Everything you need to know about income protection insurance, but were afraid to ask.
What is income protection insurance, do you need it, how do you apply for it and how do you find the best cover?
Protect Your Ability to Earn an Income
The most valuable asset in your life is your health. If you want to test me on this, ask someone who is not 100% healthy and they will back me up.
Having good health allows you to work. Working enables you to earn an income. Earning an income allows you to enjoy your life.
— The Wealth Guy (@TheWealthGuy_) August 3, 2015
The Biggest Risk
The biggest risk you face on a daily basis, is suffering an injury or illness which affects your health and in turn your ability to earn an income.
Introducing Income Protection Insurance
Income protection insurance keeps the money flowing when you can’t work due to serious illness or injury.
The income protection policy will provide you with a regular monthly payment for a specified period to replace a proportion of the taxable income you would otherwise have earned from working.
Did you know:
Not Just for Old People
Here is the income protection claims TAL paid out in 2014 according to the age of the claimant:
Video: Real Life Stories
What Does Income Protection Insurance Cover?
For an income protection policy to be triggered you must have suffered an illness or injury that renders you:
- unable to perform all the important income producing duties of your primary occupation (the job you did before the injury event)
- unable to work (whether remunerated or not); and
- under the care, treatment and following the advice of a registered doctor.
So if you are capable of working part-time in your primary occupation or if you are working in any capacity, you would not be considered disabled.
CHART: Income Protection Claims by Type
* 2014 TAL claims statistics
Income Protection Does Not Cover
It is worth noting that income protection does not cover you for:
- losing your job (being fired, or made redundant); or
- your business failing.
There are other insurance covers which you can get for such as redundancy cover and business expenses cover.
How Much Cover Can I Get?
Here is the catch; you cannot cover 100% of your income.
The maximum you can cover under an income insurance policy is:
a) 75% of income
b) 80% of income (with the super contribution option)
There must be some disincentive to receiving income protection insurance, which would make you want to return to work if possible. If you were getting 100% of your income under an insurance policy, you would probably prefer not to work. If you are only getting 75% or 80%, you are more likely to do everything in your power to return to work.
How Much With It Cost?
The cost of insurance cover is known as the premium. From an insurer’s point of view, the younger you are the less of an insurance risk you are. The less of a risk you are the lower the annual insurance premium for that policy.
WEALTH TIP: If you setup your policy correctly, income protection insurance premiums can be tax deductible.
When it comes to the income insurance premium there are two options:
- Stepped premium – one that will rise every year, with your age and risk level.
- Level premium – one that will remain constant.
Here is the catch; under a level premium you will generally pay a higher premium for the first few years, when compared to the same policy on a stepped premium.
Example: Stepped vs Level Premiums (over 30 Years)
Consider a 30 year old graduate accountant from NSW, earning $75,000 per annum. The lifetime cost of 75% income insurance until age 60 years is as follows:
- Stepped premium = $90,019.80
- Level premium = $59,788.60
As income protection insurance is such a crucial and long held cover, we often recommend level premiums.
The irony with stepped cover is that most people won’t be able to afford to premium cost at a time when they likely need it the most, between the ages of 50 – 60 years (think premiums costs of $10,000 + p.a.).
Is There a Waiting Period?
For payments to start under an income protection policy, you need to be continuously disabled for a defined period of time. This is known as the waiting period.
Ask yourself, how long could you survive without an income? For many people the answer to this question could be as little as 14 days.
If you get injured and cannot work for a period, you can be assured that your expenses won’t stop. In fact in many cases, due to medical bills, living expenses may actually increase over this period.
If you have debts and / or dependants your ability to earn a regular income is even more crucial.
The common waiting period options for income insurances are as follows.
- 14 days
- 30 days
- 60 days
- 90 days
- 180 days
A longer waiting period will result in a lower premium cost.
In most cases we believe that the sweet spot for income protection insurance is the 60 – 90 day waiting period, as it strikes a balance between the price of the premium and the length of time until the insurance kicks in.
Who Can Own the Cover?
Income protection insurance is usually tax deductible, so it may be more tax effective to pay for this insurance from your personal name (unless you are a business owner).
If your cash flow is tight, don’t worry, you can also hold income protection insurance in your super fund.
How Long With The Cover Last?
As long as you continue paying the annual premium, an income insurance policy can last up to 65 years of age.
How to Prove Your Income
Income protection policies are provided under either an
- Indemnity basis; or
- Agreed value basis.
Under an indemnity policy, your cover is calculated on your income at the time you make a claim. In other words when you go to make a claim, you have to provide proof of that income. This could be an issue if your income fluctuates and is at a reduced level when you make a claim.
Under an agreed value policy, your cover is calculated on your income at the time you apply for the policy. In other words you have to prove your income at the time of applying and is usually calculated by looking at your last two tax returns. The premiums for an agreed value policy tend to be 20% more expensive, but that is the price you pay for certainty.
- Income protection can keep the money coming in if you suffer an illness or injury and cannot work.
- In most cases, you will want to get the maximum cover available (75-80%)
- If you plan to hold your cover for the long term, you may want to opt for a level premium.
- Choose a waiting period that kicks in just as your emergency cash savings run out
- You can buy income insurance in your personal name or your super fund.
- If you income fluctuates, you may want to consider an agreed value policy.
Not all insurance policies are the same. Make sure you read the documentation before you sign on the dotted line.
The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you with this.