Income protection explained
Formerly known as permanent health insurance, this is an insurance policy that pays out if you’re unable to work because of injury or illness.
Income protection usually pays out until retirement, death or your return to work, although short-ter policies, which last for one or two years, are also available at a lower cost. Neither income protection or short-term income protection pays out if you’re made redundant – but they will often provide ‘back to work’ help if you’re off sick. Income protection is different from critical illness insurance, which pays out a lump sum if you fall seriously ill.
Why do I need income protection insurance?
Only a minority of employers support their staff for more than a year if they’re off sick from work. Given the low level of state benefits available, everyone of working age should consider income protection.
But in a recent survey, just 9% said they have some form of income protection, compared with 41% who have life insurance and 16% who have private health insurance.
Millions of us have policies such as private health insurance and payment protection insurance, sold to us over the years by salespeople who convinced us we needed protecting. However, while they were right about the protection, they were often wrong about the policies.
The one protection policy every working adult in the UK should consider is the very one most of us don’t have – income protection.
How much does income protection cost?
Your health, whether you smoke and level of cover needed will affect your premium, but your type of job also plays a major part in determining what you’ll pay.
Many insurers group jobs into four categories of risk, though some have more. For example, jobs may be divided into the following groups:
Class 1: Professional; managers; administrative staff; staff with limited business mileage; admin clerk; computer programmer; secretary.
Class 2: Some workers with high business mileage; skilled manual work; engineer; florist; shop assistant
Class 3: Skilled manual workers and some semi-skilled workers; care worker; plumber; teacher
Class 4: Heavy manual workers and some unskilled workers; bar person; construction worker; mechanic The riskier the type of job you have, the more likely it is that you may need to make a claim. Therefore, those in the riskiest occupations tend to pay higher premiums.
How much does income protection pay out?
Income protection payouts are usually based on a percentage of your earnings: 50% to 70% is the norm. Sometimes, an insurer might pay out a higher percentage of one portion of your salary (perhaps the first £50,000), and a lower percentage on anything above that.
For example, say you earn £40,000 a year, and you take out an income protection policy designed to pay out 60% of your salary. Over the course of a year, your policy will pay out £40,000 x 60% = £24,000.
The good news is that payments from income protection policies are made free of income tax.
When does income protection pay out?
Income protection policies pay out only once a pre-agreed period has passed, generally ranging from one to 12 months after you put in a claim. The longer the ‘deferred’ period you choose, the lower your premiums.
The default deferred period tends to be 13 or 26 weeks, but it can sometimes be as low as four weeks. How an income protection insurer defines your inability to work will also influence if and when your income protection policy pays out.
There are three methods insurers use:
- Activities of daily living
- Suited occupation income protection
- Own occupation income protection
Inflation is an important thing to consider when taking out an income protection policy. When you are working, you’d hope that you would be getting an increase in your salary to ensure that your pay keeps up with the rising cost of living.
But if you come to claim on an income protection policy that only pays out a proportion of your salary today and doesn’t account for future rises, the amount you receive will be worth less and less over the years. You have an option to add an ‘index-link’ to your income protection, meaning it rises with a measure of inflation, such as the consumer prices index (CPI) or the retail prices index (RPI), each year.
This will increase your premiums each year, too. They’re usually increased by a little more than inflation.
Need to know more? Call the experts at Mint FS on 0330 1355914 for an initial consultation – or complete our contact form and we will call you back.
What is ‘stepped benefit’ income protection?
When deciding what type of income protection you need, you should always check with your employer to see what sickness benefits they pay. If, for example, your employer pays you in full for a period, then reduces how much it will pay you, ‘stepped’ income protection could be useful.
With this, you can choose two different levels of payment, designed to pay out after different time periods. So, you could get a lower payment while your employer is still paying you a higher percentage of your salary, which then increases if your employer reduces how much it will pay you.
Will income protection affect my state benefits?
The UK’s benefits system is designed to support people who cannot work through illness or disability, are looking for work, or have a low income. And it is changing radically at the moment, as the UK looks to consolidate multiple different benefits into a single system called Universal Credit.
If you have a policy and are looking to claim Universal Credit, this will affect the amount of level of state benefits you’ll get. Income protection is treated as ‘unearned income’. This is taken into account when calculating how much Universal Credit payments you receive.
For every £1 of income you receive in unearned income, your maximum Universal Credit payment will be reduced by £1. If you think this might apply to you, read our guide to how Universal Credit is calculated.
Buying income protection
Be aware of the different types of income protection and which is most suitable for you. If you’re a smoker use a broker to shop around for you. Some providers don’t add an extra premium. With most other providers, smokers can pay 50% more than non-smokers.
Make sure you reveal all your health issues when applying for a policy. Insurers can turn down a claim if they find out about a health condition you didn’t previously flag up, no matter how small it seems. It is always better to disclose too much information than risk a rejected claim further down the line.
Make sure you know if the premiums are guaranteed throughout the policy, linked to age or inflation, or reviewable. If possible, choose ‘own-occupation’ cover, as this will pay out if you’re unable to do your own job. Avoid policies that cover ‘activities of daily living’ (ADL) or ‘activities of daily working’ (ADW). These often won’t pay out unless you’re unable to do a series of basic tasks such as dressing yourself or holding a pencil. Cut the cost.
If a full looks too expensive for you, consider reducing the monthly payout, extending your deferred period or looking at full short-term Income Protection.
A policy with a long deferral period is much cheaper than one with a short deferred period.
Most providers pay your premiums for you while you’re receiving payment under the policy. Most Accident Sickness policies do not. Check what practical ‘back to work’ help you might receive in the event of a claim, including counselling and rehabilitation.
Take independent advice. Protection insurance can be complicated, and receiving IP benefits can impact on state benefits. An independent expert – such as Mint FS will be able to find the right cover for you.
After you’ve bought an Income Protection policy ensure you have regular reviews. As your income rises over time, you may want to increase your cover. Some policies include an indexation option.
If you switch, don’t cancel until your new policy is in place. Otherwise you could be left without cover.
Need more information – pick up the phone and speak to an expert at Mint FS on 0330 1355914. Or complete our contact form and we will call you back.