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Premiums can be a fatal blow

Premiums can be a fatal blow

Life insurance as a form of saving is not the best plan

By Elmie de Jager

17 July 2021

Mike Tyson, the legendary American boxer, once stated: “Everyone has a plan ‘till they get punched in the mouth”.

In our profession we often see people who believe they have a plan that can work… until they get punched in the mouth. Life insurance as a form of ‘saving’ and to specifically mitigate inheritance concerns, is one of these proverbial fists to the mouth.

There are few things in life that can break strong family bonds, but where we see this happening in practice, is when inheritance, especially in the form of cash or assets, becomes involved. We see many clients struggling with the problem of how to divide their assets between their children fairly.

It especially becomes problematic when family businesses or agricultural activities are involved. Traditionally, the eldest son will inherit the family farm or business and the rest of the assets are divided equally amongst the rest. It sounds fair and reasonable, but we have experienced that a plan that has not been thought through properly can go awry.

A seemingly simple solution is to take out life insurance for the children who do not inherit the family business/farm, thereby providing a sizeable (although not necessarily similar in size) inheritance for them. This solution might work over the short-term, but if it is your only solution, it can become unaffordable over the long-term. Unfortunately, none of us know when our lives will eventually come to an end, but it is important that the plans you have in place today must be able to see you through until a realistic age.

Until what age?

One could rightly ask what a realistic life expectancy is. There is no definitive answer, but what we do know is that people currently live an average of five to seven years longer than their predecessors and most readers of this article fall into a demographic that will typically live longer than the conventional average life expectancy figures.

Therefore, we believe it is realistic to plan until the age of 95. However, I can tell you with certainty that you do not need to continue with your life insurance premiums until the age of 95. Although life insurance has a place in your financial planning, it is imperative that you should assess the sensibility of life insurance as an inheritance strategy and subject the strategy to further analysis.

The sustainability of premiums is the proverbial punch to the mouth. We see this in practice. The plan always starts out sensible, along the lines of “I only pay R500 for cover of R1 million, it’s cheap.” However, few people pay careful attention to what can happen to the premiums and cover amounts over time and whether it is sustainable at all.

An example

I will use a recent case of mine as a practical example. The client is 55 years old and has done a good job at attaining assets outside of their enterprise, from which he can receive an income of R100 000 per month (in current terms), once retired.

The client mentions that he would like to keep his life cover in place so that his daughter can receive the life cover payout and his son can inherit the family business. See below the table with premiums for life insurance versus income generated from investments, with 5-year intervals.

If the client wishes to keep the life insurance as an inheritance strategy, by the age of 80, half of his monthly income will have to be used to pay the premiums. By the time the client reaches age 90, the premium as a percentage of his total income will be 97%… quite clearly a knockout!

Once you cancel life cover, you lose all the premiums paid and receive nothing in return for the millions you spent to keep the cover in place. You can therefore find yourself in a situation that, without dire consequences, seems impossible to escape from.

Another very important point to consider is that life cover premiums are paid with after-tax money. The farm or family business is then often burdened with this premium to be able to prevent an affordability issue from arising. The payment of the life premiums on behalf of the life insured is, however, a taxable fringe benefit and must therefore be taxed as remuneration.

From the example above we can assume that the profit the business or farm must generate to afford the premiums should be considerably more than the premium itself, seeing as it must be issued as a salary before tax to be able to pay the premiums after tax.

A good place to start evaluating your existing financial plan is to utilize a graph like the one below, apply it to your existing plan and to determine your realistic life expectancy to judge whether the current plan is worth it.

In our example above, investing the premiums (at a 10% yield) would provide more than the insurance from the age of 82. Keep in mind that premiums on an investment can be paused at any point in time. To eventually receive the life cover payout, the premiums must be maintained consistently.

Ask yourself the following

There is certainly more depth to this topic and further points of debate, but if this article has made you question whether your financial path is sustainable or not, start with this simple exercise:

  • Ask for the detailed projection of your life insurance premiums.
  • Ask your financial advisor or accountant to display the premiums that you will be paying by the age of 85 and older, in current terms.
  • Compare this premium with what you realistically will be “earning” at that stage (as illustrated in the table).
  • If it turns out to be unsustainable, it may be necessary to seriously consider a plan B.

The fair (not necessarily equal) inheritance of children where family businesses or farms are involved is a complex problem. Therefore, be careful when presented with oversimplified solutions.

Elmie de Jager is a certified financial planner at ProVérte Wealth and Risk Management. Contact her at info@proverte.co.za.

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.

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Samuel Rossouw CFP®
(BCommHons; Adv PGDFP)
Wealth Manager
Director

Contact

True to company culture, Samuel strives to build solid long term relationships with clients and has a meticulous way of identifying needs, defining goals and compiling an executable plan to reach one's goals. He firmly believes that one has to be a specialist in one's field to be able to add value, and continuous training & education is therefore paramount. To be objective and to have an independent approach to a client's planning is critical to make a difference.

Born & bred on a farm in the Montague region, Samuel matriculated in 2001 from Montague High School. He completed his BComm Honours degree in Business Management as well as his Postgraduate & Advanced Diploma in Financial Planning. Samuel is a CFP charter holder. Apart from a short stint at an agricultural company Samuel has spent his whole working career with ProVérte. Samuel is a shareholder and valuable member of the board of directors of ProVérte.