Each year, around 1m people in the UK are unable to work due to sickness or injury. One insurer claims that the average period of long-term ill health is 7 years. How would you cope in this situation? Income Protection Insurance is a policy that provides you with a guaranteed monthly sum if you’re unable to work for medical reasons.
In this post, I’ll explain how Income Protection Insurance works, what factors affect the costs, and why you might need it.
How does Income Protection Insurance work?
Income Protection Insurance is designed to cover your core financial outgoings while you’re coping with an illness or accident. Unlike many other types of income insurance, it continues paying out until you’re able to return to work and you can claim multiple times. Products such as Critical Illness Cover, on the other hand, pay one lump sum and apply only to specific conditions. Short-Term Income Protection and Payment Protection Insurance stop after a specified period.
Usually, you can cover up to 65% of your gross income. If you have a limited company and pay yourself mostly through dividends, you should check that your insurer takes these into account when calculating your maximum cover.
What does it cost?
As ever, the cost depends on your age, health, occupation, and lifestyle. And, of course, the length of the policy and the amount of cover. You might take out a policy that covers your direct debits and lasts until you’ve paid off your mortgage, retired, or when you no longer have dependents.
There are also three levels of cover that are generally available and determine the conditions in which the policy pays out:
- Own occupation – you’re unable to do your own job.
- Suited occupation – you can’t do your own job or a similar role that’s suited to your qualifications or experiences
- Any occupation – you’re too ill for any type of work
Different insurers will have their own way of describing these levels, but you should be able to easily distinguish between them.
Own occupation is the most expensive level of cover, as this is the most likely. Any occupation is the cheapest, simply because it’s the least likely to pay out. It’s unlikely that you’d be rendered incapable of doing a home-based admin job, for example. The question is whether you’d want to find another job under such circumstances. If not, Own occupation would be most appropriate.
You can make a few other choices that affect the cost:
- Deferral period – this is the time before which you start receiving the payments. The longer you defer it, the cheaper your policy. If you receive full sick pay for 3 months, you could opt for a 90-day deferral period.
- Inflation-linked? – the policy is more expensive if you want the payouts to increase with inflation. This could be important if you’re covering day-to-day costs such as food and heating, but less so if its purpose is to repay a fixed-rate mortgage or loan.
- Guaranteed vs reviewable premiums – with guaranteed premiums, you know what you’ll be paying for the remainder of the policy. While more expensive initially, you won’t suffer an unexpected hike. Reviewable premiums are usually reviewed every 5 years and could increase.
Do I need Income Protection Insurance?
Income Protection Insurance is of most benefit to anyone with large financial responsibilities who is self-employed or has limited sickness benefits from their employer. However, first check what other provision you have in place, for example:
- Sick pay from your employer
- Significant savings/assets
- Partner or family who’ll support you
Also review your other insurance cover to ensure there isn’t overlap. For example, you might have Payment Protection Insurance (PPI) on your mortgage or other loans. Here are the main differences between Income Protection Insurance and PPI:
Income Protection Insurance
|SCOPE||Usually covers a specific loan||Usually covers 65% of your gross monthly income|
|DURATION||Often lasts 12-24 months||Pays until you return to work|
|COST||Premiums are reviewable, so can increase||You normally have the option to guarantee the cost of your premiums|
|LEVEL||Tend to be Suited occupation or Any occupation (see above)||You can choose Own occupation (see above)|
|CONDITIONS COVERED||Sometimes unclear||Tends to be medically underwritten, so you know exactly what’s covered|
Not all insurers cover mental health problems, so check any prospective policy carefully. You can download a useful guide from MIND on how to choose the right cover for your situation.
For impartial general guidance, take a look at the Money Advice Service guide to Income Protection Insurance.
If you decide to go ahead, devote some time to reading any policy you’re considering. As this is a complex area, you could end up paying for something that doesn’t suit your needs. Advisory brokers, although more expensive than going direct to an insurer, can give you expert advice and guide you through some of the complexities. This is especially important if you have pre-existing medical conditions. Visit MoneySavingExpert for recommendations. You could also consult an Independent Financial Advisor if you’re looking at insurance during a wider review of your money situation.
Whatever you do, make sure you have a plan.
This post is for information only and does not constitute financial advice.