Do I need income protection insurance?

Whether you see being unable to work as a stressful experience or a chance to catch up on your Netflix binging, there’s one thing that you can definitely count on: the bills still need to get paid.

If you’re like most people, paying usual monthly expenses like rent, grocery or electricity bills might get a bit tricky without your paycheck coming in. And it only gets worse if you’re providing for a family or paying off a home loan.

But there’s no need to lie awake at night worrying about it - because that’s where income protection insurance comes in.

What is income protection insurance?

This one is just what it says on the tin: an income protection policy will replace income lost if you’re sick or injured and unable to work. Once you’ve bought income protection insurance, that policy will usually be in place until you’re 65 years old, as long as you continue working and pay your premiums.

Income protection insurance is a pretty important thing for anyone who relies on a pay check to cover their living costs, but it's especially important if you’re self-employed or own a small business, where your employment and income is a bit less stable.

What does an income protection insurance policy cover?

Generally speaking, the maximum benefit you can claim under your policy is 75% of your gross income from the past 12 months. You might decide this is the right level of cover for you to continue covering living expenses while out of work, or, in some cases, you can opt for a lower benefit when you take out the policy.

Once your insurance cover kicks in, you’ll receive monthly payments, just like if you were receiving a salary from work. So what has to happen before you’re eligible to receive these payments? Well...

Types of unemployment covered

Always be sure to check your PDS to be sure what your particular insurance policy covers, but in general, these are the events covered by your income protection insurance:

  • Being made redundant
  • Being dismissed from your job
  • A business you own or have a significant interest in going into insolvency administration
  • A fixed term employment contract of 12 months or longer being terminated before the agreed date.
  • Suffering from a sickness or injury that leaves you unable to work

Keep in mind, if you quit or otherwise make the decision to leave your job, that won’t be covered by your insurance. Other things that might stop you working but often aren’t covered under an income protection policy include:

  • Pregnancy
  • Mental illnesses
  • Substance abuse
  • Injury or sickness caused by alcohol consumption (for example, if you’re hurt in a car accident while drink driving)

How to choose an income protection policy

Income protection insurance is tailored to suit you and your situation, which can make choosing a policy pretty tricky. It’s important to weigh up your options and find one that works for you. Here are some of the things you’ll need to consider:

The waiting period. When you buy your policy, you’ll need to nominate a waiting period, which is the length of time between when you become unable to work, to when you are eligible to start receiving payments from your policy. Usually this is 2 weeks to 2 years and a longer waiting period should mean a cheaper policy.

When choosing a waiting period, think about how long you could afford to cover living expenses without the payments. If you have a heap of paid leave built up, you may be able to opt for a longer waiting period and save money on your insurance premiums.

The benefit period. The benefit period is the maximum amount of time you’ll receive payments under your policy, regardless of how long you’re out of work. This period is decided upfront - sometimes you’ll get to choose, but some insurers have a set benefit period. Usually, benefit periods last either 2 or 5 years, or until the age of 65.

Keep in mind that the longer the benefit period, the more expensive your insurance premium will be.

Percentage of income insured. Remember when we said that the maximum benefit is usually 75% of your gross income? And remember how we said you can sometimes choose a lower amount? Well, that’s something else you’ll need to think about. The higher the percentage of your income being paid to you, the more expensive your premium will be, so choose carefully.

At this point you might be wondering what the right benefit level is for you. Well, read on...

How much cover do I need?

You don’t want to set the cover level too low, or you’ll wind up dipping into your savings despite your income protection insurance, but if you set it higher than necessary, you might be paying high premiums for no reason. So to work out how much of your income you should have insured, you’ll have to take a long, hard look at your budget.

The aim is to work out what percentage of your income you’ll need in order to cover standard monthly costs. Costs to consider include:

  • Monthly mortgage or personal loan repayments
  • Living expenses such as groceries, rent, or petrol
  • Electricity, gas and internet bills
  • If you’ve got kids, school fees
  • You may also want to factor in the potential cost of medical bills, in case you’re unemployed due to sickness or injury.

Agreed value vs Indemnity

Some insurers will give you the option to choose between agreed value and indemnity contracts. Here’s the difference between the two:

Agreed ValueIndemnity
You’ll receive a set monthly payment which is established in your policy when you buy it.The monthly benefit is assessed based on your income when you make a claim.

The main thing to think about when deciding which is right for you is how stable your income is. If it’s very stable and not likely to change, opting for an indemnity policy could save you some money on your premium.

On the other hand, if your income tends to fluctuate, an agreed value policy may give you better security. That’s why these policies are often better suited to self-employed people.

Stepped vs level cover

One more thing you need to consider: stepped premiums vs level premiums. The decision here will likely come down to whether or not you will review your policy and shop around for a better deal in the future.

If you like to shop for a better deal: a stepped premium may be better for you. These policies start out cheaper and then get more expensive as time goes on, so when the price starts rising, you can ditch your policy for a better bargain.

If you like to set and forget: a level premium might be just the ticket. These premiums will remain the same for the life of your policy, but the price varies depending on your age when you first buy your policy. So if you’re likely to buy your income protection early, then stick with the same policy for the next decade, it will usually be the cheaper option.

Making a claim

Ideally, you’ll never have to make a claim on your income protection insurance. But if you do, it’s worth knowing a little about the claims process to keep the stress to a minimum.

You can usually claim either over the phone, online or by going into to visit your insurer in branch if they have one. When you do start a claim there are a few things you might need to provide, such as:

  • A certified copy of your I.D, such as a driver's licence or a passport.
  • A completed medical report if you’re claiming due to illness or injury.
  • Evidence of your income, such as an employment contract or a letter from your employer.
  • Evidence of your involuntary redundancy, which might mean a letter from your employer or dismissal notice.
  • Evidence that you’ve been searching for jobs during the waiting period.
  • Any other forms or documentation relevant to your state of employment that might back up your claim.

Something important to keep in mind…

When you make a claim on your income protection policy, there’s a bit of waiting around before you’ll receive any payments. Firstly, you’ll have to clear the waiting period, which you set when you bought your policy. But you may not realise that many insurers make benefit payments one month in arrears.

Check out this example:

Do I pay tax on income protection payments?

Figuring out how tax and your income protection payments work can be tricky. The basic rule is, the premiums on your income protection are tax deductible, but you will need to pay tax on any benefits paid.

What next?

Now that you’ve got income protection insurance covered, the next thing to tackle is finding an awesome life insurance plan. Head over to our life insurance page to find some of the best deals around, or read our guide on how much life insurance you really need

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