What is it?
It's an insurance that provides a tax-fee replacement income if you're unable to work through illness or injury.
These policies normally only start paying out after you've been unable to work for a period of time, typically ranging from a few weeks to several months. The income level you can protect is limited to ensure you can't make a profit.
Income protection is especially relevant to the self-employed, as their income could plummet if unable to work.
Do I need it?
If you would be unable to pay your monthly outgoings without your salary or self-employed earnings then income protection might be appropriate, depending on the level of sick pay you might receive.
Employee Sick PaySelf-Employed Sick Pay
Firstly, you should check what provision, if any, your employer makes if you are unable to work through illness or injury. Some are generous, others simply stick to the bare minimum required by law, as follows:
If you're unable to work under a contract of service for at least four days in a row, and earn at least £109 per week (before tax), then you'll normally receive weekly Statutory Sick Pay (SSP) of £86.70 which is taxable as normal.
SSP is paid for every day you'd normally be working, starting from the fourth day of sickness and lasting for up to 28 weeks.
If, after SSP has ended, you are still unable to work then you could be eligible for an Employment & Support Allowance (ESA). ESA is unfortunately more complex than the Incapacity Benefit it replaced (and would take up most of this website to fully explain!), but in simple terms you could receive a basic payment of
£71.00 per week, or £56.25 per week if under 25, for 13 weeks while your ability to work is assessed. After this you might receive an extra £25.50 per week, but there's a number of scenarios where it could be different. For more detailed information
visit the DWP website and drink a strong cup of coffee to keep you awake.
The bottom line is whether the sick pay you'd receive from your employer and/or state benefits would be enough to keep the wolf from the door while you're unable to work. If yes, you probably don't need income protection. If no, then at least find out how much cover would cost then make a decision from there.
Types of income protection
While there are several types of insurance that help protect against being unable to work through illness of injury, income protection is by far the most important.
Income ProtectionDebt Payment ProtectionPersonal Accident Plans
Pays out a monthly tax-free income if you're unable to work for a specified number of weeks, known as a 'deferment' period. You can typically choose a deferment period between four and 52 weeks, the greater the period the lower the premium (as it's less likely you'll claim).
You also choose the level of income to be protected and the age (usually your retirement age) that the policy will run until. Because income protection payouts are tax-free and your usual earned income is taxable, you're generally limited to insuring around 50 - 75% of your income to stop you from potentially making a profit.
Premiums can be either guaranteed (i.e. fixed) or reviewable. Reviewable usually start off cheaper but can soar over time, so guaranteed is generally preferable if you're planning to keep the policy for a while.
Always check the conditions of a policy to understand exactly what's included and excluded. For example, some policies will payout the full amount if you can't carry out your usual job, while others may payout less if they believe you're capable of carrying out a different job.
How much cover?
When buying an income protection policy be careful not to over insure yourself. Insurers will reduce your payout if they believe you would otherwise profit from a claim.
Because payouts are tax-free you need to compare to your income net of tax and also deduct any state benefits you could receive if unable to work. This means that your
maximum level of cover will likely be around 50 - 75% of your income before tax. Costs may mean you choose to insure less than this, but it's a good idea to at least cover
your mortgage payments and basic living costs.
Work out your income after tax using our Employed or Self-Employed Tax Calculators
Although more expensive, a policy that increases the cover and potential payout with inflation makes sense if you're planning to keep the policy for 10 years or more. At
an assumed inflation level of 2.50%, £1,000 of cover would be worth £776 after 10 years and just
£603 after 20 in today's terms.
How long do I need cover for?
For most people cover until retirement is wise, as this protects you against an illness or injury that prevents you working for the rest if your life. However, while you
might select retirement age as the length of the policy, that's not to say you'd actually want to keep the policy until then.
You might find that after the kids have left home and you've actually managed to build up some savings, then protecting your income is that not as important to you as it once
was. In that case you can simply cancel the policy.
What affects cost?
The cost of an income protection policy tends to be most affected by the following:
AgeDeferment PeriodSexHealthFamily HistorySmokingOccupation/Hobbies
The older you are the more likely you'll suffer from illness during the policy term, hence higher premiums.
Loan payment protection and personal accident plans tend to be far less fussy and simply base the premium on age.
What's not covered?
