Ever heard the story about the guy who was paying for insurance for years and years, but when he needed to claim back, what he got paid out wasn’t enough to cover his loss?
Discovering that you, or someone you depend on, doesn’t have enough insurance can really be a tragedy on top of a tragedy, because you usually only find out when things go wrong. Which is why we think it’s important you learn how to work out what the right amount of cover is, way before that happens.
Why is the Right Amount of Cover So Important?
Insurance is meant to pay out the right amount if something happens to your assets (things of value). If your car were in an accident, could you buy a new one? If you became disabled in that accident and couldn’t do your job anymore, could you pay your bills? Finding the sweet spot between too little and too much cover comes down to identifying your assets, risks and needs.
For short-term insurance (insuring your stuff), you’d want enough cover to be able to replace the asset, so you’d need to know what that asset is worth in today’s money. It’s the same with long-term insurance (insuring your life), except you’re not replacing a thing, but the earning potential or security provided by a person. And it’s not necessarily in today’s money, but a prediction of how much cover will be needed years into the future.
What Things Should I Consider When Working Out How Much Cover I Need?
When trying to work out how much life cover you need, you’ll want to consider how much you earn, how much you spend, your loans and debts, and whether or not you have people who depend on your income for support.
You’ll also need to consider the impact of time. For example, if in 10 years time you earn the same salary as you do today, your money won’t go nearly as far because things get more expensive over time. This is called inflation and, for life insurance, you should predict how much money will be needed to cover your future expenses.
Another time-related factor is the number of years you’d like to cover your dependants for. Say your dependants are your elderly parents, you’d probably only need enough cover to pay for your funeral costs, outstanding debts, home loan (if they live with you), and to continue providing them with an income up to a certain age (let’s say age 90). But, if those dependants are young children, you’d want to cover the same things, but also include the cost for childcare and their education up to a tertiary level for a different, and possibly longer, period of time (say until they’re 25 and old enough to earn an income).
How Do I Calculate This?
Okay, so this part can feel really overwhelming, which is why we’re going to help you out by breaking it down into four steps.
Step 1: Gather Your Info
Get together the following things:
Your annual after-tax-earned income (we specify earned to distinguish from passive income)
Your total debt.
Step 2: Identify Your Personal Needs
If you are earning an income, then Income Protection cover is a good idea. This ought to be equal to your after-tax-earned income, to protect that income in the event that you become disabled and unable to do your job.
It’s a good idea to have some lump-sum disability cover and lump-sum critical illness cover to cover once-off costs associated with those claims. A good rule of thumb is about 6 months worth of income for disability and 6 to 12 months worth of income for critical illness cover. For example, if you earn R20,000 after-tax income per month, you could consider buying R120,000 lump-sum disability cover, and between R120,000 and R240,000 of critical illness cover.
Finally, it’s recommended that you have a lump sum of life cover equal to the amount of total debt you have outstanding and an allowance for the final expenses which would be incurred should you pass away. It’s generally a good idea to make an allowance for R100,000 for funeral expenses and executor fees, unless your estate is likely to be above R3.5m in value. In this case, it’s best to consult an advisor who can assist you with a calculation to determine your potential estate taxes.
Step 3: Identify Your Dependants’ Needs
The first thing to ask yourself is whether there are any dependants who are relying on you to provide an income for them. This would usually include children, parents and your spouse or partner.
If you do not have anyone financially dependent on you, you won’t need any additional cover. However, if you do have financial dependants, you’ll want to work out approximately how much income they would need should you die. In addition, try to approximate how long they might need this income for.
For example, you may want to provide income to your children until they reach the age of 21. So if your youngest child is 5, you may want to provide income to cover 16 years of income for them.
You then have two choices: you could either take the annual income they require and multiply it by the number of years they require it for, and buy that amount of lump sum life insurance cover. Or, you could buy Death Income cover whereby you buy the amount of income required and specify for how long that income would be required by the dependants. Read more about this benefit here.
Step 4: Identify Your Funeral Needs
Firstly, do you have any family members who would look to you to contribute to various funeral expenses of immediate and extended family? If you’re likely to be on the ‘hook’ to help out with other family members’ funeral expenses, then buying funeral cover on those lives is a great idea.
If you’d like some reassurance that you’ve not missed something important, you can always arrange a meet-up with a financial advisor.
What Do I Do Next?
When you’ve worked out how much of what types of cover you need, it’d be wise to shop around a little and to ask lots of questions. You don’t want to be convinced into paying for something that sounds too good to be true, but actually amounts to a shortfall when it comes time to claim.
Also, when you’ve taken out a policy, be sure to revisit it every couple of years because, if your situation changes significantly (like you buy a house or have another child), so too should your cover.
Is There Anything Else I Should Be Doing?
Finally, insurance isn’t the only way to prepare for your future. Insurance is awesome at covering you immediately, but it’s also a good idea to start growing your wealth by saving and investing your money so that you can eventually become self-sufficient.
There are insurance companies that embrace the best of both worlds: rewarding clients with an investment that grows while they’re being insured.
So, the bottom line is to know your situation and make sure you get the right amount of cover to match. Happy shopping. It’s important to note that the examples in this article are meant only to illustrate our point, and aren’t meant as financial, investment, or any other type of advice. For advice about your money, speak to a registered financial advisor.