My Guide To Family Income Benefit Policies
A family income benefit policy is an often overlooked type of life insurance. However the advantage that it offers compared to a regular term insurance policy is guaranteed income. A large number of term insurance policies are taken out to provide for a family. In the instance of a claim with a typical term insurance policy the lump sum would be invested to create an income.
An income from a lump sum can be effected by market volatility, investor knowledge as well as the clients ability not to spend the lump sum. The family income benefit policy aims to combat the above 3 factors by providing a guaranteed income. This post will uncover more details of the family income benefit policy and how it works.
Family Income Benefit Introduction
Family Income Benefit Options
Examples of Family Income Benefit Cases
A Look at Trusts, Inheritance Tax and Income Tax
Family Income Benefit Introduction
Why Choose Family Income Benefit Insurance?
Guaranteed Income – If a family would suffer from the loss of a breadwinners income due to death or critical illness, then it would make sense to insure theme for an income rather than a lump sum. As the saying goes provide a lumps sum to pay off a lump sum, provide and income to replace and income.
The Problem with Lump Sums –Some clients prefer the stability of a guaranteed income and to not want the extra responsibility of investing a lump sum to provide an income. There is always the temptation to spend the lump sum. Therefore giving a client a lump sum through a typical term insurance policy is not always the best solution, although it would ease the situation.
The solution – This is why lump sum insurance policies should be used to pay off liabilities such as mortgages and debts. However family income benefit policies should be used to replace income. This post will uncover some of the options and uses for this under used but highly needed cover.
4 Reasons to Use a FIB Policy
- May be cheaper than a term assurance policy.
- No risk of spending the money.
- You wont have the hassle and extra pressure of investing the lump sum to make enough income as the income you will get is guaranteed
- You have the option of linking the income insured to inflation to help the income keep pace with price rises.
Extra Options Available with Family Income Benefit Policies
If you cover yourself for a £30,000 annual income today but set the policy up on a level basis then if you need to claim in perhaps 20 years time then inflation will have eroded the buying power of the £30,000. To attempt to lower the chance of the income being eroded many life insurance companies offer the chance at outset to include an optional indexation option. Each year the sum assured will increase in line with the retail price index or RPI. With this option the monthly premium that you are paying will normally also increase every year in line with the extra sum assured.
Critical Illness Cover
No doubt the death of a breadwinner or a house person can have a major effect on the financial stability of a household. However the chance of a policy holder getting a critical illness and surviving is much more likely than the chance of the policyholder’s death. That been said the financial consequences of a breadwinner or house person getting a critical illness is normally much more severe than death. The client still needs feeding, may need transportation to and from hospital appointments, may need a carer, may need the home adapting for special needs etc. For this reason some of the family income benefit insurers offer the option of adding critical illness benefits. The major illnesses covered under a typical critical illness policy are cancer, heart attack and stroke. These 3 illnesses account for around 85% of all claims. However the providers usually cover around 35 or more illnesses. The cost of adding the critical illness option will increase the cost of the cover, however it will also increase the chance of claiming.
Waiver of Premium
Waiver of Premium is used to continue the policy in the event of the policyholder becoming disabled or ill, and unable to work for longer than (usually) 26 weeks. In this event the insurance company will pay the premiums until the policyholder is able to return to work.
Guaranteed or Reviewable Premiums
The premiums for the policy can either be Guaranteed rates where the premium is guaranteed throughout the term of the policy and would only change on the basis of pre-determined escalation increases – e.g. RPI. Reviewable rates” – the premium is reviewed after regular periods, normally 5 years, and may change according to a general change in rates in the light of claims experience.
Example Family Income Benefit Cases
Example 1 Single Parent Life Insurance
For single parents that have children the need to provide for the children if the single parent dies or gets critically ill is even greater than the needs of a family with 2 parents. As typically the single parent takes on 2 roles that of breadwinner and also income provider. In most cases a grandparent or close friend or aunty may look after the children should the single parent die. However in most cases with no life insurance in place the new carer will not have sufficient funds and this is where a family income benefit policy fits very well.
