A guide to Income Protection insurance

Income protection insurance – what is it?

Income protection insurance is a type of personal insurance policy that can be referred to as sick pay insurance or salary protection because essentially it pays the insured person an income if they become unable to work due to an illness or injury. The illness does not have to be physical as mental health conditions are high on the list of reasons for claims on income protection insurance.

Income protection cover is one of the most underutilised types of personal insurance around. Most of us take out insurance to cover our home, car and even our mobile phone these days, but often overlook protecting our income.

If you had to stop working for a few months, a few years or even longer due to illness or injury what finances would you have in place to keep up with all your monthly outgoings? The reality is that most people would drain their savings within the first year and then have no choice but to rely on state benefits.

For most individuals, the only real way of protecting earnings with sufficient financial support (other than saving), in the long-term, is to take out income protection insurance (which was formerly called permanent health insurance or PHI).

Won't the state pay me if I'm unable to work?

You may qualify for state sick pay if you meet the eligibility criteria but it is important to understand the limitations of state benefits. With state support, in the form of the Employment and Support Allowance (ESA), standing at only £90.50 per week (if you are over 25 and may be able to get back to work in the future) or statutory sick pay which pays £116.70 per week for up to 28 weeks, long-term incapacity would mean a significant change in living standards for most households. It is also worth noting that to get some state benefits, you must go through a fairly strict capability assessment – so it is not guaranteed.

You can find more information in our article, “What happens when sick pay runs out?“.

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What does income protection insurance cover?

Income protection insurance covers you if you become ill or injured and cannot do your job resulting in a loss of income. You will usually be required to provide a fit note from your doctor to confirm that you are unable to carry out your work duties. It acts like salary protection so that you can receive up to 70% of your pre-taxed income to maintain your living costs while you recover. You can tailor your income protection insurance around your employer's sick pay and any savings or other income sources you may be able to use in a situation where you can't work.

When will income protection insurance payout?

For all but the riskiest jobs, it is usually possible to take out a plan with an ‘own occupation’ definition of incapacity. This essentially means that the plan would payout if you are “unable to perform the duties of your own job due to illness or injury”. Proof of this is usually requested by the insurance company in the form of a fit note from your doctor or other authorised people. There are other definitions of incapacity that could be applied to your particular income protection insurance that would mean that it would only pay out if you couldn't work in any job or if you were unable to pass a functions test where the insurer checks if you're unable to carry out a number of daily activities before a claim is paid. These are less desirable and largely, avoidable so you should read more about incapacity in our article, ‘Sick pay insurance – occupation incapacity definitions explained‘ before you buy your insurance.

How long will income protection cover my wages?

The duration that an income protection policy will keep paying you a monthly benefit to replace your wages will depend on the type of income protection policy you choose. There are two different types of income protection policies that determine how long your wages will be covered and we explain them below.

Long-term income protection insurance

Long-term income protection insurance pays you a regular income until you either;

• recover and return to work
• reach the end of your plan (usually your retirement age)
• die

Long-term income protection insurance is the most comprehensive type of wage protection you can buy as it covers your income for the entire duration of your working life and you are able to make multiple claims during the policy term. Your plan would continue paying out each month (tax-free if it is a personal policy, or under PAYE if taken out via your employer) until you are fit to return to work, or you reach the policy end date, which is usually set at the age you expect to retire. Thus, if you were off work for five years whilst recovering from cancer the plan could cover your earnings for five years.

You may also wish to explore the benefits of critical illness cover which would pay a lump sum of cash if you were diagnosed with a serious illness that was listed within the policy terms. You can read in our article, “What is critical illness cover?”

Short-term income protection insurance

Short-term income protection insurance is a cheaper type of income protection insurance because the duration of a claim period is capped therefore limiting how long you are able to receive an income benefit. Short-term income protection policies come in a choice of payment periods – 1, 2, 3 or 5 years.

So, if you chose a 2-year short-term income protection policy and had to claim, the claim would pay you for up to 2 years – if you return to work before your 2 years is up, you will stop receiving the benefit.

The fact to note here, though, is that you are only limited to 2 years per claim but this does not prevent you from making multiple claims. As long as you have returned to work for at least 6 months between claims (this period can vary) then you can claim again if you become unfit to work and receive up to another 2 years of benefit.

A short-term income protection insurance can be very worthwhile as a cost-effective solution and it protects you through the initial period of even a long-term illness which means that you can try to make a plan while you rely on the income you're receiving.

When does income protection pay out?

Income protection pays out when you are deemed unfit to work due to illness or injury and have been off for the duration of the waiting period which is known as the deferred period, chosen on your policy. Your income protection insurance will not pay your benefit if you are still receiving an income from your employer whether this is on a mandatory or discretionary basis.

Deferred period – what is it?

The deferred period is the waiting time between your first day off work and when your income protection insurance will start paying you an income. As you would expect, a short deferred period will make your income protection insurance more expensive than a long one. You can choose between waiting:

• a day
• a week
• 4 weeks
• 13 weeks
• 26 weeks
• 52 weeks

How to choose the best deferred period

A few facts will help you to work out the best deferred period for your income protection insurance:

• the amount and duration of sick pay your employer will pay
• how much of your savings you are willing to use and how long these will last
• any other income that you can rely on such as a partner's income or unearned income
• state benefits that will you can claim or continue to receive

Once you know the above information, you will be able to work out how long you can be off work without falling behind with your bills. This is ideally the length of time that you would choose as your deferment period.

A longer deferment period will cost less than a shorter deferment period but striking a balance between how much you spend on income protection insurance and making sure that it pays out when you need it to, is vital.

Income protection claims

Of all the different types of personal insurance you can buy, income protection is the personal insurance you are most likely to claim on. This is because the likelihood that you'll become unable to work because you're ill or injured at some point during your working life is much greater than the likelihood that you will die or become critically ill.

Most people think about life insurance because we can fathom how awful and devastating that would be for those we leave behind but not enough of us think about how a period of illness or an unfortunate accident could make us unable to earn a living.

What are the main reasons for claims on income protection insurance policies?

Some of the leading causes of claims on income protection insurance are:

• Back pain
• Mental health conditions
• Cancer
• Heart disease

A report from www.gov.uk confirms that only half of employers paid SSP only (54%), 28% paid above SSP, 13% did not provide any form of sick pay and 5% did not know.

Summary guide to buying income protection insurance

• Incapacity definition – as shown above, definitions vary considerably and often people will take out income protection policies thinking they are covered should they be unable to do their own job. But this may not necessarily be the case, especially if they have a work task definition.
• Sick pay – if your employer provides long-term sick pay then this will restrict the level of cover you can have under an income protection policy.
• Cost – income protection policies can be tailored to suit your budget and policies that pay out as soon as you become unable to work will be the most expensive so be realistic about how long you can survive without claiming to keep your monthly premiums down. Also, shop around for the best deal but make sure the policies are comparable.
• Non-permanent contracts and introductory periods – some policies may stipulate that you can't claim within a certain time period from the date you started a job or took out the policy.
• Over insuring – as stated, there are limits to the amount of income protection you will be able to take out. If you are being paid by your employer whilst you are unable to work, this will reduce any claim you can make so do factor this into your policy so that you're not paying for cover that you won't be able to claim.

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