How does income protection work?

If somebody asked you “what is your most valuable financial asset?”, what would you say? Your house? Your car? Your personal jet? For most people – your most valuable financial asset is your ability to earn an income OR the present value of your future earnings. For most people at the beginning or in the middle of their working life their most valuable financial asset is their ability to earn an income. If this is the case for you, isn’t your ability to earn an income worth insuring against not being able to work, due to an accident or illness? Income protection provides an ongoing monthly benefit (e.g. 70% of your income) for the period you are unable to work due to an accident or an illness.

Here is the breakdown of income protection:

1.      What is the purpose of income protection?

The purpose of income protection is to replace a percentage (e.g. 70%) of your income if you are unable work due to an injury or illness so that you can still cover your basic living expenses such as your mortgage, rent, food, bills etc. Income protection policies are designed to relieve the financial stress of having to work when you are injured or unwell, and to give you the time to recover. Insurers are very careful to ensure that you are not in a better financial situation while on claim so that you have an incentive to return to work when you recover. For this reason, income protection policies can include offset clauses for sick leave, worker’s compensation payments or ongoing business income. If you are able to return to work in a partial capacity, income protection policies can pay a partial benefit.

2.      Waiting Period

Income protection policies are not designed to replace your income if you are off work for only a few days or even a couple of weeks due to a minor injury or illness (e.g. cold or flu). If income protection policies provided cover from day 1 the premiums would need to be horrendously expensive as people would be able to claim every time they have a couple of days off work due to a cold. To get around this, income protection policies have a waiting period, which is the period of time you need to be off work (or at least partially off work for some policies) before the benefit payments commence. The typical minimum waiting period length for most policies is 28 or 30 days. Longer waiting periods (e.g. 60 or 90 days) are usually also available, and taking a longer waiting period if it suits you lowers the premium for your policy. Employees have the option of taking sick leave during the waiting period, but it is a good idea to put some money aside to help cover the waiting period. It should be noted that income protection policies generally pay monthly in arrears, which means that even with a 30 day waiting period it could be 2 months from the date you stop work until your policy pays you.

Income protection policies are not designed to replace your income if you are off work for only a few days or even a couple of weeks due to a minor injury or illness (e.g. cold or flu). If income protection policies provided cover from day 1 the premiums would need to be horrendously expensive as people would be able to claim every time they have a couple of days off work due to a cold. To get around this, income protection policies have a waiting period, which is the period of time you need to be off work (or at least partially off work for some policies) before the benefit payments commence. The typical minimum waiting period length for most policies is 28 or 30 days. Longer waiting periods (e.g. 60 or 90 days) are usually also available, and taking a longer waiting period if it suits you lowers the premium for your policy. Employees have the option of taking sick leave during the waiting period, but it is a good idea to put some money aside to help cover the waiting period. It should be noted that income protection policies generally pay monthly in arrears, which means that even with a 30 day waiting period it could be 2 months from the date you stop work until your policy pays you.

3.      Benefit Period

Income protection is designed to continue paying you an ongoing benefit until you are back at work full time, but what happens if you have a serious injury or illness and can’t go back to work for a long time or you can never go back to work? You might ask, “will income protection keep paying me until I die if I can never go back to work?” There used to be policies that could keep paying until you die, but these policies have not been available in Australia for a long time. All income protection policies now have a benefit period, which means the policy will keep paying until you are either able to go back to work or until the end of the benefit period for any particular injury or illness. Typical benefit periods are 2 years, 5 years and until you turn 65. The benefit period that is right for you will depend on your personal circumstances, the premium you wish to pay and the amount TPD insurance you have. TPD insurance pays a lump sum benefit if you can never go back to work due to an injury or illness. Additionally, most income protection policies will pay you an ongoing benefit if you are not able to work in your own occupation due to an injury or illness for the first 2 years. For long term disability claims, many policies replace the “own occupation” part after 2 or 5 years with less favourable wordings such as suitable occupation or any occupation. 

4.      Underwriting and guaranteed renewability

If you purchase income protection through an adviser your policy will be fully underwritten and guaranteed renewable. Fully underwritten means to take out a policy you need to provide information including your income, your medical history, your occupation, and your pastimes. The underwriting assessment at time of application rather than at time of claim increases the chance of claims being paid. Guaranteed renewable means that your policy cannot be cancelled, and premiums cannot be increased due to any change in your health, occupation, or pastimes. Additionally, if your health, occupation, or pastimes change, no exclusions can be added to your policy. If you purchase income protection through your Super fund your policy may not be fully underwritten and won’t be guaranteed renewable.

5.      Paying premiums from Super or outside Super

You have the option of either paying your premiums from your Super fund or directly (e.g. bank account or credit card). There are pros and cons for each payment method, and you will need to consider your personal circumstances and preferences to decide on a payment method. Paying your premiums from Super increases your cash flow but decreases your Super balance and the amount you will receive at your retirement. Premiums that are paid directly (e.g. bank account or credit card) are tax deductable, which for most people works out less expensive after tax than premiums paid from a Super fund. For income protection policies paid from Super there are additional conditions that must be met before a claim can be paid (e.g. you must be employed at time of claim).

6.      What happens with an income protection claim?

The first thing to do when you suspect you might need to claim is to visit your doctor as for most policies the waiting period starts from the time your see your doctor. When visiting your doctor, it’s a good idea to ask your doctor for an estimate of the time you are likely to have off work. If you’re likely to have more than a few days off work, the next step is to contact your adviser (or your insurer if you don’t have an adviser). Income protection claims generally require proof of your income (e.g. pay slips, tax returns, profit & loss statements). If you have a business, you might need your accountant’s help with tax returns (both individual and company), financials, profit & loss statements. Claim forms will also need to be completed by you and your doctor to provide information regarding your claim. At claim time, it is definitely to your advantage to have an adviser, who will be your advocate and help you through the process.