Thinking about how you’d keep up with your financial responsibilities if you couldn’t work due to illness or injury isn’t the most fun thing to think about.
But unfortunately, as most of us know only too well, life doesn’t always go according to plan, so it’s important to consider what sort of financial safety net you have in place in case something goes wrong.
A worrying number of people don’t have any kind of protection in place, leaving them with little financial resilience if they fell ill. Few of us are fortunate enough to be able to manage without an income, so having an adequate financial safety net can provide valuable peace of mind.
Here’s what you need to know.
What is a financial safety net?
A financial safety net is a blanket term for a set of measures you can put in place to protect your finances from life’s uncertainties, whether that’s an unexpected tax bill, a car breakdown, or not being able to work.
Financial safety nets look different from person to person but they can be a combination of all sorts of financial products including savings accounts and insurance policies. We cover the different types of financial safety nets in more detail below.
Why is having a financial safety net important?
Having a financial safety net is an important step in building financial resilience, so you’re better able to manage unexpected situations or emergencies.
Few of us would be able to manage our finances for very long if we lost our income and unfortunately, as we get older the likelihood of not being able to work because of illness or injury increases, so having measures in place to soften this blow can be incredibly useful.
A safety net can be especially useful when living costs are high, as they are at the moment, as many people’s disposable income will be taken up by additional costs. This can often mean that people are less able to manage unexpected costs or loss of income.
Unfortunately, this is particularly true for people aged 50 and over, 46% of whom said that they didn’t expect to have any disposable income this year, according to research carried out by wealth manager Quilter. This number suggests that large numbers would find themselves in financial difficulty if their income stopped.
Of course, when money is tight it might feel impossible to put aside any money for another rainy day, but even a few pounds each month can add up to a decent sized nest egg eventually.
What are the different types of financial safety net?
There are numerous approaches you can take to building a financial safety net, but generally, most people’s will include either savings accounts or insurance policies, or a combination of both these:
Savings accounts
Experts usually recommend trying to save three to six months worth of income as an emergency fund to fall back on. The type of savings account that people choose often depends on their goals, and as long as the account you choose offers a competitive interest rate and the features and flexibility that you’re after, there’s no right or wrong.
Two popular types of savings accounts for creating a rainy day fund are instant access savings accounts and notice accounts with a short notice period.
As the name suggests, instant access savings accounts are popular as you can access your money quickly if you ever need it. Some people, however, find an instant access savings account is a little too tempting to dip into, so a notice account with a short notice period, or one which limits the number of withdrawals you can make, can be a good option too.
While interest rates are starting to fall on some savings accounts, there are still some great rates available. You can discover current best buys in our articles Best instant access savings accounts and What are the best notice savings accounts?
Insurance policies
There are several types of protection policy that you can take out as part of your financial safety net, including:
Life insurance
More than half (63%) of homeowners and around a third (29%) of renters have life insurance in place, according to insurer Royal London, making it one of the most common insurance policies that people have.
When you take out a life insurance policy, you’ll pay monthly premiums, and if you die, the insurer will pay out a lump sum to whoever you nominate. This provides your partner and/or dependents with a financial cushion.
Generally, you’ll find that the younger you are when you take out your policy, the cheaper your premiums will be, as there’s less chance of a claim being made during the policy term.
Whilst it’s not a legal requirement to take out life cover at the same as you take out a mortgage, it is advisable if you want to ensure that the mortgage will be paid regardless of what happens. You can read more about life insurance in our article Life insurance for over 50s explained.
Critical illness cover
Critical illness cover is a type of insurance that is designed to pay out a tax-free lump sum if you are diagnosed with one of the serious illnesses or disabilities predefined in the insurer’s policy during the policy term.
The types of conditions that critical illness usually covers will vary between insurers, but normally include illnesses and disabilities that are long-term such as some cancers, heart attacks and strokes, and also usually include multiple sclerosis and Parkinson’s disease.
One key thing to be aware of with critical illness cover is that lots of conditions might not be covered, so you need to make sure to read the small print carefully before taking out a policy. Read more about critical illness cover in our guide Everything you need to know about critical illness cover.
Income protection insurance
Income protection, as the name suggests, is a type of insurance policy that’s designed to provide you with a regular income if you’re unable to work because you’re unwell or have had an accident or injury. However, redundancy is not usually covered by this type of policy.
Of all the insurance policy types listed here, income protection is the least common option with only 20% of homeowners and 6% of renters having a policy, says Royal London. This is despite there being a higher chance that you’d need to make a claim for this type of policy than any of the others. Royal London says that men face a 26% chance of being off work for two months or more, with this rising to 37% for women.
Again, you’ll pay monthly premiums and in the event you have to make a claim, the insurer will usually pay out a percentage of your salary each month, typically around half. You’ll be paid this amount until you’re well enough to go back to work, or until you retire or pass away, whichever happens first. For more information on income protection insurance, have a look at our guide Income protection explained.
How big should a financial safety net be?
If you’re thinking about building a pot of savings or an emergency fund as part of a financial safety net, then it’s useful to have a goal in mind of the amount you’d like to reach.
The size of the financial safety net you need will depend on your circumstances, but generally, making sure that you can cover your basic living costs, such as property costs, bills and food shops, for three months is a good target.
You can read more about this in our article How to build an emergency fund.
How can I build a financial safety net?
The best way to get started with a financial safety net is by mapping out a budget and working out how much you can realistically set aside each month after paying your mortgage or rent, bills, food costs and debts, if you have any. This is sometimes easier said than done, so if you want some tips on making a budget that you’ll actually use, have a look at our guide How to make a budget and stick to it.
Once you’ve worked out how much you can afford to put aside for your safety net each month, the next steps you take will depend on how big you want your net to be, how quickly you want it to grow and whether you want to open a savings account, take out an insurance policy or both. Remember, there’s no right or wrong way to build a financial safety net, and it’s important to take the approach that works for you.
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