Beware that policies do not payout under certain circumstances. These vary from policy to policy but the most common circumstances include:
- Health problems you had before taking the policy out, known as 'pre-existing medical conditions'.
- Problems arising from pregnancy or childbirth
- Self-inflicted injury.
- Problems arising from alcohol or drug abuse.
- Taking part in dangerous sports or other activities which you failed to disclose when buying the policy.
When you complete an income protection application form you normally have to provide details of your health and family health history. The insurance company will then
decide whether to insure you and, if so, whether to increase your premium from a normal level. This process is known as 'underwriting'.
As part of the underwriting process the insurance company might require you to see or speak to a doctor or nurse to gather further information.
Some insurers have a level of cover, called a 'free cover limit', below which no underwriting is required, so you don't need to provide any details about your health. This
is especially common in 'group' income protection schemes offered via employers.
Ways to buy income protection
InsurerFinancial AdviserDiscount Broker
Buying an income protection policy direct from an insurer is unlikely to be any cheaper than using a discount broker and might be more expensive.
Income Protection Insurance Jargon
Here's some of the more common income protection jargon you might come across:
|ABI Model Definitions||A list produced by the Association of British Insurers that aims to standardise what is meant by 'critical' when applied to a specific illness.
|All Risks||Contents insurance with all risks covers possessions such as a laptop or watches when taken outside the home.
|Building Insurance||Insurance that intends to provide sufficient cover to totally rebuild your home if necessary.
|Contents Insurance||Insurance that covers items that are not a fixed part of your home, e.g. TV, from damage or theft.
|Convertible Term Assurance||A type of term assurance that allows you to convert into a whole of life policy.
|Debt Payment Protection||Insurance that's intended to help you manage your debts if unable to work through illness or injury.
|Decreasing Term Assurance||A type of term assurance where the sum assured reduces over time, typically linked to a repayment mortgage.
|Deferment Period||Period of time that you must be unable to work for before you can claim on an income protection policy. The longer the period, the lower the premium is likely to be.
|Employment & Support Allowance||State benefit intended to pay employees (and potentially the self-employed) unable to work through illness after Statutory Sick Pay ends.
|Endowment||A type of life insurance policy that is also intended to provide investment returns. They have a very patchy track record.
|Excess||The amount of an insurance claim you agree to pay before an insurer pays the rest (for example, the first £50 of a claim).
|Exclusions||Insurance policies often exclude certain risks or events. It's vital you check these before buying a policy.
|Family Income Benefit||A type of term assurance that pays out a regular tax-free income on death rather than a lump sum.
|Full Medical Underwriting||When you buy private medical insurance the insurer asks for full details of your medical history and may also contact your doctor for more information.
|Income Protection||Insurance that pays out a monthly tax-free income if you're unable to work through illness or injury.
|Increasing Term Assurance||A type of term assurance where the sum assured increases over time, usually inline with inflation.
|Inpatient Costs||The costs of staying in a private hospital, usually covered by private medical insurance policies.
|Loss Adjuster||An impartial claims specialist responsible for investigating claims on behalf of insurance companies.
|Material Fact||Information that would affect an insurance company's willingness to accept a policy, or the premium it would charge. Don't omit these when applying for cover as it could invalidate the policy.
|Moratorium Underwriting||When you buy private medical insurance the insurer does not require details of your medical history. Any conditions that have existed over the last five years are not usually covered.
|Outpatient Costs||The costs of private medical care when you're not admitted to hospital. Not always covered by private medical insurance policies.
|Personal Accident Plans||Insurance that pays out a lump sum in the event you have an accident and suffer a permanent or temporary disability.
|Premium||The money paid to an insurance company for an insurance policy.
|Private Medical Insrance||PMI, a type of insurance that pays for you to receive private health care.
|Statutory Sick Pay||State benefit that pays employees if they're unable to work for at least four days in a row. Lasts for 28 weeks.
|Sum Insured||The maximum amount an insurance company will pay for a claim.
|Term Assurance||Simple type of life insurance that offers cover for a fixed period of time for a (usually) fixed monthy premium.
|Underwriting||The process where an insurance company decides how risky it would be to insure you and how much to charge you for cover, assuming they're prepared to insure you.
|Whole of Life||A type of life insurance that can run until you die, however old you might be. However, premiums tend to increase over time so it can become very expensive.