Do I need income protection insurance?

Chef smiling in kitchen, considering the need for income protection insurance.

For most Australians, covering essential expenses like rent, groceries and power bills will get tricky without a paycheck coming in. It only gets more complicated if you’re providing for a family or paying off a home loan.

If you're worried about something impacting your ability to work and bring home an income, it might be time to investigate income protection insurance under a life insurance policy.

What is income protection insurance?

This one is what it says on the tin: an income protection policy will replace a portion of your income 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.

What does an income protection insurance policy cover?

According to ASIC, the maximum benefit you can generally claim under your policy is 85% of your pre-tax 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.

To ensure you're eligible to receive these payments, make sure your circumstances align with the conditions below.

Types of unemployment covered by income protection

Always be sure to check your product disclosure statement (PDS) to see what your particular insurance policy covers. In general, these are the events covered by 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 (sometimes including mental illness) injury that leaves you unable to work
Do you still pay income protection premiums while claiming?

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

How do I choose an income protection policy?

Standalone income protection insurance policies are usually 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. This can be anywhere from two weeks to two 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.

Seeking work during the waiting period of your income protection insurance

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 insurance providers have a set benefit period. Usually, benefit periods last either two or five years, or up to a specific age (often 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 the maximum benefit is usually 85% of your gross income, but sometimes you can choose a lower amount? Well, that’s something else that affects premiums. 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 income protection 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. 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
  • School fees (if you care for children)
  • Potential medical bills, in case you’re unemployed due to sickness or injury

What's the difference between agreed value and indemnity?

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

  • Agreed value: You’ll receive a set monthly payment which is established in your policy when you buy it.
  • Indemnity: 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.

How does my income changing affect my income protection insurance?

How are stepped and level cover different?

The difference here comes 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 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 the 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 on income protection insurance

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 visiting your insurance provider in branch if they have one. When you do start a claim there are a few things you might need to provide, such as:

  • ID like a driver's licence or a passport
  • A 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 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 many providers make benefit payments one month in arrears. Check out this example:

How much should I save for before my income protection insurance kicks in?

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 you’ve got income protection insurance covered, the next thing to figure out is if you need a life insurance plan. Head over to our life insurance comparison page to find some of the best deals around, or read our guide on how much life insurance you might need.

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