Why it pays to take out income protection
Covering yourself with income protection could help you avoid financial struggles if you were unable to work. We explain how it works and what to look out for.
You may wonder how you might pay your mortgage if an illness or injury prevented you working. Nicola Downs, director at Trentham Invest, says ‘The impact of you stopping working could be devastating for your family.’
Protecting your loved ones by taking out income protection insurance that pays out if you become unable to work could prove to be a wise move. Here we explain how it works and why it could make a big difference:
What help is available from the government / my employer?
Many of us expect the government – or our employers – to step in should we become unable to work. And indeed the state benefits you qualify for can offer some limited help, particularly if you have a mortgage. You may even qualify for housing benefit, but it can take months to arrange and normally will only cover the interest on your loan.
Even if you are employed full-time, your employer will also generally stop paying your full salary after a period of time – leaving you and your family to survive on benefits. This can be from as little as £85 per week.
How can income protection insurance help?
Designed to help cover your outgoings while you are unable to work, income protection kicks in if you have an accident or fall ill. Payments should therefore start as soon as you suffer a loss of income.
If claimed in accordance with your policy’s terms and conditions this could be within a few weeks of your accident or – if your contract states that your employer will continue paying your full salary for a set time – the payments could start when your salary payment stops. In other words, you can defer payment of benefits to suit your circumstances and reduce the cost of the cover.
You’ll also need to consider how much income you want to receive while you are not working. You can generally choose to receive up to 75% of your salary but, again, you will pay less for cover if you think you can survive on 50%.
I have critical illness insurance. Is that not the same?
Protecting your financial security with critical illness insurance is a sensible move. However, insurance of this kind does not replace the need for income protection cover because the benefits offered are very different.
Critical illness insurance pays out a lump sum if you are diagnosed with an illness that is included on a pre-determined list.
Income protection insurance, on the other hand, pays you a regular income if you are unable to work due to an illness or an injury.
What else do I need to know?
No matter how comprehensive the protection, insurance of this kind will not cover loss of income due to redundancy or being sacked by your employer. Illnesses that you have had in the past are also likely to be excluded, as are certain professions.
Deep sea divers, for example, will find it hard to find cover, while short-term contract workers will generally be turned away. Checking the small print before taking out a policy is therefore crucial.
‘Read the terms and conditions of the policy carefully, and make sure you understand all the definitions,’ says Nicola.
‘You may, for example, be surprised that an insurer who refuses to pay out for claims linked to misuse of drugs considers forgetting to take prescription medicine as a form of “drug abuse”.’
Practicing extreme sports such as skydiving or rock climbing will also push the price up due to the risk of injury.
Income protection insurance: key things you need to know
All financial goals depend on a consistent monthly income. This type of insurance is designed to help keep your plans on track, if illness or injury stop you from working.
Imagine you got so ill that you couldn’t work for months on end. Or imagine you got injured in an accident and had to take months or years off to recover. Would your employer give you enough sick-pay to cover your essential outgoings? If you are self-employed how would you cope? Would you have to dip into savings to get by? And how long could you cope if you had to rely solely on the state to help out?
Income protection insurance is designed to banish worries like these by replacing some of your income until you’re able to work again or until you retire – whichever comes first.
How it works
- It replaces part of your regular income. When you take out an income protection policy, you have to agree what proportion of your regular income you want to cover – and the more you want to cover, the higher the premiums you’ll have to pay. You can typically only cover up to 75% of your regular income before tax, but the payments you receive will be tax-free.
- It pays out after an agreed ‘qualifying period’. A set amount of time has to pass between the moment you become unable to work and the first payment you receive from the insurer. The length of this period affects the size of your premiums. So, if you’re willing to wait for longer until the policy kicks in then you’ll pay less for the cover. It’s worth thinking carefully about this when you’re deciding which policy might be right for you. If you have an employer that offers generous sick-pay for a long period of time then you may be able to pay less for the cover you need. If, on the other hand, you are self-employed and do not get any sick-pay at all, you may wish to opt for a very short qualifying period such as four weeks.
- It won’t cover certain things. If you have a dangerous or a highly specialised profession, you may struggle to find an income protection policy that will cover you. Workers on short-term contracts can also be refused, and some policies will only cover you for physical work if injury stops you doing particular tasks such as lifting, bending and climbing. There may also be some exclusions on income protection cover – specific types of illness or situations that won’t be covered. These exclusions will vary from policy to policy, but they’ll typically include pre-existing medical conditions (e.g. any health complaints that you knew about when you bought the insurance), and any forms of injury or illness that are self-imposed.
- It only pays out under an agreed set of circumstances. Most types of illness and injury are covered by income protection insurance, subject to the exclusions mentioned above. However, your policy will specify when it pays out, based on a definition of your ‘incapacity to work’. For example:
- Own occupation’ – you are unable to do your usual occupation but could still do other work
- Suited occupation’ – you can’t do any job that your qualifications, skills and experience make you suited to (as judged by the insurer)
- Any occupation’ – the lowest form of cover by far, it will only support you if you can’t do any job at all.
Do you need it and what does the state provide?
If you’ve got children or if your partner depends on your salary then income protection insurance could give you real peace of mind. But even if you don’t have any dependants at all, it’s worth considering to maintain your standard of living and financial independence.
Your employer may offer you generous sick-pay and/or support you over a long period of time. As a minimum, however, you’re only entitled to 28 weeks of Statutory Sick Pay at a rate of £88.45 per week. You can find out more about SSP here. (You may also be entitled to an Employment and Support Allowance (ESA) of up to £109.30 a week, no matter what your employment status.)
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