The single parent takes out a family income benefit policy for an annual sum that they deem adequate for the carer to take care of their dependantsAny individuals who depend on the borrower for financial sup... should they die. The policy should be set up in trust with the names of the children and usually the new carer as beneficiaries. It is good practice to have critical illness as an added benefit that way if the parent gets a critical illness they will still have a sufficient income to take care of their family.
With cases like this the term of the policy can be set to match the ages that the parent expects their dependants will become independent and not rely on their income any longer. Typically this will be around the ages of 21. Thus if the youngest child is age 5 the policy can be set with a term of 16 years
Example 2 Critical Illness to Cover Maintenance Payments
When parents separate or get divorced in many cases one of the parents will have to pay a monthly maintenance payment to the other parent. For this example we will assume this is £1000. For the parent receiving this payment getting it or not getting it can mean the difference between providing for the kids or living in poverty. For this reason it is good practice to ensure that regardless of the health of the parent paying the maintenance the maintenance continues. I have advised clients in this situation where the parent receiving the payment takes out a policy on the life of the parent paying the maintenance.
Typically with these cases the person paying maintenance will also pay the premiums for the policy. In this example the monthly maintenance is £1000 and thus the policy should cover an income under the family income benefit policy of £12,000 per year. The policy should be taken out for life and critical illness. The term of the policy should match the term that the court or solicitor agreed that maintenance should be paid.
With this arrangement as the policy is taken out on the life of the maintenance payer there is no need to put the policy in trust. If the maintenance payer dies or becomes critically ill then the sum assured is paid to the maintenance receiver as a tax free payment. Another feature of taking the life on the life of another in this instance is that the maintenance receiver will get notification if the other parent misses any direct debits and therefore they can take action to ensure that the direct debit is set up again before the policy lapses.
Example 3 Typical Family Income Benefit Use
Most family income benefit policies are taken out on a joint life basis. Most clients have 2 incomes or 1
income and the other person is a house person. In cases like these if either partly should die then the household would need addition income. This is where the family income benefit policy plugs the gap. The income that the policy pays out can either be used to replace the income of the breadwinner who has died or be used to pay for a nanny or for the breadwinner to reduce their work hours if the house person dies.
As the policy is a joint policy there is no need to write the policy under trust. If one policyholder dies the benefit is paid to the remaining policyholder.
Read more more about insurance claims, appraisal and mediation.
Trusts, Inheritance Tax and Income Tax for Family Income Benefit Policies
You need to be careful with family income benefit policies. One would think that a policy paying out £40,000 per year would not cause any Inheritance Tax issues. However if the term of the cover was 15 years then this could potentially cause problems. For example lets assume the policy was a single policy, lets assume the policy holder died 3 years in with 12 years remaining. Although the life insurance provider will normally pay the sum assured as £40,000 per year HMRC calculate the total amount against Inheritance Tax thresholds therefore in this case the threshold for Inheritance Tax is payable at the rate of 40% (2015/2016) on estates that have a value in excess of £325,000 (2015/2016) at death. As the total sum assured is £480,000 ie. £40,000 times 12 years remaining. This makes £155,000 subject to inheritance tax and therefore a tax bill of £62,000.
If the sum assured was going to the spouse of the policyholder then no inheritance tax would be due. However if the sum went to children, common law partners, parents etc then this would cause a problem. There is an easy way to avoid this and the section below looks at this.
With any single life policy unless the policy is written on the life of another it should nearly always be written in trust. The case above which talks about IHT and the tax bill of £62,000 could quite easily be avoided by writing the policy in trust. Other Writing family income benefit policies in trust ensure that the sum assured stays out of the estate and therefore free of inheritance tax. Writing the policy in trust ensure the sum assured is paid to the person who the policy holder intended it to go to and is not subject to the laws of intestacy. Writing the policy in trust also speeds up the claim and gets the sum assured to the beneficiaries on the trust straight after the claim has been agreed instead of waiting for probate.
Family income benefit policy are paid free of income tax