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Do you need income protection?

  • 09 March 2020
  • 20 minutes
  • Injury and long-term insurance affects one million people every year

  • Yet very few of us have some form of income protection in place

  • But this is a complex area with many variables to consider

Each year one million people in the UK find themselves unable to work due to a serious illness or injury [1]. Yet less than 1% of UK households currently has any type of cover in place in case the worst should happen [2]. If something happened to you, could you and your family survive on sick pay or your savings, never mind maintain your current lifestyle?

Income protection insurance (also called permanent health insurance) is designed to help you if you can’t work because you’re ill or injured and could provide some much-needed financial help.

Income protection policies have no cash-in value at any time. If you don't pay your premiums on time your cover will stop, your benefits will end, and you'll get nothing back. If the benefit amount has not been paid out by the end of the selected term, the policy will end and you'll get nothing back.

That sounds a lot like payment protection insurance (PPI) to me

It might do but there is one critical difference. PPI is associated with a specific need: such as maintaining the payments on a mortgage or other loan. And in contrast to other types of income protection, the money is paid directly to the lender rather than being paid to you. In itself, there is nothing intrinsically wrong with having PPI if you identify that you need it. The problem lies in how it was sold. It was tacked onto loans without asking the right questions, sometimes without the loan taker knowing it had been sold to them. People were even told it was a pre-requisite for being accepted for the loan.

So why is this different?

Income protection aims to ensure you receive a regular income until one of several situations occurs: you retire, you return to work, you die or the period of cover comes to an end. You can cover yourself for most debilitating illnesses and injuries, and you can claim as many times as you need to while the policy lasts.

There’s often a waiting period (the 'deferred period') before the payments start, ranging from one day to two years, and you can usually choose how long you want this to be. Choosing a longer deferred period can help reduce the cost of your premiums.

I’m still not sure I need it

You’re most likely to need it if you’re self-employed.

If you’re employed find out whether your employer provides sick pay as part of you employee benefits, and if so for how long. When this comes to an end you will be reliant on Statutory Sick Pay (SSP). This currently pays out £94.25 a week but only lasts for 28 weeks [3].

How much cover do I need?

Well, like many questions when it comes to money, it depends on several factors. But as a starting point you could follow these three steps

What are your outgoings?

Start with your mortgage and other debts, including credit cards and personal loans. Then add other day-to-day costs like utilities, food and childcare. Lastly, the amount you roughly spend each year on large items like holidays and replacing your car. If you become seriously injured will your needs change? Could you pay for nursing care or for an adapted vehicle?

Don't underestimate this figure just to keep your premiums low.

What cover do you already have?

Check your employee benefits for how long your salary will be paid before you are moved to SSP.

Now calculate the cover you need.

Simply take the latter away from the former to establish your level of cover. And note down the period over which your employer will pay you as this will guide your deferment period. As an insurance pay-out, any money you receive will be tax free. So a higher-rate tax payer only needs to target 50% of their gross salary. In any event you won’t be able to target more than your gross salary, because insurance cover doesn’t allow you to make a profit out of your misfortune.

Tax treatment depends on the individual circumstances of each client and may be subject to change in future.

In general, long-term policies will only cover you for up to 65% of your gross income, and some short-term policies will cover you for up to 70% of your gross income.

How much does income protection cost?

How much you pay will depend on the options you select and on your circumstances, including:

  • your age

  • your gender

  • your current health, weight and family medical history.

  • your job

  • your hobbies

  • whether you have ever smoked, used drugs or drank heavily

  • the percentage of income you’d like to cover

  • the waiting period before the policy pays out

  • the range of illnesses and injuries you’d like to be covered against

  • the age at which you’d like the policy to stop covering you (i.e. retirement)

If you have existing health problems or a particularly dangerous job, traditional insurers are likely to consider you too high a risk and you might not be able to get cover at all.

