As a parent, we are constantly worrying about whether we are doing the right thing for our children. You want to ensure that they reach their full potential and enjoy rich, active, fulfilled lives.
However, to do this, it is also important to look after yourself. While many perceive this to mean eating healthy, exercising, and sleeping eight hours a night, it is also important to consider your financial health.
Having structure, and a backup plan in place can help safeguard your finances and your children’s future. This can prevent you from making financial mistakes and leaving your loved ones with money worries.
This is a contributed post aimed at providing practical, helpful and useful advice to parents.
Life Insurance vs Income Protection – which is best for parents?
Although very uncomfortable to consider, for many parents, the impact of the COVID-19 pandemic has made us even more aware of what we may leave behind. This has led to a spike in people taking out insurance protection policies.
In the UK the two most popular forms of cover are life insurance and income protection, but which is best for parents and why? Keep reading as we break the pros and cons…
1. Covering loss of salary
The loss of a salary can dramatically affect one’s financial health and every household should have a contingency plan to prevent or limit the loss of an income.
Life insurance pays out a single cash lump sum if you pass away during the policy term, whereas income protection provides a monthly income if you’re too ill or injured to work.
So, which is best to cover the loss of salary? Well, they both have their merits.
Life insurance can pay out a significantly larger lump sum, potentially paying off your mortgage and/or any debt. This is at the cost of a parent and results in a terminated policy and no additional payments.
Income protection however can keep paying out to help cover essentials and aid in your recovery until you’re able to return to work. It works similarly to your monthly earnings and while you’ll only receive a percentage of your salary (up to 70%), it may still be sufficient to cover your monthly outgoings.
As a result, income protection is more of an ongoing answer to help keep things afloat while also providing recovery time for the policyholder. Life insurance is more of a final gambit. It is a bigger lump sum payment after which the policy expires. It also requires the death of the policyholder in order to be activated. This one goes to income protection
Life insurance 0 – 1 Income protection
2. Covering the passing of a parent
The passing of a parent is obviously a devastating loss, both to the children and the wider family. There is nothing that can ever replace the loss of a parent. Instead, you can only alleviate some of the secondary problems which will likely arise.
Whether it is the main breadwinner or a stay-at-home parent who passes away, things are going to be difficult for your children and the remaining parent.
This is where life insurance can be a great option. The lost annual income or additional childcare required can be fully covered by the proceeds of a pay out. It could potentially secure the family home, cover the drop in income for a period of time or give breathing space to help a lone parent and the children rebuild their lives. As policies are also terminated after the death of the policyholder, no additional paperwork would be required once the claim has been successful.
Income protection policies are also terminated when the policyholder passes but provide no lump sum or additional payments upon their death. They are designed to pay out if the policyholder is too ill or injured to work but will not cover their death.
For this reason, life insurance is the significantly better option in this scenario.
Life insurance 1 – 1 Income protection
3. Covering a funeral
Funerals can be a surprisingly costly affair. SunLife, a leading funeral plan provider, recently stated that a basic UK funeral now costs on average £4,056, with the average total cost of dying a mammoth £8,864.
This could be an extra shock at what is already a very challenging time. So having the necessary financial coverage to counteract this, is crucial to allow you to concentrate fully on grieving.
By design, this is where life insurance is primarily the better option. Due to the nature of having a lump sum paid out upon the passing of a policyholder, money can be allocated to cover funeral costs.
There are certain life insurance products designed specifically to cover the cost of your funeral, such as certain over 50 plans, meaning that it’s a wise investment for funeral cover.
With income protection acting more like a substitute for your monthly income, it can be difficult to save up the required funds, particularly as you will only receive around 50 – 70% of your monthly income.
It may be possible to put money aside from income protection payments but for the sake of ease and purpose, the winner here has to go to life insurance.
Life insurance 2 – 1 Income protection
4. Covering a mortgage
Stepping onto the property ladder is the holy grail for many parents in the UK. It can take many years and a degree of luck to climb onto the first rung and it is not always easy to climb.
Those who lose their income or cannot keep up with their mortgage payments are at risk of slipping off the ladder and potentially losing their family home.
Therefore, having a plan to cover your mortgage, rent or any form of accommodation is a good idea. However, those with mortgages are arguably facing the biggest loss considering how much potential equity is tied in their homes.
Life insurance, as already stated, can pay a lump sum on the policyholders’ passing. Many people choose their life insurance term to mirror their mortgage, with the pay out amount being determined by their remaining mortgage debt. This lump sum can assure the mortgage is fully paid off, so the remaining parent and the children do not lose their family home at what is already a very stressful time.
Income protection does not provide a lump sum pay out. A monthly payment similar to a paycheque will be paid out instead. Depending on your income protection amount, you could cover your monthly mortgage payments and prevent a default on your home.
