There are contentious issues that arise when talking about the need for life cover. We usually ask our clients ‘Why do you have a specific amount of life cover?’ or ‘What is the purpose of your life cover? There are very few clients who can give an exact answer to these questions.
Three principles on which life cover is built
1. Capital need
Capital need is to provide your estate with enough liquidity to enable the executor to settle any outstanding debt. This can either be an outstanding bond on the property in which you and your family live, or any other property that you own.
Capital need can also include an outstanding instalment sale agreement on your vehicle. It might be to cover estate duty and capital gains tax if certain assets are bequeathed to either your children, a third party or a trust. It is important to settle outstanding assets because if you don’t make provision to settle the outstanding bond on your property, your family will be burdened with the financial obligation to make a monthly repayment. If they fail to pay the monthly bond, they run the risk of losing the property.
2. Income need
If you are the breadwinner in your household, you should ensure that if something were to happen to you, your family will be financially taken care of. There needs to be enough provision for your loved ones to receive the same monthly income for a number of years.
The provision can be different for different people, with some wanting provision for five years or ten years or even into retirement. There is usually a meeting with the spouse or partner and an amount is determined after the partner dies.
It is important to define the specific income needs that your family has and realise that this can be flexible. For example, one income need can be for five years to fund a specific child’s education, while another for ten years and can be used for something else, and so on. Bear in mind that when you do the income need calculations, that the major debt and/or expenses will be settled. You will have already made the provision to settle the debt with the capital need. Do not make the mistake to include major expenses in your income need calculations.
3. Legacy need
Legacy need is the only principle that no financial advisor will be able to make a recommendation on. You can’t be told how much money you should bequeath to your family members. Technically, if you don’t have capital need or income need, you don’t need any life cover. However, there are some clients that have a strong desire to leave a legacy for their family and that legacy is a personal wish that you can include in your portfolio. You’ll need to make sure that you make enough provision for your family to receive the same monthly income for a specific number of years.
An existing provision within your estate
Once the capital and income need have been established, the existing provision within your estate before the amount of life cover is determined. It is important to look at provision because some assets might have to be sold in the event of death, and the money from the sale could be used to fund the capital and income need that has already been established.
A good example of this is what we commonly refer to as lazy assets. Lazy assets are assets such as a vehicle in the family that is not being used or a holiday house that has not been used in many years. It is important to point out that you’ll need to make sure that lazy assets will in fact be sellable.
You can quantify values with the mentioned needs and look at what liquid assets you have available in your provision. This needs to be specified in your will, and what is left over after you have provided for the need, that is the shortfall on life cover.
The next time someone asks you why you have a specific amount of life cover, you will know exactly why that amount of life cover was recommended to you.
