What is income protection insurance?
Income protection insurance provides you with an income if you can’t work due to illness, accident or injury. After you have been unable to work for an agreed period of time (known as the deferred period) the policy starts to pay out. With the most comprehensive policies this continues until you can return to your normal job, retire, reach the end of your policy term or die, whichever comes first.
This insurance used to be known as permanent health insurance or PHI.
Why you might want it
If you can’t work because of an illness you may be entitled to state benefits, but these are modest. If you don’t have another source of income (such as a partner’s income or savings) to fall back on you might struggle to meet your financial commitments and maintain your lifestyle.
If you’re employed your employer may have its own sick pay scheme. But even the most generous scheme may mean a drop in your income over time. And if you’re self-employed there will be no employer help and you may have to rely on your savings.
How income protection insurance works
You choose a waiting period before the insurance pays out. The most common waiting periods are 4, 13, 36 and 52 weeks. The longer the waiting period, the cheaper the insurance will be.
When choosing your waiting period it’s important to think about how you would manage financially before the insurance would start to pay out. For example, if your employer’s scheme pays out for six months, it makes sense to have the insurance kick in after that. However, if state benefits would be your only income, you might need to consider a much shorter waiting period.
Many policies you take out yourself (rather than through an employer) pay out a maximum of 50% of your gross income although some offer cover of up to 70% of your gross income. This limit is usually the total for all the income protection policies you have so be careful not to over insure as you won’t be paid more than this.
The idea is to make sure that the income you receive whilst you’re sick does not leave you better off than when you were working.
If you take out your own policy, the pay-out is tax-free.
If it’s a policy arranged through and paid for by your employer, the pay-out is taxable as if it were your salary.
If you receive state benefits, then any income you receive from an income protection policy may affect your eligibility for these benefits so it’s a good idea to check the position with the insurer first before taking out a policy.
How long does cover last?
There are both long-term and short-term* income protection policies. Long-term policies usually pay out until you can return to your job, retire, reach the end of your policy term or die, whichever comes first. Short-term policies are cheaper but may only pay out income for a maximum period of say two or five years. Also watch out for policies which only pay out benefits until you can return to any form of work, not necessarily your usual occupation.
How much cover do you need?
This depends on how much you need to live on and what resources you’d have if you were unable to work such as state benefits, payments from an employer and savings.
*There are other providers of Payment Protection Insurance [Short-Term Income Protection] and other products designed to protect you against loss of income. For impartial information about insurance, please visit the website at www.moneyadviceservice.org.uk