Level term assurance - how much to put aside to pay for it?

PLEASE NOTE: I am NOT qualified to give financial advice and this is in no way intended as advice to purchase level term assurance (for that, you should seek proper advice from a qualified IFA).

====================================================================== I've been looking at taking out level term assurance and decided that (in my case, at least) it would be prudent to put enough money aside to pay for this in a separate account at the inception of this policy (as I can currently afford to do so) so that I need not worry about being able to pay for this throughout the term of the cover and therefore do not need to include cover for the premium payments themselves.

Anyway, being the mathematician that I am, I worked out an equation for calculating the necessary deposit up front that, along with an assumed rate of interest, and taking into account annual payments out of this account, will be sufficient for funding the policy on the basis that the premiums are guaranteed not to change throughout the term of the policy. For the benefit of the readers of this NG, here it is:

D = A(1 + (1+I) + (1+I)^2 + ... + (1+I)^(Y-1))/(1+I)^(Y-1)

where: D = initial deposit A = annual premium I = assumed interest rate (net of tax), 0 < I < 1 Y = policy term (in years)

NOTE: While I firmly believe that the above equation is correct (and my annualised statement in the example below seems to corroborate this) feel free to point out any problems with it or ask any questions as to its derivation.

As an example, if you were to take out a 25 year policy that is charged at £100 per year and assume a fixed interest rate of 5%, reduced to 3% after tax at 40% (a conservative assumption), the calculation would be as follows:

D = initial deposit A = 100 I = 0.03 Y = 25

Total premiums to pay = 2500.00

Initial deposit must be 1793.55

At end of year 1, balance = 1744.36 At end of year 2, balance = 1693.69 At end of year 3, balance = 1641.50 At end of year 4, balance = 1587.75 At end of year 5, balance = 1532.38 At end of year 6, balance = 1475.35 At end of year 7, balance = 1416.61 At end of year 8, balance = 1356.11 At end of year 9, balance = 1293.79 At end of year 10, balance = 1229.61 At end of year 11, balance = 1163.50 At end of year 12, balance = 1095.40 At end of year 13, balance = 1025.26 At end of year 14, balance = 953.02 At end of year 15, balance = 878.61 At end of year 16, balance = 801.97 At end of year 17, balance = 723.03 At end of year 18, balance = 641.72 At end of year 19, balance = 557.97 At end of year 20, balance = 471.71 At end of year 21, balance = 382.86 At end of year 22, balance = 291.35 At end of year 23, balance = 197.09 At end of year 24, balance = 100.00 At end of year 25, balance = 0.00

For anyone thinking of doing this, what I would suggest is that you do an annualised calculation as above and staple it to your paperwork. Then you can check your balance on account against the model every few years and, if it is deficient in any way (because of a period of particularly low interest rates) you only need to make up the difference in the feeder account to get back on track. Chances are, if your original interest rate estimate is conservative enough, you will never need to top the account up at any stage and may even end up with a sum of money remaining in the feeder account after the policy lapses.

If anyone uses Linux, I have written a simple perl program that does this calculation for you - PM me if you would like a copy.

HtH Reestit Mutton

Reply to
Reestit Mutton
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Have you considered a single premium policy?

Reply to
Doug Ramage

Call yourself a mathematician? You could at least have reduced it to something more manageable, like: D = A(1 - G^Y)/(1 - G) where G = 1/(1+I)

BTW, how big a lump sum would you need to set aside to fund the equivalent of endowment premiums (but really just regular contributions into something like an ISA) calculated to pay off your borrowed mortgage lump sum over its term? :-)

Reply to
Ronald Raygun

Fair dos. Substituting your G into my equation and looking up info on the sum of a geometric series (my knowledge of power series is very rusty these days) it becomes blindingly obvious now...cheers

Can I assume that you've already done this calculation, Ronald? Or is it a genuine question looking for an answer? Go on...show us the maths... ;-)

RM

Reply to
Reestit Mutton

Is it possible to get a single premium quote for level term assurance from most providers?

It would be worth a comparison with the lump sum required to fund the annual premium figure that I currently have (obtained from Cavendish Online, who refund 100% of their commission - they make their money from a one-off £35 application fee instead).

If it's cheaper to do in one payment, that may be ideal as I intend this level term assurance to run in addition to any work-related cover that may come and go as my employment changes over the years.

RM

Reply to
Reestit Mutton

I don't know what the position is currently.

I used to work for an insurance company, and all I had to was go to one of the company's actuaries who would calculate the premium for me. :)

Reply to
Doug Ramage

Just pay off the mortgage and be done with it

Reply to
Jonathan Bryce

If the (net) interest rates are the same, then it'll just be the loan times G^Y.

As it should make no difference whether you plough annual contributions into the savings vehicle or just leave the lump sum where it is for the mortgage term.

If the net interest rates are different it gets more complicated...

Reply to
Andy Pandy

Neither. I don't know, you put in a smiley and some folk still don't recognise a joke question. JB's answer hits the nail on the heid.

