The ins and outs of income protection

Given the current climate, it’s not surprising that income protection is a key concern for many people. Insurers have reported that the number of enquiries about this type of cover rose by more than 1,000% in March as the number of people fearing redundancy skyrocketed.

Income protection is an insurance policy that pays out if you’re unable to work because of injury or illness. It can include: 

• Mortgage cover
• Redundancy protection
• Loan protection 
• Accident and sickness cover  

Despite it being probably one of the policies most needed, traditionally it’s been one of the least popular products that people take out. According to a survey by Which?, only 9% had income protection compared with 41% with life insurance and 16% with private health insurance. It is, however, recommended for any adult of working age as very few employers will cover your salary for more than a year if you find yourself unable to work.   

The cost of income protection is worked out depending on factors such as your health, whether you smoke and how much cover you need. Insurers also take into account the level of risk in your job. 

Some insurance providers have started adding coronavirus exemptions or pulling out of the income protection market altogether. However, others have shown quite a bit of flexibility by offering payment holidays for vulnerable cases or offering the option to put policies on hold. They will still offer policies to those on furlough, although they won’t pay out if you are made redundant. 

A policy will usually pay out between 50%-70% of your earnings, tax free, although sometimes this is capped. It will pay for as long as the policy lasts or until you can go back to work, whichever is soonest. Most policies don’t pay out until after a waiting period which can be as long as 13 weeks on some of the longer ones.      

If you’re thinking of buying income protection to cover the COVID-19 outbreak, it’s unlikely to pay out if you’re only ill for a short while or are self-isolating. Most policies are designed for long-term absences. By the time the waiting period is has passed, your period of illness or self isolation  could be over and you could have gone back to work. 

You may want to consider index-linking your protection. This means that it will rise with a measure of inflation such as the consumer price index (RPI). Otherwise you could come to make a claim only to find that the level of protection hasn’t kept track with the way your salary might have risen.     

A further consideration is ‘stepped benefit’ so that you opt to choose between two different levels of payment depending on the sickness benefits offered by your employer, a lower payment while your employer is still paying you a higher percentage of our salary and a higher amount when your employer reduces their contribution.  

There are over 20 different income protection providers so shop around and make sure you’re clear about the conditions under which the policy will pay out.  

Some people object to insurance on the principle that it may not provide any tangible benefits: an insurance policy only pays out if the event occurs that it’s designed to protect against. If your house doesn’t suffer fire, flood, subsidence or other damage, your house insurance won’t pay out. And so on.

Of course, many such policies provide peace of mind and reassurance, which surely has some value. But it must be agreed that many types of insurance never pay out. Your house may never suffer damage. And even though term assurance is a type of life assurance, if you don’t die within the period specified, it won’t pay out either.

However, there is one type of insurance guaranteed to pay out: whole of life protection. This type of life assurance runs for your whole life; and as death is unavoidable, it will pay something sooner or later.

This provides you with the peace of mind that your family won’t suffer financial stress due to your death, whenever it occurs. But this type of policy also has other uses. You can combine it with term assurance to cover particular debts. It can also be used as part of estate planning by providing money that can help with Inheritance Tax bills. It can even have value for businesses: when used as so-called key person cover, it can protect a company from the financial consequences of losing a vital employee, partner or director.

Whole of life protection comes in various forms. In essence, though, there are two types of cover: maximum and balanced cover. With maximum cover, the initial premiums and the sum insured don’t change for the first 10 years. Thereafter, the premiums may go up depending on various factors – such as the performance of the life fund in which the premiums are invested.

Balanced cover plans aim to keep the original premium level for however long the policy runs for. However, premiums still might rise if the fund doesn’t perform as well as anticipated, or if charges go up.

How much does whole of life cover cost? The premium rate depends on a number of factors: your age, how much cover you want, your sex, whether you’re a smoker, and your state of health at outset. However, because whole of life cover is guaranteed to pay out eventually, it will tend to be more expensive than term cover which might not pay out anything.

You can bolt on some extras to increase your security. One of these is critical illness cover. While life assurance only pays out on your death, critical illness plans pay their sum assured following diagnosis of a specified serious illness; and the money can be used however you want. Waiver of premium might also be worth considering: this will pay your premiums for you for a set period if you’re unable to work due to illness or accident.

As always, it’s worth discussing your circumstances with a trained and qualified financial adviser to make sure you buy the plan that best suits your needs.

Recent research carried out by Scottish Widows has found that three quarters of UK households would only manage to cover their bills for seven months if the income of the woman in the family was lost through death or illness. In addition to the financial ramifications, women spend almost an entire day (23 hours) each week carrying out household chores and caring for children, which the family would struggle to carry out or pay for were she no longer there to do these vital tasks.

Despite these statistics, Scottish Widows discovered that less than a third (31%) of women in the UK have a life insurance policy, with less than one in ten (7%) holding a critical illness policy. The most popular reason for women not taking out such cover is them not seeing it as a financial priority or simply not believing that it was needed. More worryingly, over half (54%) of the women surveyed did not have a will in place.

The survey also asked what would happen should a partner find themselves out of work for six months, with a quarter of respondents stating they would have to rely on state benefits to cover household expenses. 68% of the women surveyed admitted to not being able to save for the long-term future due to the need to pay for other things.

“One of the most important things a woman can give her family is security, but financial protection is still too far down the priority list because women simply don’t recognise their own value,” said Scottish Widows’ protection director Jackie Leiper. “It’s crucial that everyone – no matter what stage of life they’re at – considers whether they have the right protection in place to ensure their loved ones aren’t left coping with financial strain on top of emotional trauma if the worst were to happen.” Reacting to the findings of the research, Ms. Leiper also emphasised the “need to recognise the monetary value of women’s time and effort in the household, and to safeguard it accordingly.”