Case Study 1: Protecting Your Income - Your Most Valuable Asset

Leanne is a hairdresser in a busy salon. With an income of $36,000 she needs to jointly service the family mortgage of $240,000 that she and her fireman husband Rob share, as well as support their six year old daughter, Tayla.

A lover of all sports, Leanne and her family set off for a small ski resort in Thredbo in early July where within two hours of arrival, Leanne had badly twisted her knee - the prognosis didn’t look good; a knee reconstruction was necessary.

Having a knee reconstruction meant Leanne was going to be completely off her feet for at least three months and when she was able to return to work she would only be able to do so at 50% capacity.

Fortunately for Leanne, she had taken out income protection insurance for 75% of her monthly income.

She received the full 75% figure of $2,250 for two months after her initial 1 month waiting period, where she was covered by sick leave. When she returned to work 21⁄2 days per week she was able to receive 50% of her monthly benefit based on the 50% loss of income.

With the added protection of her income protection policy, Leanne received $12,750 during the five months she was disabled. Without this, Leanne’s earnings would have been $6,000.

Case Study 2: Protecting Your Wealth - Mike & Diane's Story

Mike and Diane celebrated Australia Day 2002 much like any other Australians - with a barbecue and beer. But no beer for Diane though, with only 6 weeks until the birth of their first child.

Five days later, their whole world was turned upside down when Diane suffered a severe brain aneurysm, leaving her comatose and requiring immediate life support. While doctors felt Mike and Diane's baby could be saved, they were not as confident about Diane. Six days after the aneurysm, baby Makenzie was born by Caesarean.

The long road to recovery

Diane remained on life support for a further three weeks before waking up and becoming aware of her precarious situation. Significant paralysis throughout the right side of her body meant she was not only paralysed but also unable to communicate clearly. The aneurysm also left Diane suffering from Aphasia - a neurological disorder causing language and comprehension difficulties.

Three months of intense rehabilitation saw Diane re-learn how to walk, talk and do everyday tasks like boiling water.
Things were now starting to look up for the family from a health perspective. Their financial situation, however, was a different story.

Battling an uncertain financial future

Before Diane's life threatening aneurysm, her future looked set. They were financially secure with a mortgage on their home in one of Brisbane's inner city suburbs and a baby on the way. Diane was earning around $50,000 pa. as an HR manager, while ironically Mike had recently given up a 6-figure salary to begin his studies in financial planning. Two years prior to marrying Diane, Mike was advised to take out income protection insurance which he did - just in case. However, he was not advised and didn't consider reviewing Diane's insurance requirements. And unfortunately, illnesses like brain aneurysm's do not discern between those who have insurance and those who do not.

Without the benefit of insurance for Diane and with Mike in the middle of a career change they could not afford assistance at home. However, Diane could not cope at home alone with her disabilities and a baby, so they moved in with her parents. In order to continue to reduce their level of debt, the couple rented out their inner city home.

The hard road to independence

After nearly nine months of these living arrangements, Mike and Diane decided the time had come to go it alone. Unfortunately, as their level of debt was still too high to allow them to move back into their inner city home on just one salary, they moved to a suburb much further out to start their new life.

Had Mike and Diane had the benefit of insurance behind them, this story may have had quite a different ending. They might still be living in the inner city home they worked so hard to achieve, and they might not have had to depend on Diane's parents for so much assistance. While Diane's great determination helped her to succeed in learning to walk again (in fact just 18 months after the aneurysm, she ran the 42km Sydney marathon) and communicate effectively, the added pressures the couple experienced financially could have been avoided had they been advised about protecting their wealth.

Case Study 3: Salary Sacrifice and Insurance

Tony wants to take out life insurance cover and he has a choice of funding it outside or inside superannuation. Tony has $1,000 he wants to spend on insurance premiums. If he were to hold the insurance outside of superannuation, Tony would need to pay the premiums for his own net income (ie gross income less income tax). Tony is on the highest marginal tax rate of 45% plus 1.5% Medicare levy. The after tax value of Tony’s $1,000 is $535, this means that Tony would have only slightly more than half of his initial $1,000 to pay insurance premiums.

If Tony chose to hold the insurance inside his superannuation fund he could salary sacrifice the $1,000 to pay for the premium. The $1,000 contributed to the superannuation fund by Tony’s employer will be taxed at the concessional tax rate of 15%. However, where the tax deduction for paying the insurance premiums is used to offset the 15% tax, the whole $1,000 is available, meaning that the insurance premiums are being paid with pre-tax contributions. However this is done on a fund-by-fund basis and you should check whether your superannuation fund credits deductions received for insurance premiums paid back to the member’s account.

