your death or a serious illness. But, as the COVID-19 pandemic highlighted, we can rarely predict when these scenarios might occur.
While it's a sobering thought, serious illnesses are more common than we think. One-in-two UK residents born after 1960 are likely to contract cancer during their lifetime, according to data from Cancer Research
The question you need to ask yourself is this: "If I have to stop working because of illness or if I pass away early, would my family have adequate financial support to sustain a comfortable lifestyle?"
Being proactive in assessing your family's unique requirements is key to ensuring your loved ones will be taken care of in the event of a debilitating illness or an untimely death. Effective plans can take the financial and emotional burden off your family's shoulders during what will be a difficult time; it will also save them unnecessary costs.
Protecting family wealth may require a two pronged approach:
- Obtaining life or illness insurance designed to replace lost income – this provides for your family by repaying debts, meeting lifestyle expenses such as school fees and covering other essentials.
- Using life cover to match any inheritance tax liability (IHT) on an estate passed to children. At a rate of up to 40 percent, this can severely reduce the amount they would otherwise receive.
Family protection: Insurance can help protect your family's standard of living
Picture a high-earning company executive who supports their family with a certain level of income. They want to ensure this standard of living will be maintained even if they develop a serious illness or pass away unexpectedly, while still of working age. Both family protection in the form of critical illness cover or income protection and life insurance can offer peace of mind, acting as a financial safety net for the family by providing enough money to sustain them for years to come. Let's look at these in more detail.
- Protecting against illness: This cover can be an effective way to offset the potential costs that can result from having a debilitating illness. Critically, it can guarantee you a lump sum or replace after-tax income.
- Life insurance: Pays out a lump sum in the event of death. This may be used to repay debts or meet the family's lifestyle expenses. Opting for it earlier rather than later can be a smart decision. “If you are younger and in good health, that's the perfect time to think about life insurance, because it will likely never be cheaper," says Lucy Day, associate director, RBC Wealth Management in the British Isles.
"Clients often say, 'Well, I'll save money if I wait 10 years.' But that's not necessarily going to be the case; life insurance typically gets more expensive as you get older – especially if any unforeseen health issues arise."
Inheritance tax cover: How to retain your family's wealth by insuring the inheritance tax liability
Imagine an older serial entrepreneur based in the UK. They've built up significant wealth and are currently enjoying or nearing retirement. The likelihood is they have “enough," with minimal debt and sufficient funds in the bank to cover their spending in retirement. As a result, they're thinking more about what will happen to their assets after they're gone.
If the entrepreneur and their spouse both passed away, their children or other beneficiaries would have to forfeit a significant portion of their estate's value to HMRC in IHT
Mitigating the impact of IHT boils down to four key strategies, explains Nick Ritchie, director of wealth planning at RBC Wealth Management in the British Isles – spending, gifting, investing in exempt assets, and the tactical use of insurance. “It's a perfectly acceptable strategy to say, 'I'm not going to gift anything or do any structuring using trusts, corporate structures or other dynastical vehicles. When I die, there's going to be an £x million IHT liability, so I'll just take out an insurance policy to cover that.'"
“It's really about considering the extent of any lifetime planning you wish to undertake to reduce the exposure to IHT on your estate, versus simply covering it with adequate levels of insurance," adds Day. She also recommends writing a will as early as possible, so your wishes are clearly defined and your loved ones are spared excess time, money and stress.
The risks of not making inheritance tax plans
What are the consequences if you fail to plan for IHT? Without proper estate planning, your assets could be frozen while probate takes place – which can be a very long process. This means your family could end up without the liquidity required to meet their immediate financial needs. In this situation, families may be forced to make painful decisions, such as whether to sell a family home or business, or divest portfolios in order to pay an IHT bill.
“When someone has multiple properties and illiquid assets, it can take a long time to administer the estate; but typically there's only six months in which to pay the IHT bill," explains Ritchie. “Having insurance in place can reduce the burden by giving executors or administrators a lump sum of cash to pay that liability, taking the pressure off as they distribute the estate."
Is your existing cover sufficient?
When it comes to inheritance tax planning, it can be hard to answer the question 'How much cover do I need?' Day suggests looking at the value of your estate and determining your IHT liability accordingly. Start from the amount you would need to cover that bill now; then reduce the amount over the term of the policy as you gift money over the years, reducing the size of your estate.
From a family protection perspective, think about your expected family income for the next 25 years, then consider how long your children will be dependent and how many more years it will take to pay off your mortgage. This should help you come to a minimum figure.
Note: While you should prioritise your insurance premiums for as long as you need cover, remember you're not tied to a policy and can cancel it if your financial situation changes and the policy no longer suits your needs.
Are you covered by a death-in-service benefit?
Executives who are covered by their employer's death-in-service benefit may think when it comes to life cover, they have ticked all the boxes and don't need anything else. But what they may not realise is their benefit could be capped – and it might not be enough to support their family in the long term. For example, if your death-in-service benefit pays out eight times your salary, but you had planned to work for the next 20 years, your family will be left with a shortfall.
It's important to speak with your family and financial advisor early on about your family protection and IHT cover options, as they are valuable risk-management tools that can be used to powerful effect to protect your loved ones – and how much you might leave behind for them.
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