Income Protection Insurance Guide

What is Income Protection Insurance? 

Income Protection Insurance provides a monthly replacement income, tax-free, if you are forced to stop work for any medical reason.  It can pay out for physical or sudden health conditions like back pain, cancer, or a stroke, as well as stress-related or mental health illnesses.  

Policyholders are covered until retirement or their return to work, depending on the policy taken out. 

Why get income protection insurance?

Income protection gives you the peace of mind that your bills would be paid if you were off work due to illness or injury.  

You might need income protection insurance if you:

• Are self-employed

• Are employed but your employer offers limited sickness benefits

• Have lots of financial responsibilities, like a mortgage and bills

• Have limited savings and investments

• Have dependants or people relying on your income

• Are single and responsible for all household expenses

• Don’t have mortgage protection insurance and critical illness cover

Most people in the UK are eligible for up to 28 weeks statutory sick pay funded by the government if they are too ill to work.  But this is currently only £96.35 a week, which is why some form of personal insurance could be needed.

How does income protection work?

Income protection policies pay out a set amount of income after you’ve been out of work for a specified period of time.  You pay a monthly premium in return for this valuable protection.

Be aware that payments don’t start straight away, but after an agreed waiting period (often 4, 13 or 26 weeks).  This is the ‘deferred’ period before your payout kicks in.  The longer you defer, the cheaper the policy tends to be.  This means if you have emergency savings, you could set a longer time period to cut the costs of the insurance.

Normally income protection cover pays out a specific percentage of your salary. Between 50%-70% is standard, and the level you get impacts how much the insurance premiums cost.

Income protection then usually pays out until either:

• You return to work

• You retire

• The policy expires

• Death

 What does income protection cover?

Income protection (and critical illness) cover only pay out for illness or injury, not death, (which is covered by life insurance).  Income protection tends to be the most expensive option, but it is the most comprehensive, covering you for a wider range of circumstances.

Income protection covers most illnesses and injuries that stop you working, but you aren’t usually covered against being made redundant.  You need to check your policy terms carefully to see what conditions are included – we can help you with this.

Some policies include extras like:

• Pay-outs for hospitalisation

• Life insurance

• No deferral if you get ill again in 12 months

• Payments if you need a staggered return to work

You can buy policies that will cover you for unemployment.  These are normally called Accident, Sickness and Unemployment (ASU) insurance products (see below).

Types of income protection insurance

Overall income protection insurance is divided broadly into two categories:

1. Short-term policies of up to 12 or 18 months (although some insurers offer five years)

2. Long-term policies, until you retire

‘Index linked’ income protection 

This simply means the payout rises in line with inflation.  Potential pay-outs increase each year, to take into account higher standards of living and a higher salary as time goes on.  Most providers increase the potential payout in line with the retail price index (RPI) measure of inflation, but some use a fixed percentage each year.

In comparison, a non-index-linked policy will offer to pay out a certain amount per year –  let’s say £12,000 – and this figure stays the same throughout the term of the policy.  The cost of an index-linked policy is higher to start with (vs. a non-indexed) and will increase each year.

‘Stepped benefit’ income protection

Here you can get different levels of pay.  A stepped-benefit policy takes into account whether your employer already offers sickness cover.  For example, you might opt for lower payments early on when you’re getting enhanced sick pay, and higher amounts when you move to statutory sick pay.  Or your company may offer to pay your salary for three months in the event of illness or injury.  This is where a “stepped” insurance policy comes in, as it pays lower amounts while you’re receiving a salary from your employer, and increases payments when your company’s contributions reduce or stop.

Permanent health insurance (PHI)

This is the technical name for income protection insurance, often used by insurers.  It covers all forms of long-term income protection insurance.  PHI protects against long-term sickness or injury only, and will pay out until you retire.  Normally you can make as many claims as required on a long-term PHI policy (so long as they’re legitimate). 

Accident and sickness cover

This provides a replacement monthly income if you are forced to stop work for health reasons or an injury.  It can be taken out as a short-term or long-term policy.  

Unemployment cover

This protects against potential redundancy, paying an income for the time you’re out of work.  It’s only available as a short-term policy, normally up to 12 months.

Accident, sickness and unemployment (ASU)

This is a combination of Accident & Sickness and Unemployment covers above, encompassing all scenarios why you might be out of work.  Unlike PHI, these policies are short-term and tend to pay out for up to two years and only allow a single claim. The policy is cancelled after you claim.  You’d then have to take out a new one if you want to be covered again.

How much does income protection cost?

Some income protection plans cost as little as £10 a month, but you can spend more than £80 a month in some cases.  If you’re a high earner, for example, your protection could cost more.

The cost of income protection insurance varies widely and will depend on:

• Your age

• Your current health

• Whether you are a smoker or have smoked in the past

• Your job

• The percentage of income you’d like covered

• Whether you want guaranteed or reviewable premiums - with guaranteed premiums the monthly price remains the same. With reviewable premiums the price may rise over time.

• The time set before payouts begin - the longer the “deferral period” the lower the cost

• The length of the policy

• Any potentially hazardous hobbies, e.g. hand gliding or off-piste skiing

Is income protection insurance the same as PPI?

Short answer, no.  Payment protection insurance (PPI) normally covers loan repayments (e.g. a mortgage), whereas income protection insurance funds broader living costs.  The payout from an income protection policy can be used to cover mortgage repayments, but it can also pay for household expenses like food and bills.  PPI policies tend to be short-term (up to 24 months) while income protection can pay out for much longer.  PPI is notoriously unreliable when it comes to paying out in the event of a claim, and can often be over-priced and mis-sold.  Income protection tends to be more reliable and covers more than one specific loan.  It’s therefore usually a better option for protecting your finances against being unable to work. 

Income protection insurance vs. critical illness cover?

Income protection payout: provides regular payments if you’re unable to work, after a deferral period of at least four weeks.

Critical illness payout: pays a one-off lump sum.  There’s no deferral and payment would be on diagnosis of a listed condition.

Income protection cover: anything that means you’re medically signed-off work.

Critical illness cover: tends to just cover potentially life-threatening illnesses.  These are specified when you take out the insurance, normally about 50 conditions. 

Income protection cover length: you can make multiple claims during the policy term.

Critical illness cover length: only pays out once, after which the policy ends. 

Considerations and Risks

·       Life Assurance plans typically have no cash in value at any time and cover will cease at the end of term. If premiums stop, then cover will lapse.

·       If any relevant information provided, when applying, is not disclosed accurately and honestly, this could result in any cover offered becoming invalid and / or may result in the non-payment of any future claims.

·       The contract will typically exclude certain conditions, particularly those which pre-exist the commencement date of the contract. Full details will be incorporated within the Policy Summary.

·       The payment of any benefits may affect any claim to means tested state benefits.

·       Benefits may be reduced if you receive other regular income, such as salary or pension.