Outside of superannuation, Tony is using $1,000 of pre-tax money to pay a premium of $535. If Tony was paying the same premium via his superannuation fund, he would only need to salary sacrifice $535, he would save $465.
Alternatively, if Tony had the insurance inside his superannuation fund he could use the entire $1,000 to pay the insurance premium, effectively achieving almost double the cover for the same amount of pre-tax money.

Some issues to consider

A number of issues should be considered before entering into any salary sacrifice arrangement:

• A concessional contribution cap (which includes contributions from salary sacrifice arrangements) of $50,000 applies. This cap is indexed annually, increasing in $5,000 increments. For people aged 50 and over a transitional cap of $100,000 applies until 1 July 2012.
• Contributions that are made to superannuation through salary sacrifice made after 1 July 1999 are subject to the Government’s preservation rules. This means that any contributions made must generally be kept in the superannuation fund or rolled over to an approved fund until you retire at or after age 55. Contributing additional funds to superannuation is not a viable solution if you wish or have a need to withdraw the funds prior to retirement.
• Before arranging a salary sacrifice arrangement, you should check that this will not affect other entitlements that you have with your employer, such as workers compensation.
• Salary sacrificing may not be appropriate for those in low income tax brackets.

Effective salary sacrifice

Salary sacrifice is only effective if the following conditions have been satisfied:

• As an employee you must elect to enter into the salary sacrifice arrangements prior to the point in time at which any relevant employment services are performed, or prior to the commencement of services. In other words, salary sacrifice must not be retrospective. Salary sacrifice arrangements must be made in writing between you and your employer.
• Your cash salary must not be reduced below the minimum level specified in any relevant award or industrial agreement.

Case Study 4: Estate equalisation

Ted, a widower and third generation farmer, has worked on the family farm his whole life. Ted has groomed his son, Stephen, to take over the farm (valued at $1.2 million, including a current uncrystallised $294,000 capital gains tax liability) when he decides to retire.

Ted suffers a stroke while drenching the sheep and dies a few days later. In his Will, Ted left the entire farm to Stephen. Realising this would be an unfair result for his two daughters, Carol and Laurel, whom he also wants to provide for on his death, Ted had taken out a life insurance policy so that his daughters would each receive a lump sum amount of $906,000 - equivalent to the value of the farm left to Stephen less the capital gains tax liability. In this way, Ted has ensured his wishes to maintain the farm within the family are carried out yet managed to treat all his children fairly.

Tips and traps

• Family Maintenance provisions vary in each State. You should get professional legal advice in relation to the provisions in your State, including whether arrangements made under an estate equalisation strategy will be sufficient under each State’s provisions.
• An uncrystallised capital gains tax liability may reside in the business passed onto the child(ren). To ensure all beneficiaries are treated equitably and to account for the future payment of this and any other liabilities, the insurance benefit provided to the other child(ren) may be less than the ‘full’ value of the asset.
• There are a number of different ways of ensuring the life insurance proceeds are received by the intended beneficiaries. Some of these methods include having the intended beneficiary as the policy owner, nominating them as a beneficiary of the policy, or through the operation of your Will. Each alternative may have different legal and tax outcomes which you should consider before settling on a particular arrangement.
• To maintain fair treatment amongst your children, you should update your insurance cover in line with the (increasing) value of your business. Failing to do this may lead to one or more beneficiaries receiving less than others.

An estate equalisation strategy addresses one issue in estate planning. Comprehensive and professional estate planning advice should also be obtained, acted upon, and regularly reviewed.

Case Study 5: Caring for your family when you are no longer able

Recognising the need to protect the future of their three children, John (5), Michael (31⁄2) and Belle (2), Peter and Wendy have decided to list out their future financial commitments.

Peter expects to work for another 27 years and will continue to support his family financially for at least 18 years. Based on day-to-day commitments, Peter should insure for a minimum of $590,400 for death and total and permanent disability (simple calculation of 18 years @ $32,800 per annum and not taking into consideration the increases in the cost of living). Provisions should also be made to clear any family debts at the same time.

Should Peter die or become totally and permanently disabled, the insurance lump sum benefit can be used to maintain the family's financial commitments and lifestyle. Peter may also consider the option of critical illness insurance, protecting his family’s lifestyle in the event he suffers a serious medical condition (as defined by the policy).

