What is income protection insurance and when do you need it?

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I’m not a big fan of buying endless insurance policies ‘just in case’. But income protection insurance is one that’s near the top of my list. Find out when you need income protection and what to look for.

What is income protection insurance?

Income protection insurance will pay a percentage of your salary (normally between 50% and 60%) if you can’t work because you’re ill. Payments from an income protection policy are tax free if you buy an income protection policy privately from an insurance company. However, the payments are taxed if they are from an income protection policy through your work.

The amount you pay in premiums will depend on:

  • Your age. The older you are when you take out the policy, the more you’ll pay each month.
  • The deferred period. This is the length of time between you falling ill and receiving payment. The longer the deferred period, the lower the premiums.

SAVVY TIP: Six months is a typical deferred period. Reducing it to 13 weeks will cost you a lot more. But increasing it to 52 weeks will cut the premiums by a relatively small amount.

  • Your health. Your family’s medical history will also be taken into account.

SAVVY TIP: If you have an exclusion, which means the income protection insurance won’t pay out if you can’t work because of certain illnesses. Some insurers will reduce your premiums to reflect this. Others won’t.

  • The job you do. Some occupations have a higher sickness rate than others.
  • How the policy pays out. Some policies will pay you if you can’t do your own job. Others if you can’t do any job at all.

SAVVY TIP: Be warned; if you choose a policy that will only pay out if you can’t do any job, you could find you have to be very ill to be able to trigger a payout. Examples of tasks you’d have to be incapable of doing include using a pen, pencil or keyboard with either hand and being able to lift a weight (often around 1kg) and carry it for five metres.

  • Whether your premiums will rise. You can choose to let your premiums rise as and when the insurer decides or opt for guaranteed premiums. Guaranteed premiums will stay the same (or normally, increase by inflation).

SAVVY TIP: Guaranteed premiums are likely to be more expensive at the start, but you’re reducing the risk that you won’t be able to afford the policy in the future if premiums were to rise sharply.

How much income protection insurance do you need?

Before buying an income protection policy you should:

  • Check sick pay offered by your employer. Find out how long you would get sick pay for if you were unable to work.
  • Work out how much you’d need to be able to live on, bearing in mind that you won’t be able to insure more than 60% of your salary as payouts are tax-free (or 75% if it was a policy provided by your employer, in which case you’d be taxed on the money you were paid).
  • Calculate how long any savings you have would last.

SAVVY TIP: It’s a good idea to make sure your payout will rise by inflation so that you can keep up with increases in living costs if you can’t work for many years.

When you won’t need a private income protection policy

Having given a few reasons why income protection insurance is a good idea, there are situations where you don’t need to buy it. If your employer gives you income protection or subsidises the cost as a perk of your job, you won’t need to buy your own policy. The cover that you get through a plan that your employer has arranged may be better than a policy you could buy privately.

SAVVY TIP: It’s easier for you to get insurance through work if you’ve had health problems or a serious illness in the past because the insurer will agree to cover all employees no matter what their medical history is.

Useful links:
Lifesearch: income protection, life insurance and critical illness brokers who really know the market inside out.

Related articles:

Critical illness insurance; how to buy the right policy

How depression can affect the cost of some insurance

Complaining to the Financial Ombudsman Service

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