For many of us, our ability to work and earn a salary is our most valuable asset. Yet, how many of us have a backup plan if we suddenly became too ill or injured to continue working? Income protection is designed to provide financial security in such situations, ensuring you still have a regular income even if you’re unable to work for an extended period.
What is income protection?
Income protection insurance is a policy that provides you with a regular income if you’re unable to work due to illness or injury. It generally pays out between 50% and 70% of your pre-tax income, helping you maintain your standard of living and cover essential costs such as rent, mortgage payments, bills, and other living expenses.
Unlike other forms of insurance, such as life or critical illness cover, income protection is designed to offer long-term support. It doesn’t just pay out a one-off lump sum; instead, it provides ongoing monthly payments until you’re able to return to work or the policy reaches its end.
When would income protection pay out?
Income protection policies pay out if you’re unable to work due to illness, injury, or disability. The payout starts after a deferral period, which is the waiting period before the payments begin. You can usually choose the length of this deferral period when you take out the policy, and it could be anything from four weeks to 12 months.
The length of the deferral period will affect your premium—policies with shorter waiting periods tend to have higher monthly premiums, while policies with longer deferral periods are usually cheaper.
Once the policy kicks in, it will continue paying out until:
- You recover and can return to work.
- The policy’s agreed payout period ends (for example, after 1 or 2 years for a short-term policy).
- You reach retirement age (typically 65 or 68, depending on your policy).
Types of income protection policies
There are two main types of income protection policies:
- Long-term income protection: This type of policy provides income replacement until you’re well enough to return to work or reach the end of the policy term, often linked to retirement age. It’s the most comprehensive form of cover and offers long-term financial security.
- Short-term income protection: This covers a limited period, typically between 1 and 2 years. While it’s less expensive than long-term cover, it may not provide enough protection for prolonged periods of illness or injury.
Additionally, income protection policies can be tailored with different premium structures:
- Guaranteed premiums: Your premiums remain fixed throughout the life of the policy.
- Reviewable premiums: Your premiums are reviewed and can increase at the insurer’s discretion, typically every 5 years.
- Age-banded premiums: The cost increases as you get older, as the likelihood of illness or injury rises with age.
What doesn’t income protection cover?
While income protection provides valuable coverage, there are some things it typically doesn’t cover. These exclusions usually include:
- Pre-existing medical conditions: If you have an existing health condition when you take out the policy, it may be excluded from coverage.
- Self-inflicted injuries: Deliberate harm to yourself is typically not covered.
- Unemployment unrelated to health: Income protection is specifically designed for illness and injury, not redundancy or voluntary unemployment.
- Short-term illnesses: Policies may not pay out for minor illnesses that only prevent you from working for a short period.
How do you set up income protection?
Setting up income protection involves a few key steps, and working with a financial adviser can help you find the right cover for your needs. Here’s how it typically works:
- Assess your needs: Start by evaluating how much income you would need to cover your essential living costs if you were unable to work. Consider your mortgage or rent payments, bills, and any other regular expenses.
- Choose your deferral period: Decide how long you can wait before the policy starts paying out. The longer your deferral period, the lower your premiums will be, but you’ll need to ensure you have sufficient savings or alternative support in place during that time.
- Tailor your policy: Work with an adviser to select the right policy and premium structure, whether that’s long-term or short-term, with guaranteed or reviewable premiums.
- Undergo a medical assessment: When applying for income protection, insurers will ask about your health and lifestyle. Depending on your answers, they may request additional medical information or assessments.
Tax benefits of income protection
Income protection insurance payouts are generally tax-free if you pay the premiums yourself, as they are considered to have already been taxed. This means you can receive up to 70% of your gross income without additional tax deductions. However, if your employer pays the premiums, the payouts are taxed as income. Additionally, employers can deduct the premiums as a business expense, potentially reducing their corporation tax. This makes income protection a valuable financial safety net with favourable tax treatment for both individuals and businesses
Final thoughts
Income Protection Awareness Week is a great time to reflect on the importance of protecting your income and securing your financial future. Think about it—if you were to suffer a long-term illness or injury and could no longer work, would your savings be enough to cover your expenses for several months or even years? For most people, the answer is no.
By setting up an income protection policy, you can safeguard your finances, giving you and your family peace of mind in case the unexpected occurs.
If you’re interested in finding out more or want to explore options that suit your personal circumstances, please contact our financial planning team by emailing financialplanning@pmm.co.uk or calling 01254 679131.
