How To Protect Your Income

Life insurance can provide financial protection for your family if you die. However, there are also a range of products that can protect your income if you’re too ill to work or you’ve suffered an injury.

To start with you can buy private health insurance or long-term care insurance to fund medical and care bills. These policies have their place but here we’re concentrating on products that provide you with wider financial protection.

You can buy accident, sickness and unemployment insurance. This is often sold to protect loan payments where it is known as payment protection insurance. This product has received a lot of bad press in recent years due to its high cost and rampant mis-selling. As well as only covering loan payments rather than your wider financial needs, it tends to only pay out for a period of 12 to 24 months so it’s not suitable for long-term income protection.

There are two types of insurance policy that provide much better all-round cover and they are the focus of this article. They are critical illness and income protection. These are quite complex products so it’s often helpful to get independent financial advice to help you understand what’s available and what’s right for you. However, here are basics you need to know.

Critical illness

Critical illness insurance provides a tax-free lump sum in the event that you are diagnosed with one of about thirty conditions. The exact number of conditions differs between insurers and you need to survive, normally for a two week or four week period after being diagnosed, in order to make a claim.

These policies should also pay out if you suffer total and permanent disability due to any illness or injury which means you are unable to work. Being “unable to work” can have various definitions depending on the policy’s small print.

It can mean you are unable to carry out your current job (most people’s preference), unable to carry out any suitable job or unable to carry out any type of job.

Policies usually have a long list of exclusions relating to claims including participating in a criminal act, drug abuse, self-inflicted injuries, HIV/AIDS and hazardous sports and pastimes.

You will need to disclose any pre-existing medical conditions you have, your drinking and smoking habits and details of your family’s health history. There have been many reports of insurers not paying out due to non-disclosure, sometimes of trivial and unrelated conditions, but this situation now appears to be improving and the Financial Ombudsman can arbitrate in any disputes. Overall it’s reckoned that between 5% and 10% of claims are not paid due to non-disclosure.

The cost of critical illness will vary depending on your age, sex, health, how much cover you want and for how long. Many people like their cover to last until their mortgage is due to be paid off or until they retire. It’s possible to get the payout index-linked so that it increases each year in line with inflation.

Most companies provide guaranteed rates that won’t increase each year. These tend to be more expensive at the outset than reviewable rates but obviously give you peace of mind regarding future costs. It may be that you require additional cover at a later date, if your family expands or you take on a bigger mortgage, so look for a policy that gives you the option to do this.

It’s also possible to get a policy that covers your children. The amount payable following a claim tends to be much lower than for the main policyholder but it can still make all the difference if one or both parents need to take time off work as a result.

Finally, you can often get combined critical illness and life insurance policies. These are cheaper than separate policies but tend to only pay once, whereas separate policies could pay out when you contract an illness and when you die. Check to see that the critical illness element of a combined policy covers all the features you’d want in a separate policy.

Income protection insurance

Income protection insurance, also known as permanent health insurance, provides you with a tax-free income in the event that are unable to work due to illness or injury. So in this respect it differs from critical illness which pays out a lump sum. You may also find that some conditions are covered by income protection insurance and not by critical illness and vice versa.

Another key difference is that a critical illness policy will only pay out once whereas income protection can cover you for multiple periods of absence from work until the policy expires.

With income protection insurance you can choose how much cover you require, typically up to 60%-65% of your annual income. As the payout is tax-free, you should only see a small reduction compared to your normal take-home pay. It’s also possible to get cover, typically up to £15,000 a year, if you look after the house and/or children and don’t earn any money. This can be useful to pay for childcare fees.

There are number of similarities with critical illness insurance with regards to what sort of job you are unable to do (i.e. your current job or any job) before the policy pays outs and exclusions relating to criminal acts, drug use etc. Some policies also require you to declare your medical history and so there can be similar problems with unpaid claims due to non-disclosure.

Like critical illness, the premiums you pay can be either guaranteed or reviewable and any payout you receive can be increased each year by the rate of inflation. You can also specify how long you want to policy to last for, up until you retire for example, or for a certain number of years.

It can often be better to get a policy while you’re younger as the premiums tend to be much lower. For example, income protection premiums can rise by a half to two-thirds between the ages of 30 and 40. Females typically face higher premiums as they are more likely to face extended periods off work.

One way of lowering your income protection premiums is to increase the time before you receive the first payment. Typical limits are 4, 13, 26 and 52 weeks. If you have substantial savings that you could live off first, this is an option worth exploring.

You should also check your employment contract to see what your employer will pay you if you are unable to work. Some will only pay Statutory Sick Pay while others are far more generous. It may even be the case that your employer offers income protection insurance as a benefit.

However, as people are switching jobs more frequently these days, it may be the case that your next job does not provide a similar level of benefits so bear this in mind when deciding what level of cover is appropriate.