The question of whether or not you need income protection insurance isn’t likely to come up often, partly because we don’t like to think about something going wrong, but also because it’s all just a bit dull.
And anyway – isn’t that what life insurance and even its cousin critical illness insurance is for?
The majority of us will have to take some form of protection out at some point in our lives – whether to give us peace of mind that the mortgage will be repaid, or to ensure the family finances are secure if one or other breadwinner becomes too ill to work or worse.
But what many consider the most worthwhile form of protection insurance – one that pays you a monthly income if you are unable to work – has flown under the radar for the majority of people.
Income protection insurance, also known as income replacement, protects your monthly income if you can no longer work due to injury or illness.
It has never been a best-seller – partly because it is seen as complex, more expensive and pays out on a monthly basis instead of as a one-off lump sum.
Income protection has never been a best-seller but many see it as the best form of protection
It also hasn’t helped that income protection has been lumped together with the notorious ‘payment protection insurance’, also known as PPI.
Although the names are similar, these two types of cover are worlds apart in what they actually offer.
PPI covers a debt, and the payout goes to the lender. It was widely missold for years and the subsequent scandal is probably the best known financial misselling case in British history.
Income protection insurance is completely different.
This type of insurance pays out to you if you can’t work due to an injury or illness, such as a back injury, stress or a chronic condition such as multiple sclerosis.
Unlike critical illness cover, it doesn’t pay you out a lump sum – instead it will provide a monthly income of up to 80 per cent of your salary until you are healthy enough to return to work or you retire.
Some experts argue that this little known form of cover is actually the best form of protection insurance if bought right.
This type of cover pays out to you if you can’t work due to an injury or illness such as stress
Getting the right level of cover
One of the key considerations you must make when taking out cover is whether you want a policy that will pay out if you are unable to do your own job, or only if you can’t do a similar job or if you cannot work at all.
Policies generally fall into three different categories: ‘activities of daily living’, ‘suited occupation’, and ‘own occupation’.
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An ‘activities of daily living’ policy is the lowest level of income protection cover. This cover will only pay out if you are unable to complete certain tasks, such as walking or lifting.
Because the cover is limited, this are usually the cheapest form of income protection. It has a poor reputation and many experts agree it should generally be avoided.
If you are insured on a ‘suited occupation’ basis, you probably won’t get a payout if you are still capable of working in a role your insurer thinks you are ‘suited’ to after your injury or illness.
What is a ‘suitable’ occupation is determined by your skills, experience, and qualifications.
For example, a teacher no longer able to work in a secondary school because of stress may still be able to work in a primary school.
If you insurer believes you could move to another profession that you are suited to despite your injury or illness, you won’t get a payout.
‘Own occupation’ cover insures you against specifically not being able to do your own job – ie. the job you are holding at the point of making a claim.
As this is the highest level of protection, this is the most expensive type of income protection.
There are a lot of income protection policies around, but it is essential to realise they are not all the same. Cheap cover may not deliver when you need it, so it is worth paying for a good policy.
What do I need to ask my work?
One of the first things to do when thinking about getting cover is check with your employer what sickness benefits you are already entitled to.
Some employers will pay your full salary for a set period, before reducing how much they pay you over time.
In this instance, ‘stepped’ protection can help make up the difference. This means you will have the option to pick two different levels of cover, each with a different monthly benefit, which pay out at different times.
You might already have some form of income protection, and not realise it.
Some employers offer some form of this insurance as an employee benefit. Ask your work what you’re already covered for if you’re unsure.
Some employers offer will some form of this insurance as an employee benefit so ask them first
What to watch out for when taking out a policy
When buying this type of cover, premiums are either guaranteed or reviewable.
If they are guaranteed, this means they will stay the same over the policy’s term. If they are reviewable, this means they will be reviewed and changed, usually every five or 10 years.
Talking to an experienced independent adviser may be a good idea when picking exactly what type of cover you need.
You’ll also need to consider at what age the policy should finish. Usually, it is at around 65 to coincide with retirement although it is also possible to have shorter-term policies.
Not all income protection policies pay out at the same time. You’ll have a pre-agreed period that must pass following your claim before you get your payout – and this can range from one month after you put in your claim to up to a year.
This is known as a ‘deferral’ period, and your policy will be cheaper the longer you have to wait.
You’ll also need to consider the effects of inflation on your payout if you’re out of work for a long time.
If your policy only pays out a proportion of your salary as it was at the point of claim and doesn’t rise in line with inflation, in the future the cost of living could outstrip your income.
When taking out this type of insurance, you will have the option to index-link your cover so that it rises with the retail prices index, or the consumer prices index.
But remember, this means your premiums will also rise with inflation.
Unlike critical illness, which pays out as a lump sum, income protection pays out monthly
Are there any alternatives?
There is a similar type of insurance out there known as accident, sickness and unemployment cover. This is usually a short-term policy that can replace your income for up to a year if you fall ill, have an accident or get made redundant.
Though usually sold as a package, ‘accident and sickness’ and ‘unemployment’ cover can both be bought separately as standalone cover.
These products usually cover around 50 per cent of your income, and only pay out for a defined period. It’s because of this that they are considered an inferior product to income protection.
While premiums are a lot cheaper, there is no guarantee that you will be covered if you are unable to work for longer than the defined period.
There’s also critical illness insurance, which pays a tax-free lump sum if you are diagnosed with any of a range of illnesses listed in your terms and conditions, including some forms of cancer.
In the past, most providers would pay only if the illness was fully developed. But now many insurers pay at least something for an early-stage diagnosis.
Unlike income protection, critical illness pays out as a lump sum.
If you have any other forms of protection insurance, there may again already be some provision included that protects your income in the event of an injury or illness.
Double check the policy wordings on any existing insurance policies you have. Also, be wary of cheaper policies that seem too good to be true.
Insurers will want to know about pre-existing conditions, or illnesses that run in your family. They may not cover you for those specific illnesses in these cases, so always double check what you’re actually covered for.
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