Have a go yourself, grasshopper, and I'll give you marks out of 0.

Reply to
Ronald Raygun

I did wonder...hence my smiley...and hence why I didn't bother doing the calculation...

cheers, RM

Reply to
Reestit Mutton

Bloomin' 'eck, Reestit, are you *everywhere*? ;-)

Jon

Reply to
Jon Green

Nope.

uk.finance was an old haunt of mine before my website came into existence. ;-)

RM

Reply to
Reestit Mutton

"Jonathan Bryce" wrote

But really, as Andy has shown, the amount will **not be enough** to pay off the mortgage anytime before the end of the term.

That's because Ronald only specified funding the "endowment premiums" - not the regular interest paid as part of the mortgage agreement as well - and hence the initial lump sum required *just* to fund "the equivalent of endowment premiums" is much less than the total mortgage lump sum advance.

Ah well. He tried to make a joke and failed this time (and Jonathan fell for it!) - never mind!!

Reply to
Tim

I think the whole point was that, unlike my original level term assurance scenario, the effective lump sum would be so large that it would be pointless NOT putting it into the mortgage at the outset and thus take out a substantially smaller mortgage.

Also, let's not forget that you will be paying interest on this sum while it's not in the mortgage so the growth in the endowment has to at least match the interest rate or it's pointless. Infact, I would argue that it has to have the potential to substantially beat the mortgage rate otherwise it's just not worth the risk.

Infact, my preference, if the mortgage is going to be *that* small, would be to take out a current account mortgage (or similar) and keep as much of the cash as possible in the savings/current account offsetting the mortgage. Make sure you go for a deal that allows 100% of the outstanding mortgage in savings (e.g Yorkshire Building Society).

When my partner came out of her redemption period a year or two ago, she wanted to pay off a large portion of her mortgage. As a result of some bullying, she moved her mortgage to the YBS Offset mortgage. Her intended mortgage size (after investing her spare cash) would have been too small for any lender to be interested in remortgaging her. But, by transferring her mortgage at its existing level and then paying the cash into savings after the transfer she got the size of mortgage that she wanted and has now completely paid it off via adding to those savings.

It's psychologically much easier to pay off your mortgage when you know the cash isn't tied up by doing so. I'd argue that most people would pay off their mortgage much quicker if they had a current account mortgage for this reason alone.

RM

Reply to
Reestit Mutton

Bearing in mind what you say below, I'm not sure it would be pointless.

Of course, and that's exactly what has made endowments so popular (before they became unpopular), aided and abetted by tax incentives, i.e. the fact that there has been a general expectation that endowments would overperform relative to their target, but also that the target itself was based on a rate of return which exceeded the loan interest rate.

The conclusion is obvious: If you had this lump sum available, you'd be better off *not* paying it off the mortgage (nor, equivalently, using it as a bigger deposit, so you could take out a smaller loan), because you would do better by plowing it into the same investent as the endowment is based on.

The down-side is the fluctuating nature of the investments involved, and so it could well be better to break up the lump sum, and to drip-feed it into the investment, to take advantage of pound cost averaging. The down-side of *that*, in turn, is that the lump sum being drip-drained is meanwhile underperforming, sitting in an unexciting low-rate interest bearing account.

The solution? Pay it off the mortgage, thereby "earning" interest at the high borrowing rate, but make sure it's a flexible mortgage, so you can periodically re-borrow chunks of it to transfer them into the endowment investment which returns at an even higher rate.

That sounds daft, borrowing more on your mortgage in order to help pay it off, but if you get the numbers right, it works.

Reply to
Ronald Raygun

...hence my suggestion about the current account/offset mortgage.

Anyway, why should it be an "endowment" scheme? The investment could be in anything theoretically, couldn't it?

Admittedly, no matter how sensible it might be, many don't feel comfortable with the idea of taking chunks of the offset balance and investing them - yet they were happy enough to enter into an endowment scheme to pay off their mortgage many years ago. Sometimes life just doesn't make sense.

RM

Reply to
Reestit Mutton

The reason for having the endowment premiums is to pay for an investment which will hopefully pay off the mortgage in 25 years time.

If you have a lump sum now which is about the same as the money you owe to the building society, then you could try putting it in an investment which generates enough income + return of capital to put into another investment which generates enough money to pay off the loan.

You could do this, and you might make a profit out of it. Then again, you might not. You might make a loss out of it.

Alternatively, you could just pay of the mortgage and be done with it.

Reply to
Jonathan Bryce

Ah, but the lump sum you have now is *not* about the same as what you owe the building society. It's only enough so that if invested for 25 years it will grow to reach the value of what you owe now.

Typically it would only be a third or so of what you borrowed.

Reply to
Ronald Raygun

"Ronald Raygun" wrote

Thanks Ronald. I wonder if Jonathan will understand your "... *not* about the same ...", better than my "... will **not be enough** ..." !!

Reply to
Tim

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