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Lee Gathercole and Neezam Romjon talk all about Income Protection.
How does income protection work?
Income protection is a policy that guarantees you an income if you can’t work due to an accident or an illness, after a specified period of time.
As a basic example, you work for an employer that gives you sick pay for one month – so you still receive your normal income from work for one month. But if you still can’t work after that period, you would be reliant on statutory sick pay (SSP) which is under £100 a week.
Income protection is designed to kick in and start paying out from when sick pay stops. So in our example, in the second month of not being able to work you will receive a set monthly income of an amount stated in your policy.
There are certain limits on what you can protect, but as an example it might pay out £2,000 a month either until you return to work or, in the very worst case scenario, until you retire. There are also some policies that will pay out for a set period of time.
The idea is that you can still pay your mortgage and your bills without having to borrow money to cover your costs – which is obviously a very dangerous place to be.
Is income protection worth it? Do I need it? Who should have it?
It’s absolutely worth it. And in terms of who needs it – anyone that has an income should look to protect it. Whether you’re employed or self-employed or you’re receiving income from a rental property. Not many of us can afford to lose an income that’s coming in.
If you can’t afford to lose your employed income or if you haven’t got an income coming from your business then you should set up income protection.
An employer would cover your income for a short period of time, but what do you do afterwards? What happens if you can’t work for a year or two – or even longer? How will you pay your mortgage, your bills and everything else?
What are the pros and cons of income protection?
As we’ve heard, the big benefit of income protection is to make sure you can maintain your lifestyle if you can’t work due to illness or injury.
The disadvantages are the same as with any insurance. If you take a policy out direct that might not be suitable for you or your circumstances change and you haven’t reviewed it, you might not get the level of cover you need.
The cost is also a downside – you are having to pay for a policy that you might not ever need to claim. It’s a safety net that does come at a price.
Another thing to consider is that an income protection policy will have what’s called a ‘deferred period’. What that means is how early you can start claiming on the policy. For example, if somebody doesn’t get any sick pay benefit from their employer or they’re self-employed, they will have an immediate need to cover their income. In that case you would want a very short deferred period on the policy.
On the other hand, some employers are generous. If you work for the NHS, for example, you might get six months’ full pay sick pay followed by six months’ half pay. In that case you might have a policy within a deferred period of 12 months. That will be a much cheaper way to get income protection cover – because you’re much less likely to claim on it.
So if you don’t get that deferred period quite right you might be paying more for a policy than you need to – or miss out on income that you urgently need. But these downsides are all things that can be avoided by getting advice from a mortgage protection advisor.
If income protection pays out is it subject to tax?
When you claim on the policy you will receive an income to cover your employed or self-employed income. Your normal income is taxed before you receive it from your employer, but when you receive payments from your income protection policy these are not subject to tax.
What does income protection not cover?
It’s not life cover so it doesn’t pay out on death. It’s not there to protect your family once you have passed away. It’s also not a critical illness cover – it won’t pay you a lump sum to pay off a debt.
It’s designed to protect your income on a monthly basis. It acts as your salary normally would. You might suffer a critical illness that keeps you off work. You can certainly claim on the policy, but you won’t get a cash lump sum like you would on critical illness cover.
Importantly, too, it doesn’t cover unemployment. Income protection is there if you have an accident or an illness that keeps you off work. You will need evidence that your GP has confirmed you’re not able to work. You present that to the insurer to receive your income protection payments. But it can’t protect you from unemployment or redundancy. There are, however, different types of cover you can get for that.
How much income protection do I need?
Again this will vary depending on the individual. Generally speaking the maximum most insurers will cover you for is up to 75% percent of your income.
In terms of how much you need, that’s down to your individual circumstances. It could be that you want to cover your mortgage and your committed expenditure: your council tax, credit cards and things you pay on a monthly basis. So there isn’t a specific amount.
Again this is where advice comes in to help you make sure you’ve considered everything in setting your level of cover.
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How long does income protection pay out for?
This is where a lot of people can get caught out. There are two types of income protection policy, that differ in how long they pay out for. There’s a big difference in cost as well.
You could have an income protection policy for the next 25 years, for example, which could take you up to your retirement age. That’s a common approach. Or, you could have a ‘limited benefit’ policy that pays out for one or two years off work as a maximum.
It’s important you don’t get caught out on that. You will notice that the cost of limited benefit policies is considerably less, which may make it a more suitable option for you.
How much is income protection insurance?
The cost of income protection insurance will vary depending on a number of things. The cost factors include how much cover you need – that is, how much income you need to protect. Will you be OK with £1,000 a month or do you need £3,000? Obviously the latter is going to be more expensive.
You also need to identify how soon you need that policy to start paying out – this is the deferred period we talked about earlier. The shorter the deferred period, the more expensive it will be.
Another factor is the added benefits. Some insurers offer optional extras. Each provider is different and has their own unique benefits, so they charge different premiums. It’s all about what’s important to you. Some people prefer the cheapest, basic cover, while others are happy to pay a little bit more for the full safety net.
It also depends on whether you have ‘full-term benefit’ or a ‘limited period benefit’ as we saw earlier: the first will pay out until you retire (or another set date) whereas a limited benefit period would stop paying out, even if you were still unable to work after 12 or 24 months.
The benefit of a limited policy is cost, but the downside is that if you are off work for years, you might need to rely on state benefits which will be a lot lower than your income protection policy benefit.
Costs also depend on your health, what you do for a living, how old you are and whether you smoke. There’s a lot of variables there. Again talk it through with an advisor and we’ll be able to give you more more specific options and costs.
What else do we need to know about income protection?
There’s a lot of technical jargon – particularly online – with the types of policies that are available. We highly recommend seeking advice to make sure you get the right cover at a good price.
With an advisor on hand you can ask questions and make sure you fully understand what you’re paying for and when it will pay out.
Income protection is really important. Not many of us can survive on statutory sick pay which is at most £99.35 per week (as of November 2022). If you can’t work you are potentially going to be leaving yourself in a financially vulnerable position.
So make sure you know what your employer offers as sick pay. We tend to find that a lot of people aren’t aware of this and very often they find that they would be put straight on statutory sick pay. So if you can’t survive on £99.35 a week maximum, you need to look at getting an income protection policy in place.
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