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How to take out income protection and trauma insurance

Debra Cleveland

When it comes to protecting your family, don’t be daunted by cost and complexity. Read Debra Cleveland’s guide to income, trauma and life policies and how to make them easier on the pocket.

Newly-weds Carl and Melissa Malouf liken risk protection to health insurance - it’s easy to be put off doing the research because it all looks so complicated, but once you start you find it’s not so complex.

The couple may still be in their 20s but they’ve already built up a small portfolio of shares and four rental properties. Even more impressive, they’ve taken the next step and signed up for life insurance and income protection to safeguard what they’ve amassed from life’s unexpected events.

“It’s always something people think they should look into and never do,” says Carl, 25, a risk analyst in the energy industry. “But once you make the decision, it’s really worth the effort because you feel a lot more comfortable once you actually have the policy.”

Consider your own situation. Are you from a household that spends hours working out the holiday budget or fine-tuning phone plans but puts insurance into the too-hard basket?

Remember, we’re not talking cars or jewellery here - we’re talking about how your family would survive if an adult died or became ill.

If you’re like many people whose eyes glaze over at the mention of life insurance, it’s probably because your focus is on the wrong end - the cost of the cover - rather than how your family would juggle income, debts and living standards after the unimagined has happened.

Brisbane-based Carl and Melissa have worked out a trade-off when it comes to “what-if” insurance. Once they start a family, one of their investment properties will become their primary residence. So, rather than having life insurance to cover the $1.1 million debt on all four properties, Carl has about $600,000 cover through his superannuation fund - enough to pay off the family home.

“If something unexpected happened to one of us, the other person would have no debt on the home and could then decide whether the other properties were worth keeping,” Carl says. “It’s a trade-off between how much insurance is enough and what we can pay.”

After rental income, the properties cost the couple about $2000 a year. Making one of the properties the family home will reduce their investment property outgoings to almost zero, assuming no changes in rent or interest rates.

Carl, who increased his life cover through super to $600,000 by buying extra blocks of insurance, also has income protection through his fund. Because the benefit period for this cover is a maximum of two years, he also has protection elsewhere with a two-year waiting period and benefits payable long term.

As he’s the main breadwinner, it was decided Melissa’s life cover - also through her super - could be lower at about $300,000. This will be reviewed once there are children.

Melissa, 28, works as a property manager and the couple has saved by living on site in accommodation managed by her company.

They have a modest share portfolio and feel comfortable with four properties because their super funds are aggressively weighted in Australian and overseas shares. They have no trauma cover as Carl felt there were too many exclusions for the cost of the premiums.

If you already have a good handle on your income and spending, you’re halfway to working out your risk protection needs. Don’t dismiss the process as morbid - it’s basic housekeeping that takes the fright factor out of life’s ups and downs and prepares you and your loved ones for any eventuality.

Go through our guides to the main types of cover and how they can work together and you’ll get a good idea of what you need.

If it’s all too much, planner Suzanne Haddan of BFG Financial Services suggests your priorities should be - in order - income protection, total and permanent disability, life cover and lastly trauma.

Life cover

What is it?

Also called term life insurance, it pays a lump sum upon the death of the person insured. While it’s essential cover if you have dependants, it’s probably less important if you’re single.

What is it meant for?

It helps your family maintain its lifestyle if you or your partner dies. It’s used not only to provide an income but also to pay off debts. In a family, ideally both adults should be insured. In the case of a stay-at-home partner, make sure you factor in the cost of someone taking over home duties, financial consultant Mike Ingham of Godfrey Pembroke says.

How can you save on premiums?

Cover held through your superannuation fund is often cheaper thanks to group rates. It’s also better for your cash flow because you pay with pretax dollars if you’re salary sacrificing into super and the premiums come out of your contributions.

Is the benefit taxable?

Not if the policy is held outside super. Inside super, the benefit is tax-free if it goes to a spouse or dependant children (under 18) but in the hands of adult children as much as 30 per cent can be lost in tax, David Kerr of ipac Securities says.

What do you need to know?

If you have health problems and might not pass a medical test, you might be able to skip this process by insuring through super or another group plan. Before switching jobs, check whether you can take your cover with you or if you’ll need new medical tests. Many policies now pay out early if you are diagnosed with a terminal illness - check if this is the case.

