This is a very good question and one that I get on a fairly regular basis. Before I answer this question, I think it is important to note that you get two types of disability insurance cover. The type that pays out as a lump sum at claim stage (the insured benefit amount) and the type that pays out as a monthly income (better known as an income replacement policy). Lump sum disability insurance benefits are very popular in South Africa and in order to estimate what is an appropriate level of lump sum disability cover to take out in order to cover your salary, it’s suggested that the disability lump sum is converted into an equivalent monthly income. I am going to cover that little calculation later in the blog post for you.
You see, we take out disability insurance to protect ourselves against the financial loss we would suffer if we became disabled and couldn’t work. No work means no income. No income equates to a financial loss and that is what we are insuring against. It’s therefore important to note that when taking out any disability insurance cover your income is what is used to determine the amount of disability insurance cover you require.
The Life Officers Association of South Africa (LOA) has a code of conduct that it asks it’s members (financial advisor’s / brokers) to adhere by. Chapter (3) of the of the code deals with “Good Practice for Disability Insurance” and I am going to use this guideline for the purpose of this blog post.
Calculating how much Disability Income Replacement Cover (pays out monthly) to take out.
As I mentioned above this calculation is based on your gross income. If you become disabled and wanted a % of your current income replaced, how much of your income can you cover? The definition of your income should be clear when applying for cover and should exclude passive earnings such as interest and rental income unless intrinsic to your occupation.
The rule of thumb is that you are allowed to cover 75% of your gross income you derive from employment. Some life insurers will, however, allow you to top up to 100% of your gross income.
Example of how the calculation works:
John earns R20 000 gross per month as an employed Human Resources Manager. His company doesn’t offer any group benefits and he is interested in taking out some disability income replacement insurance. He would be allowed to take out a disability income replacement insurance policy that covers him for 75% of his income (R15 000pm). If he claimed, the insurer would pay out R15 000 per month to John for a stipulated term. If he applied with an insurer that allowed a top-up option, John could cover his full salary (100% of his income). The income at claim stage is deemed to be income like any other by SARS and is taxable. The good news, however, is that because the income is taxed at claim stage, the premium on the policy is fully tax deductible.
Calculating how much Lump Sum Disability Insurance to take out
When taking out lump sum disability insurance cover it’s best to use the following rate table factors below in order to determine how much disability cover you require to cover your income. The factors are a guideline and will be used to convert your income requirement into a lump sum disability figure. The majority of disability insurance cover will fall away at retirement age (normally 65) so you will see based on the table and example below that the older you are the less disability insurance you require.
|Age next birthday||Factor|
|Younger than 30||240|
|Between the ages of 30-34||200|
|Between the ages of 35-39||160|
|Between the ages of 40-44||140|
|Between the ages of 45-49||120|
|Between the ages of 50-55||100|
Example of how the calculation works:
John is 32 years old and earns R20 000 per month. He would like to take out lump sum disability insurance cover because his employer doesn’t offer any benefits and he would like to cover the income he might lose a result of permanent disability. He is however unsure how much cover he can qualify for.
Step One – Determine 75% of your gross income.
R20 000 per month income x 75% = R15 000 per month
Step Two – Multiply your 75% income by the factor (based on your age)
John is 32 (factor 200) x by his revised income R15 000 (75% of R20 000) = R3 000 000. John can take out R3 000 000 lump sum disability cover in order to cover his lost income if he became permanently disabled.
It’s easy enough, isn’t it? Now that you know how to do the lump sum disability insurance income calculation, feel free to get in touch if you require any formal disability insurance quotes.
Until next time when we will be looking at the importance of having an inventory for your household goods.
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