Unlike a lot of the UK working population, you’ve come to the conclusion that, should you get ill and can no longer work, or do the job you currently do, or need to go long-term sick, you couldn’t get by on your sick pay. So should life see an unfortunate change in your circumstances, what would your options be? You couldn’t survive on government benefits; you don’t have enough savings; your partner couldn’t support you; and there’s no possibility for taking early retirement; therefore you need some sort of income protection insurance. That, at least is one positive decision made. However it can be a bit of a minefield out there, in terms of finding the right policy to suit you and your family. Therefore the question you’re probably asking yourself is: which kind of income protection do I need and how do I find it?
This article seeks to take a bit of the mystery away from this, relatively unknown and underutilised, insurance. Most people don’t realise that most employers don’t support staff if they’re off sick for more than a year and Statutory Sick Pay from the Government will not cover most people’s mortgage and typical household outgoings. Did you know that whilst around 40% of the UK has basic life insurance, and around 20% has private medical insurance, but only around 10% has some form of Income Protection (IP)?
What is Income Protection insurance?
So what is Income Protection and how can it provide the peace of mind you’re looking for? In simple terms, if you can’t work due to sickness or disability, this insurance cover will provide you with a tax-free ‘income’ until you can either return to work, or you reach retirement age.
Should you need to make a claim, the amount of ‘income’ you’ll receive from your cover will depend on your chosen policy. It won’t be the exact amount of money you were earning before you had to stop working. There is a maximum benefit that the policy will cover as this cannot put you in a better financial position than if you were still working, this varies with each provider but on average is around 55% of your gross income. It also won’t be paid out straight away; you’ll need to have been off work for a ‘deferred period’, which varies depending on your choice of policy and situation. You will then continue to receive payments until you can either return to work, the end of a claim period, typically two years, on a short term policy or until the end of your policy duration on a long term policy which is usually until your retirement.
Please note. One of the essential considerations when asking, ‘which kind of income protection do I need?’ is whether you’re looking for an income should you be made redundant. Income Protection does not cover redundancy but there are policies that will cover this and should be discussed with an adviser due to the limitations of the policy required.
Another consideration before taking out an income protection policy is whether you’re already covered. Some employers, although not many, do offer this as a benefit, so it’s worth checking your contract or employment handbook first as any continuing income from the employer will impact on the ability to claim on the policy.
How much Income Protection Cover do I need?
This will depend on three main considerations:
1 - What percentage of your income you'll require
2 - How long you think you'll require the policy to pay you
3 - How long you think you can get by before the policy will start to pay out (i.e. the 'deferred period' you select).
In terms of income, you can normally insure for up to 65% of your pre-tax salary. It’s key to not underestimate this in order to keep the cost of the premium down. You’ll therefore need to take into account whether the income payout will cover all of your essential outgoings, such as food, utility bills and mortgage.
So, what are the different types of Income Protection?
In regards to length of pay out, there are two main types of policy: Short Term Income Protection Policies and Full Term Income Protection Policies.
Short term policies generally only pay an income for two years, although a payment period of 1 and 5 years can be selected with some providers, and you need to be aware of this when asking which kind of income protection I need. Longer term income protection insurance policies tend to provide a monthly income until you’re either well enough to return to work or until the end of the policy term.
Finally, you will need to choose how long you’ll be happy to wait until the Income Protection policy will start to provide the ‘income’, i.e. the ‘deferred period’. The Policy cost will factor this in. The waiting period can be as little as one day, to as long as 104 weeks. Choosing a longer deferred period reduces the cost of the premium.
How can I cut the cost of an Income Protection policy?
An Full Income Protection policy will usually cover a certain percentage of your income until retirement, whilst you’re out of work due to illness or incapacitation. The alternative is to rely on Government benefits, but depending on your circumstances at the time, you may not be eligible to receive them, and the likelihood is that they won’t cover all of your monthly outgoings. Reducing the cost of an Income Protection policy depends on balancing the risk of not being able to cover all your financial liabilities against the monthly or annual insurance premium.
There are various factors that can affect the cost of an Income Protection policy. You could consider a limited term income protection policy which will reduce the cost due to the Insurer paying out for a shorter period in the event of a claim. This would generally be two years rather than to retirement age.
You can also reduce the sum assured from the maximum available to the minimum you need to maintain the essential household outgoings. You could also increase the deferment period if you have savings you can call on in the short term.
Before you purchase any Income Protection policy we recommend you review your personal situation first and write down your monthly budget requirement. A robust evaluation will enable you to gauge a true picture of what you really need and this in turn could reduce your premium cost.