Focus on Income Protection Insurance

income protection insurance pays you a benefit if you are unable to work for a period of time because of illness or injury

If you are working you should consider Income Protection Insurance. Important as protection against short-term sickness or minor accidents may be, the risks associated with a prolonged illness or disability are much greater.  The financial problems faced by a family, when the main breadwinner suffers from a prolonged illness or disability, can be much more serious than if that person had actually died.

The reality that must be faced

The thought that you might suffer from a prolonged disability is not something that you really want to dwell on.  This is probably the main reason why only 7.5% of the working population currently insure themselves against such an event (Association of British Insurer statistics for 2018), even though the results could be financially devastating for themselves and their families. 

The reverse of this is probably the reason that, each week, several million people stake their cash on the National Lottery.  They like to think about having instant financial security for the rest of their lives, even though the chances of it ‘being you’ are rather slim (According to the National Lottery website, the odds of winning the major prizes are: Lotto jackpot: 1 in 45,057,474 and EuroMillions jackpot: 1 in 139,838,160)

The Magic Box

Imagine for a moment that you have won, not the Premium Bonds or the National Lottery, but a Magic Box. This box has been wonderfully made by a power that is outside of our human understanding. What does the box do? It makes entirely legal £20 notes! How often does it make them? It produces one £20 note every hour, 8 hours a day six days a week.

On one day each week it goes through a kind of automatic servicing routine and produces no notes. So in a year it provides a total of £49,920 in £20 notes.

How long will it go on producing these notes? It has the potential to do so for the rest of your life. What is the catch! The issue of which you need to be aware is related to the highly complicated nature of the internal workings of the box. If it goes wrong, which it could do at any time, you may never be able to fix it.

There is a team of highly skilled engineers who were involved in the original design of the box. They have made quite a few of these magic boxes and are able to fix them although it can take around three months to do so. They are prepared to offer you a contract that if your box goes wrong they will get it working again within 3 months. This guarantee is valid until you reach your State Retirement Age and is irrespective of the number of times that you may have to call them out.

What is the cost for this contract? You just have to set aside the first £20 note that the box produces each week and send these notes to them at regular intervals. You will still be left with forty seven £20 notes every week.

The choice is yours. Do you want the magic box that you have won just as it is, or complete with the service contract?

This is not a figment of your imagination

The magic box is not, of course, a figment of your imagination. The magic box is you! Through the wonderful facilities your body provides you are able to work and earn lots of £20 notes each week.

Instead of setting aside the first £20 note each week for the service contract you set up a direct debit for this amount to an insurance company. The insurance company then guarantees you a replacement income of around 50% to 60% of your normal gross income if you are unable to carry out your occupation (or possibly another occupation for which you have been trained).

Because the income is tax free and, as an employee you will also receive incapacity benefit, it will not be too far short of your current net income. If you are self employed you will need to protect a slightly higher percentage of your gross income.  This guarantee continues for the rest of your expected working life no matter how often you need to claim on the policy. 

What is the risk?

The choice is yours. Before you make your decision it is worth calculating how much income you might expect to earn during the rest of your working life because that is the amount at risk. If you are age 50 and earning £50,000 a year and expect to work until your State Pension Age of 68 then your future income at risk (assuming wage inflation of 2% pa) is £1,070,000.

If you are presently age 40 the figure increases to £1,852,560 and if you are age 30 it increases to £2,805,745. Of course, if you are age around 30 to 40 you would be disappointed to think that your income would only increase by 2% pa during the rest of your career.

Your future income at risk can be a very large sum but there is a simple solution to hand and it is called Income Protection.

An example
Paul (it could just as easily be Paula) is age 40 and an administration manager earning £50,000 a year. He believes that he could pay his bills for three months if he were unable to work as the result of a serious illness or injury. For a premium of around £60 a month he could take out an income protection policy that would provide him with £2,300 a month after the first three months until he is well enough to return to work.

This amount is tax free and he will also receive incapacity benefit of around £500 a month. The £2,800 a month he will receive in total is around 90% of his current net take home income of £3,136 a month. Naturally there needs to be some incentive for him to return to work.

If Paul were age 30 the premium would be around £39 a month and if he were age 50 the premium would be around £99 a month. If because of his employer’s generosity or his savings and investments Paul believes he could pay his bills for six months then his monthly premium would reduce by around 10%.

State benefits during a prolonged disability

Many people still seem to believe that the State will look after them if they suffer from a prolonged disability.  The State does have a role in this but it is limited to providing a level of support that anyone in work would find it extremely difficult to live on. 

Certainly the State support does not consider that you need to eat out, have good holidays, buy your own home or send your children to a private school.  In other words if you rely on the State for assistance you are letting a future Government determine how you will live during a period of prolonged disability. 

The solution – Income Protection Insurance

If you are currently in good health and employed or self employed, you can apply for income protection insurance cover.  Income Protection Insurance (also referred to Permanent Health Insurance) provides a totally tax-free regular income as long as it is needed, up to retirement age, if work is ruled out by ill health. 

The premiums depend on a number of factors including the work that you do, whether you smoke, your sex and the length of time you will be ill before claiming (the waiting period).  More limited cover is also available for homemakers whose unpaid cleaning, cooking and childcare would need replacing with paid labour if they fell ill.

The main features of an Income Protection Insurance Policy

  • Definition of disability – with the most generous cover you can make a successful claim if you are unable to carry out the main aspects of your own occupation.  A more stricter definition is being unable to carry out any occupation for which you are suited by education or training.

  • Normal exclusions – being unable to work as the result of being caught up in a war, complications of pregnancy, being involved in a riot, or as a result of the misuse of alcohol or drugs.

  • Waiting periods – also referred to as deferred period, this is the period during which you cannot make a claim following the onset of your disability.  This is most commonly 26 weeks but can be 13 weeks or even a month.

  • Linked claims – this stops you from going through a further waiting period if you go back to work after a disability but then have to stop work again as a result of a recurrence of the same or a related disability.

  • Partial disability – if you are able to work part-time you can make a claim for a proportion of the insured monthly benefit.

  • Length of contract options – most plans provide benefits up to age 60, 65 or 67 but you can set a shorter period and in some cases then extend the cover for a further period

  • Occupational classes – if you are a blue collar worker who really needs a short waiting period then the Friendly Societies have designed plans which more closely fit your circumstances.

  • Homemaker cover – if you do not work outside the home you can apply for homemaker cover which has a more limited maximum benefit and more stricter definitions of what constitutes a successful claim.

On individual policies the benefit is tax free.

Risk Warnings

  • Information given relating to Income Tax legislation and Social Security benefits is based on our understanding of legislation and practice currently in force.   Whilst we believe our interpretation of current law and practice to be correct in these areas, we cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. 
  • In particular you are warned that levels of tax and tax reliefs and also State Benefits are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances. 
  • These notes are intended as a guide only and do not replace the full product details that accompany each Income Protection Insurance illustration.

Links to other types of health insurance

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.