Tips and traps

• The lump sum insurance benefit can be invested to provide a long-term income stream. You should seek advice at that time as to the most appropriate investment vehicle to provide an income stream.
• The cost of living (usually measured by the change in the Customer Price Index [CPI]) generally increases over time. You should consider insurance policies which allow you to automatically increase your cover in line with increases in the CPI.
• When calculating the lump sum requirement, it is important to accurately detail your commitments at the time of implementing the strategy.
• It is not unusual for additional expenses to be incurred at the time of the death, permanent disability, or critical illness. It would therefore be reasonable to make additional provisions for such expenses eg. funeral costs, relief childcare, nursing care etc, as applicable.
• It is important to protect all those whose death, disability or critical illness would have a serious financial impact on the family.

Case Study 6: Eliminating debt on death or disability

Wendy and Peter have three children, John (5), Michael (31⁄2) and Belle (2). Wendy has been a full-time homemaker for the past five years, while Peter, a computer technician for a small software company, is the breadwinner of the family and earns $60,000 per annum. Their family home is valued at $290,000 and they currently have an outstanding mortgage of $218,000
repayable over 30 years. A large proportion of Peter’s income is used for the mortgage repayments.

In the event of Peter’s death or permanent disability, Wendy will need to find funds to continue the mortgage repayments. Her options would be:

Had Peter and Wendy planned ahead and set up an insurance policy that would, as a minimum, clear the outstanding mortgage of $218,000 upon Peter’s death or permanent disability, the financial strain on the family would have been reduced. Importantly, Wendy and the children would be able to continue to live in the family home.

Ideally, Peter and Wendy should plan to not only clear the debts but should also make provisions for day-to-day living expenses to reduce the dependence on government assistance.

Tips and traps

• You may be able to nominate a beneficiary for benefits payable on your death. This allows the death benefit to be paid directly to the beneficiary(ies).
• In conjunction with a professional adviser, you should consider your entire estate planning position, including your Will, to ensure your wishes are carried out upon your death.
• You should ensure your levels of insurance cover are adequate for your needs. Underinsurance can present a serious problem.
• Changes in your personal circumstances (eg. taking on additional debt) often necessitate higher insurance levels. You should consider insurance policies which allow you to increase the level of cover in the future without requiring further medical evidence.
• For certain people, there may be advantages in having life and total and permanent disability insurance through a superannuation fund.

Case Study 7: Not underestimating the value of the homemaker

Nicholas and Rebecca had been married for seven years with two young children Michelle (4) and Jake (2). Rebecca had taken some time out from the workforce as a theatre nurse to care for the children.

Nicholas, a consulting engineer, earns $95,000 per annum and has a comprehensive package of insurance cover provided by his employer which includes life, critical illness, and income protection insurances.

Twelve months ago Rebecca visited her general practitioner to investigate a lump in her breast. Although Rebecca was in the medical field herself and regularly conducted her own self examinations, the results confirmed her worst fears, a diagnosis of breast cancer. Sadly, Rebecca’s cancer was particularly aggressive and, despite intensive treatment, she died within 6 months of diagnosis.

While both Nicholas and Rebecca recognised the importance of insuring the breadwinner, what they didn’t plan for was to protect the vital role of the homemaker. Even without the additional medical expenses for Rebecca’s treatment and funeral, Nicholas’s financial worries have only just begun. Nicholas has worked out just how expensive it is to run the household and look after the children without Rebecca.

The total amount accounts for almost 30% of Nicholas’s after-tax salary for the period until Michelle turns 15 (11 years) and does not take into consideration any future increases in the cost of living.

A combination of life and critical illness insurances could have provided Rebecca’s family with a lump sum which could be invested to pay for these additional costs over the upcoming years.

Tips and traps

• The selection of life and total and permanent disability insurances for a non-working spouse may have tax advantages for the breadwinner. By taking this insurance through a superannuation fund, premiums (contributions) made on behalf of a non-working or low income spouse, may attract a tax offset of up to $540p.a.
• Don’t forget to also take into account both outstanding loans and ongoing living expenses, and to ensure these can also be covered through adequate insurance.
• Consider whether using a level premium structure as opposed to a yearly premium that increases each year with age is suitable for you. While level premiums are generally not guaranteed and the premium rates may change in the future, they can be more cost–effective over time and allow you to budget for a consistent premium.
• The insurance could be owned by the working partner, thus ensuring complete control over the financial situation during a period of emotional stress. In addition, packaging insurances together may save money on policy fees.