The aim of income protection insurance is make up for your loss of salary should an accident or illness leave you unable to work with a payout made by regular monthly payments.
If you are so badly injured or ill that you are forced to give up work entirely, your payout will generally be made up until your chosen retirement age or the end of the policy term, whichever is earlier. Your cover is calculated as a proportion of your pre-tax salary and you can claim as many times as you need to.
This kind of cover can be taken out if you are employed or self-employed. You can only usually apply for income protection insurance if you're aged between 16 and 59.
Do I need income protection insurance?
You would be wise to think about income protection cover if your employer doesn't have generous sick pay and therefore there is a limit on how long you will get paid when you fall ill. It can also be a necessary element of financial planning if you're self-employed and therefore don't get a sick pay package at all.
The key question to ask yourself is whether you'd be able to continue your current lifestyle if you lost your income and only received state benefits, specifically statutory sick pay and incapacity benefit. This is especially true in the current climate when the criteria for incapacity benefit entitlement is getting stricter.
But how is it different to accident, sickness and unemployment cover?
You'd be forgiven for thinking that income protection cover and accident, sickness and unemployment (ASU) insurance work in exactly the same way. But there are fundamental differences between the two, which you need to be aware of.
The key distinction is that ASU will also cover you if you become unemployed for reasons not relating to sickness or accident (as long as it's not your fault). You may even be able to opt for this cover only, as well as sickness and injury related unemployment cover only. Whereas income protection insurance only covers you for unemployment arising from illness or injury.
However, in the event that you make a claim, ASU policies generally only pay out for one or two years, while income protection insurance will continue to give you a guaranteed level of monthly income until you retire.
Income protection insurance cover is usually calculated as 65% of your pre-tax income minus any employer and state benefits that you're entitled to. ASU allows you to specify the monthly pay out cover you'd like - within reason - and this is then used to calculate the premiums you pay. As with any insurance, the higher the cover, the higher the cost.
Income protection insurance will pay out for any number of legitimate claims and the insurer can't cancel the policy for as long as you keep up the premium payments. You can only claim once under an ASU policy, however, before it's cancelled, at which point you'd have to take out a new policy if you wanted to continue cover.
You can inflation-proof an income protection policy, if you're willing to have this take this into account in your premium calculation. This means pay outs are linked to the retail price index (RPI) so will increase in line with the official cost of living. ASU policies do not allow inflation proofing.
Which type of policy should I choose to cover my mortgage?
The main drawback of an ASU policy is that it will only cover you in the short term. This is usually 12 months from becoming unemployed, plus the policy then ends. The policy is reviewed at every annual renewal date at which point the insurer can increase the premium or even cancel it.
An ASU will also only cover a proportion of your monthly mortgage payment plus limited extra costs, depending on the insurance company, meaning that while you may be able to afford your mortgage, you may be left with other bills that you can't cover.
The key plus point of income protection insurance is the pay out only stops when you reach retirement, unless you've specified a shorter term, for sufficient mortgage cover.
As income protection insurance usually pays out 65% of your pre-tax pay minus any state or employer benefits, to give you an income close to your salary so all your bills, including your mortgage, can be paid.
You can also choose to defer payouts under an income protection insurance claim, which will make premiums cheaper. This could be an option if your company will continue to pay you a reasonable income for a period after you go off sick, or if you have savings that you can live off for a time.
While it only covers you for unemployment arising from illness or accident, income protection is much more comprehensive in other ways, and more flexible. If you're not fit to return to work after a year it will continue to let you live a similar lifestyle as if you were working.
Your insurer won't be able to cancel your income protection cover either, however many legitimate claims you make so you will always be covered.
How will my job affect the cost of my income protection premiums?
Generally, your premiums will be impacted by risk factors associated with your job. So a fire fighter will pay more than a computer technician. You won't pay more with some specialist providers though but you may get a lower payout or stricter terms on your policy so do always read the key facts and other policy documents to make sure you know what you're signing.
What else affects my premiums?
As with many other types of insurance your age, general health and the cover you require will be taken into account when your premiums are calculated.
If you decided to have a deferred period, that will usually lower your premiums as essentially it means less cover is required. This is a specified set time between going off sick and your policy benefits starting. You can opt to have this if your company sick package will pay you for a length of time or you have sufficient savings to cover your mortgage and other bills.
It is your choice whether you take out income protection insurance. There are various insurers who offer income protection insurance and various alternative types of insurance can cover you for income loss.
Income protection insurance doesn't have any cash in value and ends when the policy's term ends or if premiums are not paid.
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This article (What is Income Protection Insurance?) is intended to provide a general appreciation of the topic and it is not advice.
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Article expiry: 05 Apr 2018