Why consider a life income as opposed to a life cover lump sum?

Why consider a life income as opposed to a life cover lump sum?
 Source: Provided by Moneyweb

A life income product can effectively be used to ensure successful financial planning.

A relatively new development is that life assurers are offering life-income death benefits in addition to lump sum life cover. This offers significant value to advisors and their clients by ensuring that the beneficiary’s needs are covered in a tax-effective and efficient manner. Consider the following:

  • The lump sum that was paid is not sufficient to meet the beneficiary’s income requirements. This is particularly so in a low investment return and a low-interest-rate environment.
  • When a surviving spouse invests a lump sum and then draws down an income the income is included as part of their taxable income. It is taxed between 18%-45% and the income after tax may result in an income shortfall.
  • Beneficiaries may be tempted to splurge a lump sum.

Whilst lump sum life cover must be in place to settle debt, executor’s fees and estate duty, life income cover that grows annually with inflation should be considered for the following events:

  • Spouse income: Cover the spouse’s monthly income requirement. The income is tax-free and can increase with inflation. The income can be paid until a selected age or term and whole life can be selected to supplement retirement income.
  • Child income: This income is paid monthly until the child reaches age 18, 21 or 24. It can be structured to include costs such as education fees, boarding fees, food and healthcare costs. This income can be paid to the guardian or trust if the children are minors.
  • Ex-spousal maintenance: Maintenance payments take precedence over inheritance payments. The ex-spouse’s claim may have a significant impact on the funds available for the current spouse and any children.
  • Estate liquidity: A guaranteed monthly income is paid to spouse and children until the estate late is finalised.
  • Providing for parents and siblings: Many South Africans support their parents and siblings. On death, a predetermined income is paid to the parents for a specified term or whole life and for siblings to an agreed age.
  • Single parent family: A single parent’s greatest concern is that there is an income to provide for their child’s needs. There is no worry that a guardian has to oversee how a capital sum is invested to generate an income. A monthly income provides significant peace of mind knowing your child’s needs are being met.
  • Business continuity: In the event of the death of the business owner or a key individual an income is paid to the business for six or 12 months. This is to cover overheads and even staff salaries.

Case study

FMI conducted a case study. The criteria is based on a male, non-smoker, age 40 who is earning R60 000 per month. The death needs identified are as follows:

  • R2 million home loan to be settled.
  • R20 000 monthly living expenses payable to the widow currently age 35 until she would have turned age 65.
  • R8 000 monthly income payable to the deceased’s mother, current age 70, for the whole of life.
  • R10 000 monthly income for two children, aged 8 and 5 until they reach age 24.

A comparison revealed the following on the death of the life insured a couple of years after the cover was taken out:

Life cover lump sum of R14 700 000 at a cost of R 2 081 per month.

  • The home loan is settled.
  • R1.8 million is paid to his mother. It is projected to give her a monthly income until she is age 90. She lives to age 97 and runs out of money in the last seven years of her life.
  • R11.1 million is paid to the widow to care for her and the children. The lump-sum is invested to give her an income to age 65. The intention is to provide an income to age 65, however, the projected investment returns are not met and the widow runs out money at age 54.

 Life cover lump sum and life income combination at a cost of R1 786 per month

  • The wife receives a lump sum of R2.76 million and uses R1.8 million to settle the bond.
  • The deceased’s mother receives R8 000 per month escalating with inflation. It is paid until her death which happened to be at age 97.
  • A wife receives and income of R20 000 per month escalating with inflation until the deceased would have turned age 65.
  • His two children receive a monthly income of R12 155 escalating with inflation until they turn age 24.

The above scenario successfully illustrates how a life income product can effectively be used to ensure successful financial planning.

As a financial advisor, it provides us with an income solution that addresses each client’s specific needs and objectives. For the client, the solution is cost-effective and there are no adverse financial consequences despite the changes in inflation, investment returns and longevity of a client.

This is a win-win solution worth your consideration.

This article first appeared on Moneyweb.co.za and was republished with permission.