What is Income Protection
While we often focus on accumulating wealth and building assets, protecting our income is equally important. Imagine what would happen if, due to illness or injury, you were suddenly unable to work. How would the daily living expenses, mortgage repayments, and other financial obligations be covered? This is where income protection becomes a crucial part of your financial plan.
Income protection offers a level of protection in the event of unexpected illness or injury. In this blog, we will discuss, what income protection is, why it is important, how it works and considerations when choosing a policy.
What is Income Protection?
Income protection is a type of insurance designed to replace a portion of an individual’s income if they are unable to work due to illness or injury. Unlike other types of insurance which provide a lump sum payment, income protection pays a regular income stream (generally monthly) and is typically a percentage of the insured income before their disability. Income protection policies can be customised, allowing policy holders to choose the level of cover, waiting period and benefit period that best suits their needs. This flexibility ensures that income protection can be tailored to fit a wide range of personal and financial circumstances. The policy can also be altered overtime as your circumstances chance.
Why is Income Protection Important?
1) Financial Security
For most people, our ability to work is the largest income-producing asset that we have. While we might insure our homes, cars and other valuables, our capacity to earn an income is often overlooked. Income protection provides cover so that you can continue to meet financial obligations, such as mortgage payments, utility bills, and daily living expenses even when you are unable to work.
Consider a scenario where the primary breadwinner of the household suffers a serious injury that leaves them unable to work this could be a short-term condition for a few months or longer for years. Without income protection, they may have to use their savings, sell assets or take on debt to cover basic expenses. Over time, this could erode their financial stability. Income protection assists to prevent this by covering a portion of income, and allowing you to maintain financial security during challenging times.
2) Peace of Mind
Knowing that you have a financial safety net in place can alleviate worry, allowing you to focus on recovery without the added pressure of financial uncertainty. This peace of mind is invaluable, as stress about finances can delay recovery or cause further health issues. With income protection in place, you can concentrate on getting better, knowing that bills can be covered.
Further, income protection can also provide peace of mind to your family. They won’t have to worry about how to make ends meet while you are out of work, and they can focus on supporting your recovery. This added emotional security can make a significant difference in your overall well-being.
How Does Income Protection Work?
1) Policy Cover
Income protection policies vary in terms of benefits and features. Typically, policies pay a monthly benefit, expressed as a percentage of pre-disability income, after a waiting period, and continuing until recovery or the end of the benefit period.
It is important to note that income protection premiums are generally tax-deductible meaning the cost of the premium can be offset against taxable income if the premiums are paid personally. However, the benefits received from an income protection policy are typically considered taxable income, which is essential to factor into the overall plan.
2) Waiting Period
The waiting period refers to how long you are required to wait before the payments start. Most income protection policies offer a waiting period of between 14 days and two years. The choice of waiting period will affect the cost of the premiums.
When choosing a waiting period, it’s important to consider the overall financial situation and how long you could manage without your regular income.
3) Benefit Period
The benefit period is how long the payments will continue if you remain unable to work. Most income protection policies offer two years, five years, or up to a specific age (for example age 65). Choosing the right benefit period is crucial, as it determines how long you will be financially supported if you’re unable to return to work.
For example, for a benefit period of two years, the income protection payments will cease after two years, even if the person is unable to work.
4) Premiums
Premiums for income protection policies vary depending on factors such as age, occupation, health status, benefit amount, waiting period, smoker status, and optional policy features. When considering premiums, it’s essential to balance affordability with the level of cover you need.
Key Considerations When Choosing Income Protection
The following are key aspects to consider when selecting a policy:
Cover needs
The income protection cover should reflect the financial needs and obligations. Taking into consideration monthly expenses, debt repayment and other financial commitments. Additionally, considering how long these expenses could be sustained without a regular income and whether the current savings would be sufficient to cover them.
Policy Features
Income protection policies come with various features and options that can enhance the cover. Some features include indexation, partial disability benefit, rehabilitation benefit and waiver of premium.
Insurer
Choosing a reputable insurer is essential when selecting an income protection policy. Research the insurers claim history and customer service reputation. Insurers can be compared online using comparison tools or you may choose to consult with a financial advisor who can provide personalised recommendations based on your needs.
The underwriting process for income protection involves assessing the health, occupation and lifestyle to determine the risk level. This process will impact the terms of the policy including premiums and exclusions.
Insurers may request medical reports from your GP during this process.
Affordability
While it’s important to have adequate income protection, it’s also important to ensure that the policy is affordable and can be held for the duration that you need cover. Consider your budget and how much you can afford to allocate to income protection premiums. The policy features can be adjusted to find a balance between cost and coverage. Regular reviews of a policy are important to ensure it remains aligned with your financial situation and needs.
Income protection is an important component of financial planning, offering protection for our most valuable asset - our ability to earn an income. By understanding how income protection works and considering key factors such as cover needs, policy features, underwriting process and affordability, you can choose a policy that provides the right level of protection for you and your family.
After working as an advisor for a decade, Joel founded Unified Wealth.
Unified Wealth specialises in helping clients who are facing life’s big decisions.
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