How much life cover do I need and for how long do I need it?

colinArticle by Colin Horwitz,  Managing Director of the NMG Personal Wealth Division

I was having dinner with a family member the other evening when he asked me how much life cover should the average person have and when should this person reduce the cover. Now, as a rule I do not like dispensing advice to family or friends and tell them as much. My reasoning for this is that all social engagements thereafter become meetings and sometimes arguments. So I refer them to a colleague and will not even give second opinions. However, this discussion led me to thinking and it is these thoughts that I would like to share with you. Please note that I am trying to keep it as simple as possible.

Let’s say Mr. Average earns R45 000 per month. He is a 30 year old male, married with 2 small children. He is on a retirement fund at work with group life cover of 3 X annual salary. Mrs. Average doesn’t work and hasn’t done so for 3 years, although she is a qualified lawyer. It looks like she has no intention of working in the short term as she wants to enjoy the experience of bringing up the children

So here is the question. What life cover should Mr. A have?:- Here are some quick calculations.

To replace his current income at a 5% drawdown (which should allow for inflation) he needs R10 800 000 total life cover. He currently has R1 620 000 group life cover. So he is short of R9 180 000. And this is just to be in the same situation. Now Mrs. A may go back to work but the longer she stays away, the harder it is to get back into the swing of things. And then there are other questions such as:-

  • Is the bond on the house covered?
  • What about the HP on the car?
  • How are children going to be educated, primary and tertiary?
  • How do we inflation proof the capital?

Now a quick thumb-suck calculation tells me that Mr. A needs to cover himself for an additional R16mil.

The cost of this cover is R2 379-13 per month, which I am sure to Mr. A is a lot of money. Let’s take a bit of a closer look. The cost per R1mil of cover is R148-69 per month. This means that Mr. A can get cover at a cost of 0,18% per annum. This is cheap and costs less than a KFC dinner per month for 2. Now if I was Mr. A, I would be looking to see how many KFC meals I could forfeit to be able to give my family some security.

Let’s say that he decides to start at R3mil at a monthly cost of R446-07 per month or R5 352-84 per annum. The contribution will automatically escalate at CPI (let’s say 6% per annum) which means that there is an escalation in the life cover as well. In 30 years time Mr. A will be paying approximately R2 600 per month for R10 000 000 life cover. He would have paid a total of R 423 185-82 over the 30 years… And he hasn’t died. The kids are big, he has quite a sizeable investment portfolio etc. The question now is, Does he still need the monthly cost of the policy?

Some may call this a waste of money. But here’s the kicker, he is definitely going to die one day and there will be this thing called Estate Duty. Estate Duty is a tax levied on one’s estate after you have died. Now this can cause a lot of problems for those left behind who may find themselves having to liquidate assets in order to pay these taxes. Simply put you pay 20% Estate Duty Tax on anything above the abatement of R3,5mil. By the way this R3,5mil has not been changed in years and may not be adjusted for years to come as this is a wealth tax. So as time goes by and wealth increases, the R3,5mil will become insignificant.

So let’s assume that Mr. A keels over on his 60th Birthday whilst mulling over the question of the cost of his policy and after eating too much cake. He has a net estate worth R53,5mil.

So the calculation is (R53,5mil – R3,5mil) X 20% = R10mil

There are 2 different outcomes.

  1. Without the life cover:- Assets with the value of R10mil has to be sold to pay the Estate Duty. The cost of this is R10mil and you can take poison that assets that have to be sold under duress never realise their full potential.
  2. With the life cover:- There is R10mil cash in the estate for the taxes and the beauty of this is that R10mil only cost R423 185-82.

Wouldn’t it be a pleasure to bring your estate duty rate down to 0,85% instead of 20%.

I know that I have simplified this to a great extent but the principle remains. Everybody needs life cover and it is required for life. Please make sure that you speak to a properly qualified financial planner and if you don’t have one, let me know and I will send you one.

Please feel free to to Contact Us with any comment or queries.

NMG Personal Wealth
Tel: 0860 664 790
Email: personalwealth@nmg.co.za