Dear Miss Katsonga,
What is your opinion on Critical illness cover? What are the alternatives (for lump sum payout to cover mortgage or other debts) in case one partner is unable to work?
Very formal, Ronjoy…you can call me Heather.
So, you want to know how you can cover yourselves if one person is unable to work.
1. Critical illness cover
The first thing you mention is life insurance with critical illness cover. Typically people will have this on their mortgage insurance.
Mortgage insurance is usually decreasing term which means the amount by which you are covered falls over time roughly in line with your mortgage balance. The result is that if the person covered by the insurance falls critically ill near the end of the mortgage term the pay-out may be quite small but at least it would clear whatever mortgage is outstanding, if an appropriate level of cover was taken and updated if the mortgage amount was increased.
A problem with critical illness cover is that only specified illnesses are covered and different providers cover different things. This means if you or your partner get ill and can’t work and your specific illness isn’t covered then you don’t get a pay-out from the insurance provider.
The cover usually also has a condition that you need to be ill for a specific amount of time before a pay out is due to you, e.g. you need to be ill for 6 months plus or in an intensive care unit for at least 3 months and you’re not due a pay-out if you don’t fulfil those conditions.
2. Employment insurance
You can also buy insurance to cover you if you’re unemployed, e.g. due to redundancy. This type of policy would cover you even if you were not ill but may specify that you need to be unemployed for a given number of months before you are due a pay-out.
The key problem here is that unemployment insurance tends to be expensive during turbulent times. When I first started working in 2005 I bought unemployment cover and it was very cheap. When the 2008 crisis hit the cost of the cover increased so exponentially that I cancelled it, it wasn’t worth it.
3. Rental insurance
If you own rental property you can buy insurance to cover tenancy gaps. This could be a good idea so that you never have to worry about both being unemployment and having to support a vacant rental. The policy will likely state that the property needs to be vacant for specific amount of time before payouts are due.
I buy my rental protection via RentGuard, however, they did stop writing new policies when the government made it harder to evict non-paying tenants during the covid-19 pandemic so, it is not always available.
4. Emergency fund
A good idea would be to keep an emergency fund of 6 to 9 months of living expenses. This would give you peace of mind that you would survive even if you didn’t have both incomes coming in.
If only one person was unemployed, then a 6 month fund would last longer too,
5. Live on one income
Last, but certainly not least, if you arrange your finances such that your family can survive on the lower of your two incomes then the loss of one income is never something you need to worry about. This is our personal favourite.
Our household saves the equivalent of one income every month either as actually cash saved or as repayments on mortgage debt. Should one of us be unemployed the most we would have to do is call our bank and pay interest only for a limited period. Banks are usually very happy to do this.
In the long run, we would also like to build up a cash emergency fund but for now we do invest all disposable income and we have made peace with that risk.
Hope this helps.
p.s. subscribe to my podcast and ask me any money question, HERE - do it now!
Can you do an educational post on Life Insurance? A lot of people in our community still depend on donations when there is a bereavement, I think they’d be surprised to find out how cheap it actually is to get life insurance.
Firstly, I need apologise because I got this request in September 2017 when I was so focused on finding a job. It’s been at the back of my mind ever since but deaths from COVID-19 have prompted me to get round to writing this as a matter of urgency!
So, how do you know if you need life insurance?
The test is very simple. If you answer yes to any one of the following two questions, you need life insurance:
1.Is anyone financially dependent on me?
2.Would my death cause a financial burden for anyone else?
If you have dependents then you need life insurance. The dependents might be your children, your parents, your partner or someone else entirely.
Even if everyone is completely independent of you, if you don’t have enough money in the bank for the funeral then you need some kind of insurance, either life insurance or funeral insurance depending on your age.
Should you get life insurance or a funeral plan?
With a funeral plan you essentially prepay some of your funeral costs. The specifics of what is covered vary from provider to provider. Also, to get a funeral plan you usually need to be 50+, I won’t say much more about funeral plans in this post other than if you want to cover more than just your funeral then a funeral plan is NOT what you need.
What is life insurance? How does it work?
When you buy life insurance you make monthly payments to an insurance provider and in the event of your death they pay a pre-agreed amount of money to the dependents named on the policy, these are called the beneficiaries of the insurance policy.
There are two main types of life insurance?