Be honest about your medical history

Give your insurer the full facts to the best of your knowledge. It could mean the difference between getting a pay-out and having your claim refused.

Do you want to inflation-proof your payments?

When you are working, you hope for an increase in your salary every year to ensure your pay keeps up with the rising cost of living. But income protection policies don’t automatically adjust payments for changes to the prices of goods and services. Instead, you have to add it as an optional extra. This will push your premiums up but can provide an additional level of comfort.

How much does your job define you?

The type of pay-out you get from an income protection policy depends on the severity of the illness or injury you sustain and, again, you need to think carefully before deciding what type of cover you need.

An 'own occupation' policy, pays out if you are prevented from doing any aspect of your specific job because of an accident or illness and are not working in another job.

A ‘suited occupation’ policy pays out if you are unable to pursue an alternative but suitable occupation given your education and training etc.

An ‘any occupation’ policy pays out if you are unable to perform any occupation at all. And an ‘activities of daily living’ policy pays out if you are unable to perform a number of everyday tasks defined within the policy like washing or dressing yourself, or cooking and cleaning.

As you can imagine, these represent a sliding scale in premium payments (high to low) as the likelihood of a pay-out decreases.

Changing your mind

Like most insurance policies, you can cancel your policy any time in the first 30 days and get a refund of any premiums you’ve paid.

If you decide to change providers outside of this period – say in a couple of years’ time – or you decide to change the policy with your existing provider, you might find your premiums increase. This is because their assessment of your potential claims on the grounds of ill health is likely to change if only because you are now older. And if you have had a serious illness in the meantime (whether you claimed on a policy or not) this could also affect the premium.

Keeping your cover up to date

You should frequently review your protection to make sure you still have the right amount of cover.

You might want to consider increasing your level of cover if:

  • you become a parent

  • your partner stops working

  • you’ve taken out a new mortgage.

Remember, like many insurance policies, if you never need to make a claim, you won’t get any money back.

It seems expensive; are there any other options?

There are other insurance products you could use to protect your loved ones financially in the event that you’re ill, injured, or die.

  • Life insurance could provide some financial support to your dependants if you die.

  • Critical illness insurance provides a tax-free lump sum if you’re diagnosed with a serious illness covered by your policy.

  • Payment protection will cover specific payments, like your mortgage, if you can’t work because you’re ill, had an accident or get made redundant.

  • Short term income protection (also called Accident sickness and unemployment insurance) covers your essential outgoings if you can’t work for a short period of time (typically from two to five years).

Conclusion

The incidence of illness or injury is higher than many think, can come out of nowhere, and are an unexpected shock. Imagine you were unable to work due to an illness or an injury, you'd still need to pay your mortgage or rent, and your day-to-day bills. The lifestyle you’ve worked so hard to achieve, could be at risk. It doesn’t matter whether you have children or other dependants or not: if illness would mean you couldn’t pay the bills, you should consider income protection insurance.

Having the right type of insurance in place could help you make your loan payments or repay credit card bills in your time of need. Either until you're ready to return to work or until you retire.

However income protection is complex. You can choose when it starts to pay out, how long it lasts for, what constitutes an inability to work, what eventualities you want covered, how much income you need to receive and whether you link compensation to rising prices.

Some jobs and occupations are difficult to find cover for using comparison sites, but the list varies from insurer to insurer so you need to pick your provider carefully.

Talking to a financial adviser could provide valuable insights into how different policies work, and how much you are likely to need as some potential medical costs might be difficult to predict in advance.

Important information

Any views expressed are our in-house views as at the time of publishing.

Eligibility criteria and fees and charges apply at Schroders Personal Wealth.

This content may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.

Sources

[1] https://www.hse.gov.uk/statistics/cost.htm

[2] https://www.abi.org.uk/globalassets/files/publications/public/key-facts/abi-key-facts-2019.pdf

[3] https://www.gov.uk/statutory-sick-pay/what-youll-get

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