Both policies are attractive prospects for those worrying about their mortgage payments. Neither is better than the other in this scenario – they just cover your mortgage in different ways.
Life insurance 3 – 2 income protection
5. Covering a debilitating illness or injury
Despite living in an age with the benefits of medical advancements, chronic illnesses are not a thing of the past and can impact anyone. Similarly, anyone can break or lose a limb, impacting their life, their ability to look after their children and do their job.
Life insurance in this situation is a bit of a grey area. Regarding some term-based life insurance (policies for a set period), you may be covered for terminal or critical illness cover. However, terminal illness cover only pays out in the final 12 months of your life and both are not necessarily included in a life insurance policy. Life insurance would not cover you for any injuries either unless that injury caused your death.
Covering an illness or injury that prevents you from working is income protection’s speciality, however. Its primary function is to cover you financially if you’re too injured or ill to work and help you recover. Life insurance may work in some niche scenarios here, but income protection is superior for most illnesses and injuries.
Life insurance 3 – 3 income protection
As we all know, many things in life are subject to tax, and financial policies are no exception. The last thing you want is to have you or a significant other claim on a policy you have paid into for years, only to find a substantial portion is not there due to HMRC.
So, is life insurance taxed? Well yes and no depending on how it is set up. Life insurance is not liable for either income or capital gains tax. However, as a claim on a policy can only be made once the policyholder passes away, it means by default it will be subject to inheritance tax.
Inheritance tax is a form of tax that affects a person’s estate, and you are taxed a massive 40% on anything exceeding the £325,000 threshold. Any money, property or possessions owned at the time of death is subject to this tax, including the value of your life insurance policy.
To help avoid or minimise the inheritance tax you pay you can write your policy into trust (free of charge), separating your life insurance from your estate. Because the proceeds from a life insurance pay out in this scenario do not form part of your estate they are also not subject to probate meaning a faster pay out.
Income protection is not taxed. However, this is because the pay out is a percentage of your net income, or your usual monthly salary. For all intents and purposes, the income has already been taxed and is therefore not subject to it again. Income protection wins this round.
Life insurance 3 – 4 income protection
7. Length of cover
If you needed to claim on a policy, the last thing you want to hear is that the policy has expired. You want to ensure the length of cover meets your family’s specific needs, which begs the question: which policy has the best length of cover.
This is tricky, as there is no universal answer for the best length of cover. Some people may want policies which last their whole life, while others may only need to cover a few of years, for example until the mortgage is cleared or the children have left home.
What it really comes down to is whether life insurance or income protection have the right length of cover for you.
Fortunately, both types of policy have a range of lengths. Life insurance policies can be term based and last either a couple of years or up to 40. There are also whole-of-life policies which ensure that you are covered until you pass away, regardless of when that is.
Income protection has similar policy lengths, meaning you can also have either a short-term policy or a long-term policy that lasts until you retire or pass away. Both types of policies however will be subject to higher premiums the longer the period of cover is, (because the likelihood of a claim increases). Due to the versatility of both product’s lengths, this is very much a draw.
Life insurance 4 – 5 income protection
8. Providing an inheritance
As a parent, you always want the best for your children, whether they are following in your footsteps or forging their own path. If you were no longer around, you would want to give them as much financial assistance as possible in this ever more expensive world.
Leaving an inheritance could enable them to put a deposit down on a house, buy a car, or invest it for when it is required.
Life insurance’s sum assured usually means that you can choose a designated amount for your children’s inheritance, without fear of there being no money available when you pass.
As income protection is a monthly instalment paid to you whilst still alive, you might be able to cover a little bit of a younger child’s pocket money but certainly not an inheritance. This one is a win for life insurance.
Final score: Life insurance 5 – 5 income protection
This may seem like we are sitting on the fence, with both life insurance and income protection receiving the same score. However, both policy types are good at covering different aspects of your life and it is a case of taking the time to consider what works best for you.
It is possible to take out both policies simultaneously if you require comprehensive cover and your budget allows. However, if you are still unsure, it may be beneficial to talk to a life insurance broker such as Reassured.
Reassured can help you determine what the best policy is for you, while also helping you find the best income protection policies through Reassured Advice (their advised arm).
Regardless, it is important to take these into consideration when starting a family. Whether your child has just been born or is well into adulthood, it’s not too late to take control of your finances, and make a plan and provision for the future.
Considering what we may leave behind and making the necessary financial plans is never easy but that does not mean that it is not really important.
We hope this article has not been in any way alarmist but instead helpful and informative.
Both life insurance and income protection premiums start from 20p-a-day, so if you do not have cover why not seize the day.
Disclaimer: This is a contributed post not written by myself. Please always seek professional advice when making financial decisions.