Term life insurance and whole-of-life insurance
Term life insurance pays out if you die within a specified number of years. So, you buy the insurance policy for a fixed term of say 20 years and if you die after that 20 year term there is no pay out because the life insurance will have expired.
This is ideal if you want your dependents protected only for a specified time. For example you might choose a term that coincides with the 21st birthday because you decide that by that point a) the child will no longer be dependent on you or b) you will have saved enough money by that point to cover your dependents’ financial needs.
In addition to protecting dependents you might want to cover extra funeral costs. For example in my last will and testament I state that I want to be buried in the UK as that is where my husband and children live but I also state that flights must be covered for my parents, siblings and the children of my siblings to attend the funeral.
Think carefully about what you a) need and b) want to be covered in the event of your death. If it’s just your dependents’ living costs for x years think carefully through what their annual cost of living is likely to be, does it include school fees? or university fees? Make sure you don’t forget anything that is important to you.
If your family has a monthly budget then you can use this as the basis for calculating your dependents living’ costs.
Whole-of-life-insurance pays out whenever you die. It is more expensive because you are definitely going to die at some point. You would buy a whole-of-life policy if, say, you want to cover inheritance tax as well if you expect to have enough wealth to be subject to inheritance tax.
Most people just buy term life insurance because they just want to protect dependents. Inheritance tax only kicks in for estates worth £1million and over. This is a not a problem for most folk but is more likely to be an issue for the type of folk that listen to personal finance podcasts.
TERM LIFE INSURANCE
If you decide to buy term life insurance, in addition to the term, you need to make three critical decisions:
Level term insurance pays a fixed amount whenever you die while decreasing term insurance falls towards zero as the maturity date or the end of the term approaches.
You would usually buy decreasing term insurance to cover your home mortgage. So you would set the maturity to match the date when you will finish paying off your mortgage and over time, as the mortgage balance falls, so does the pay out.
The interest rate used to calculate the balance on your decreasing term insurance policy is usually much higher than the interest rate you actually pay on your mortgage. How this impacts you is that your mortgage balance falls faster than the pay out of the policy. This is obviously good as it means your pay out will be a little higher than the mortgage balance if the terms match exactly.
Critical illness cover increases the price of an insurance policy by A LOT but it means that if you get any of the covered illnesses you will get a pay out. Most people add critical cover to the decreasing term life insurance policy that covers their mortgage.
If you fell critically ill, the policy would pay you enough to clear your mortgage. This would be really useful if you are the main breadwinner and lost income because of your illness. As the mortgage is usually the biggest monthly expense, not having mortgage payment to worry about would reduce the household’s stress significantly.
One extra thing, you can reduce the cost of life insurance by getting a policy that pays out monthly or annually for given number of years instead of getting one lump sum. So, instead of £300,000 paid out in one go you can have a pay-out of £30,000 a year for ten years or £2,500/month for 10 years. You need to decide if this is worth the reduced monthly cost of the insurance policy. Get a quote for both before you decide. You might decide to go for the annual or monthly pay-out if you think your dependents wouldn’t use the money wisely if used in one go.
How much does insurance cost?
It depends on how old you are and what level of cover you want, i.e. the monthly payment on insurance that would pay out £100,000 if you died is cheaper than insurance that would pay out £500,000.
The younger you are, the cheaper it is but obviously the younger you start the longer you will be paying the provider for.
I know it’s easy to think I don’t want to pay for something that is likely not to be needed. Possibly the insurance won’t be needed and that’s awesome because it would mean you’ve stayed alive, the better way to think about it, however, is that “in the unlikely event of my untimely death would I regret having paid £x per month to ensure my dependents do not suffer?” Even if all you can spare is £10 per month you should be able to get some life insurance for that amount.
How long does it take for life insurance to be paid out?
Usually you can expect a payment within 30 to 60 days of filing a claim, but delays can arise—if the insured person dies within the first two years of the issuance of a policy, for example, that may need some investigating.
At a base level, this is all you need to know. So, let’s summarise to help you with next steps. If you have figured out that you do need life insurance then you need to decide:
My thoughts are that at a minimum you should have enough life insurance to cover your mortgage and the costs of living until your youngest child is 18. Critical illness is great but if you can’t afford it don’t stop yourself from getting life basic insurance. Please don’t leave your dependents to depend on the good will of people, get insured.
I hope this helps! Much love and stay blessed.
Have a money question for me?
Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.