Should I invest or should I insure?

Depending on the individual and at what stage of life they are in, the relevance of life cover could outweigh the relevance of investing.

Trevor Crouse CFP®

Trevor Crouse CFP®

Private Wealth Manager

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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!

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