Today: the story of Mr and Mrs Lim. Mr Lim makes RM7,000 a month as an IT engineer. His wife earns RM4,000 a month as a human resources executive.
Years ago, they took out a mortgage to the sum of RM450,000 to buy their home. Its instalment is RM2,000 a month, with Mr Lim servicing the payments in full despite it being a 50-50 joint mortgage.
They also purchased a Mortgage Reducing Term Assurance (MRTA) policy to cover the amount, with the sum assured also split evenly between them. An MRTA policy takes care of your mortgage payments in the event of your death or, in some cases, a terminal illness or disability.
Then one day, tragedy strikes, and Mr Lim passes away. Thus arises the following questions:
1. How much is the mortgage balance?
They still owe RM400,000 on their mortgage, which is close to their MRTA policy’s assured sum. As such, the mortgage balance is partially settled and can be successfully brought down to RM200,000.
2. Is the mortgage instalment lowered, too?
No. The bank still requires RM2,000 a month in instalments as usual. This will be a burden on Mrs Lim, as this amount is 44% of her monthly income. If she has other financial obligations, her cashflow situation will be tight and may potentially go into the negative.
So, it is crucial to note that while an MRTA can help settle debt amounts, it may not improve your monthly cash flow, especially if the mortgage is only partially settled.
The Lims have failed to consider this. Instead of a 50-50 split, they could have had Mr Lim be the sole life assured under the MRTA policy, especially since he was servicing the repayments in full.
It would, therefore, have been possible for the loan to be fully settled upon his death.
3. Could Mrs Lim have the loan duration extended?
She could certainly try but to do this, she’d need to talk to her banker and make legal payments to restructure the existing loan agreements. In the meantime, she has to continue repaying the RM2,000 monthly.
4. How might such a financial burden be relieved?
Mr Lim could have bought a life insurance policy and nominated his wife as the beneficiary. Upon his passing, Mrs Lim would inherit the insurance proceeds, and either choose to
- settle the mortgage balance in full, or
- service it on a monthly basis as usual.
The first option offers certainty when it comes to the use of the full sum assured, even though Mrs Lim loses out on a cash buffer, liquidity, and investment opportunities. Still, it guarantees the money is not squandered.
The second option offers Mrs Lim the potential to maximise her wealth. This, however, assumes she is able to make good investment decisions and not indulge in exorbitant spending.
Mrs Lim could also have set up his own living trust and placed cash into it. By doing so, Mrs Lim could collect cash payouts from the trustee if she is nominated as a beneficiary.
Finally, Mr Lim could have nominated his wife as a beneficiary of his EPF account. Mrs Lim could inherit his EPF money and use it to service the mortgage.
5. What of Mr Lim’s financial assets?
You might ask, aren’t his assets automatically transferred to his wife upon his passing?
No. Mr Lim’s cash, stocks, properties, fixed deposits and so forth are frozen upon his deise. It would take time to have them transferred to his legal beneficiaries – assuming he prepared a will.
Mrs Lim would need to locate this will, find its executor, and have them apply for its grant of probate. Then the executor would need to round up Mr Lim’s estates, settle his debts and taxes in full, and finally distribute the remainder to his beneficiaries.
The entire process could take up to two years to complete. Without a will, it could take up to five years.
In the meantime, Mrs Lim would have to continue to service the mortgage instalments out of her own pocket, since her husband’s financial assets have been frozen.
So, what can be summed up from all this?
An MRTA policy is useful for settling debts, but you need to consider the cashflow burden imposed on your beneficiaries.
It is more practical if the life assured is the major breadwinner or biggest income contributor of the family or relationship.
Estate planning is essential to ensure financial stability. The Lims would have benefited through a combination of a will, trust, life insurance policies, and EPF to structure a financial safety net.
This article first appeared in KCLau.com. Ian Tai is a financial content writer, dividend investor, and author of many articles on finance featured on KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore.