Income protection insurance is a safety net for your income, in the event of being unable to work due to sickness or disability. This continues until you return to work or you retire.
Typical policies usually payout between 50% to 70% of your normal earnings before tax.
The plan will have no cash in value at any time and will cease at the end of the term. If premiums are not maintained, then cover will lapse.
Your health, whether you smoke and level of cover needed will weigh into 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:
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.
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.
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 ‘deferral’ period you choose, the lower your premiums. The default deferral period tends to be 13 or 26 weeks, but it can sometimes be as low as four weeks.
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.
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, and own occupation. We’ve explained this below.
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 inflation.
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 to 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.
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.
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 an income protection 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.
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.
Some policies pay you a proportion of your income protection if you go into hospital, even if this is before your deferral period is over.
This means you won’t have to pay premiums while your claiming on your income protection policy.
Most income protection policies come with life insurance, usually equivalent to a year or two years’ worth of monthly premiums.
Many income protection policies don’t stop paying when you go back to work. If your earnings are reduced because of your illness (perhaps because you are working fewer days), your income protection will continue paying out, albeit at a reduced rate in line with your reduced earnings.
This will end once your earnings recover to the level when you took the policy out.
If you’ve made a claim once and you get ill or incapacitated again within 12 months, many insurers will waive the deferral period, meaning you don’t have to wait to get a payout.
When taking out critical illness cover, you will need to work out how much cover you need and how long you want the policy to run for. So, for example, you might determine that you need £100,000 of cover, to run for a 30-year term.
It’s a good idea to sit down and work out what sort of sums your family would need in order to live comfortably if you were to develop a serious illness and no longer be able to work.
The main driver for many people buying critical illness insurance is to clear their mortgage balance if they become seriously ill, but it’s worth taking into account any other debts, household bills you pay as a homeowner and the potential costs that would be incurred from your medical treatment.
You may also want to put aside a few years’ worth of your salary to give you the option of not working for a long period.
You can select whether you want the cover to increase over the course of the term, so that it keeps pace with inflation. Or, if your main concern is being able to cover the cost of the mortgage, then you can go for decreasing cover. The critical illness policy pays out once and then ends.
The exact illnesses covered by critical illness policies vary between providers. However, certain illnesses are covered as standard by most insurers. These include:
You may have the option to add specific additional diseases to your cover for an extra charge, while some insurers will cover your children too when you take out a policy.
Payments from a critical illness policy are not classed as income, so you will not have to pay any income tax on the money you receive from your insurer.
Your loved ones could face a potential inheritance tax bill, however. If you take out a joint life insurance and critical illness policy, and make a claim but do not receive the money before passing away, the payout forms part of your estate.
If your estate is valued at more than £325,000, inheritance tax will be charged on the insurance payout.
It is possible to get around this by writing your insurance policy in trust. This is where your policy is held within a trust and so classed as being outside of your estate.
