Financial Planner Tobias Doyle explains the place life insurance should have in your retirement plans.
We all look forward to retirement, whenever that may be. It is a time when you become truly free to pursue whatever hobbies or interests you have and say goodbye to the pressures that come with working life. Nevertheless, it is essential, albeit unpleasant, to consider the financial implications your or your partner’s death would have on the surviving partner. This is known as ‘stress testing’ your retirement.
It may be that in retirement your combined income more than meets your outgoings, but would this still be the case if you or your partner died? Many Final Salary pensions only pay your spouse half of the income that you were receiving, and potentially even less if you were not married. Other pensions such as the State Pension and some annuities cease entirely on death. Conversely, whilst most assume that their outgoings would also go down if their partner died, we find that this is often not the case, and that actually they stay the same (if not go up). As such, what was once a comfortable lifestyle may deteriorate into a financially challenging retirement, with individuals relying on diminishing savings, family support or even debt. Of course, many people struggle to imagine this happening to them.
Okay, enough of the doom and gloom – you want solutions, not problems!
Firstly, to stress test your retirement, you must establish how much income the surviving partner would need in the event of either death to cover their outgoings. This is done by conducting a frank review of your expenditure. Next, deduct the income the surviving partner would receive in their own right (personal pensions/spouse’s pensions etc.) and the resulting figure is your income deficit. For example, you might agree that your expenditure, should your partner predecease you, would be £2,500 per month, but find that your income would reduce to just £1,500, creating an income deficit of £1,000 p.m. On the other hand, your spouse’s deficit should you die first might only be £500 p.m.
Now for the solution: a Family Income Benefit policy. This is a life assurance policy designed to pay a regular tax-free benefit on death to replace the lost income from the deceased. The length of the policy is agreed at the outset (for example, to State Pension age) and the policyholder pays the insurance premiums throughout. Should they die at any point during the term of the policy, however, the premiums stop, and the insurance provider then pays the agreed level of income to the surviving partner for the remainder of the term.
When writing this article, I was reminded of a couple of childhood sweethearts and long-standing clients of mine who will serve as my example. We will call them Mr and Mrs Smith.
Mrs Smith was a retired teacher on an excellent £30,000 p.a. pension. Mr Smith had an office job but had only worked part time, having been the one raising their three children. As a result, his pension income was only £8,000 p.a. This gave them a household income of £2,876 net p.m. set against expenditure of £2,500 – a very comfortable retirement at just 58 years old.
I often took calls from Mr Smith, so on this occasion when he rang me, I answered cheerily. Very quickly I realised that today was different – Mrs Smith had died. Mr Smith was lost; his children were rallying around him, but he did not know if he would be financially okay, which, on top of his loss, was hard to bear.
Mrs Smith’s pension would continue to pay just half of the original amount to Mr Smith, less tax. This meant that he was set to receive just £1,209 per month. Combined with his own pension income, this meant Mr Smith was now left with £1,742 per month, but still with outgoings of £2,500. I also had to explain that the New State Pension is not passed to the spouse on death, and so he should not expect to receive Mrs Smith’s State Pension at 66.
When the Smiths retired, we stress-tested their retirement and I highlighted their income vulnerability should Mrs Smith predecease Mr Smith. I also explained how life assurance could be used to protect their retirement. That’s right, I recommended a Family Income Benefit policy.
This policy commenced on Mrs Smith’s death and began paying out £800 p.m. tax-free to Mr Smith. This would take him beyond his own State Pension age when his income would rise and ensured that he would not need to erode his savings. By linking the income payments to inflation, we were also able to ensure that they retained their real value year on year. Whilst this by no means made up for the loss of his wife, this did give Mr Smith the financial and emotional room to grieve.
The moral of this story – hope for the best whilst planning for the worst. Whilst no one likes to think about the death of a loved one, the consequences of not giving this suitable consideration can be much more unpleasant. We would also always recommend seeking impartial, professional advice before making any significant financial decisions.
As I finish this article, I am happy to add that Mr Smith is now in a better place with the help of his family, counselling, and a rather large workshop he built to sustain his woodworking and car enthusiast hobbies!
Tobias Doyle DipPA
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Information is based on our current understanding of taxation, legislation, and regulations. Any levels and bases of, and reliefs from, taxation are subject to change.
The scenario included is for information purposes / general guidance only and should not be interpreted as an advised recommendation.