Some policies also offer counselling or financial planning advice. As pointed out by public awareness campaign Lifewise (www.lifewise.org.au), the proof of the pudding is claim time. It’s worth looking at its website to see how the claims process works.

Total and permanent disability cover

What is it?

Insurance that provides a lump sum if you’re unable to work again because of illness or injury. It’s mostly sold as an add-on to life insurance but can be bought separately if, for example, you have no dependants and don’t need life cover. Payments usually aren’t made for the first three or six months. There are two types of policy - one covers you if you can’t work in your “own occupation”, and the other covers you only if you can’t work in “any occupation” to which you’re reasonably suited.

What is it meant for?

It’s much like death cover but more useful, Suzanne Haddan of BFG Financial Services says, in that you are more likely to need to make a claim. In many cases you need more TPD than life cover as it’s financing not only ongoing family costs but medical costs, home help and possible home modifications. Also, the family budget should include an extra mouth to feed, because no one has died. In a family, both adults should be insured. A stay-at-home partner may need more TPD than life cover as there may be no income protection.

How can you save on premiums?

Like life cover, TPD is cheaper if bought through super but you won’t be able to have more TPD than life cover. If you need more TPD, you may have to top it up outside super. Advisers say this is preferable anyway because even if you have an “own occupation” policy, super rules could trap any payout in the fund if certain release conditions aren’t met.

Is the benefit taxable?

Not if the policy is held outside super. Inside super, you’ll face a tax bill if you’re under 60.

What do you need to know?

“Own occupation” cover is more expensive but it’s also better. For example, if you’re a surgeon and you lose a finger, you’re likely to meet the definition of being unable to work in your own occupation. But if your cover is “any occupation” it could be argued that you could still work in another medical role. Know also that if you have a joint life and TPD policy and you make a TPD claim, you’ll lose all or some of your life cover unless you have a buy-back option, whereby you can increase the life cover back to its original level.

It’s easy to take a steady income stream but you could be in all sorts of trouble if it was to dry up suddenly. That’s where these two types can step in and make all the difference.

Income protection

What is it?

Also called salary continuance, this replaces up to 75 per cent of your salary – paid monthly – if you’re unable to work due to illness or an accident. Some policies also continue to make super contributions on your behalf.

What is it meant for?

It should cover all your monthly expenses while you’re unable to work.

How can you save on premiums?

By opting for a longer waiting period. A policy with a 30-day waiting period is half the price of a 14-day wait policy. If you have enough savings and sick leave, choosing a 90-day waiting period is about 25 per cent cheaper than 30 days, says Mark Kachor of DEXX&R. If you can live on less than the traditional payout of 75 per cent of salary, he says that taking a lower replacement ratio makes sense and will cut the cost of the premium. Most products offer this option.

Is the benefit taxable?

Yes, at your marginal rate.

What do you need to know?

There are two types of cover. Agreed value means the amount is agreed at the time you take out the policy, whereas indemnity cover is based on your earnings at the time of the claim. The former is more expensive, Kachor says, but better suited to those with fluctuating incomes. Also, if your cover is via super, check whether it lasts more than two years. If not, top it up outside super. Lastly, make sure there’s no “offset” clause that cancels cover if you also receive a TPD payout.

Trauma cover

What is it?

A lump sum benefit if you are diagnosed with a specific major illness or injury such as cancer or a stroke. Inevitably, not all your health costs will be covered by private health insurance, Mark Kachor says, and you may be required to have some time off work to recuperate. Or you may be unable to return to work and need to find replacement income.

What is it meant for?

To pay off debts and cover the cost of rehabilitation.

How can you save on premiums?

Cover against trauma is expensive and it’s hard to find savings.

Is it taxable?

No.

What do you need to know?

This cover is often at the bottom of the priority list because it is expensive. Also, working out how much you’ll need is akin to taking a stab in the dark, says Louise Biti of Strategy Steps. Many advisers suggest you self-insure with savings and the safety net of a redraw mortgage (but check if your lender will allow you to redraw extra repayments if you are unemployed) as long as you have income protection. Kachor says most cover falls between $250,000 and $400,000.

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