What is income protection insurance?
Formerly known as permanent health insurance, income protection is an insurance policy that pays out if you're unable to work because of injury or illness.
Income protection usually pays out until retirement, death or your return to work, although short-term income protection policies, which last for one or two years, are also available at a lower cost.
Neither income protection or short-term income protection pays out if you're made redundant - but they will often provide 'back to work' help if you're off sick.
Income protection is different from critical illness insurance, which pays out a lump sum if you fall seriously ill.
Is income protection the same as PPI?
Let's be clear - income protection isn't the same as the widely mis-sold payment protection insurance (PPI).
Where PPI covers a particular debt and any payouts go to your lender, income protection hands you a tax-free proportion of your income if you're unable to work because of illness or injury.
If you think you've been mis-sold PPI, you can put in a complaint using our free PPI tool.
Why do I need income protection insurance?
Only a minority of employers support their staff for more than a year if they're off sick from work (see our guide to statutory sick pay). Given the low level of state benefits available, everyone of working age should consider income protection.
However, while they were right about the protection, they were often wrong about the policies. The one protection policy every working adult in the UK should consider is the very one most of us don't have - income protection.
If you're looking to buy income protection, it pays to take professional advice. Call Which? Insurance Advisers on 0808 2911 960 for a free consultation today.
How much does income protection cost?
Your health, whether you smoke and level of cover needed will weigh into your premium, but your type of job also plays a major part in determining what you'll pay.
Many insurers group jobs into four categories of risk, though some have more. For example, jobs may be divided into the following groups:
- Class 1: Professional; managers; administrative staff; staff with limited business mileage; admin clerk; computer programmer; secretary.
- Class 2: Some workers with high business mileage; skilled manual work; engineer; florist; shop assistant
- Class 3: Skilled manual workers and some semi-skilled workers; care worker; plumber; teacher
- Class 4: Heavy manual workers and some unskilled workers; bar person; construction worker; mechanic
The riskier the type of job you have, the more likely it is that you may need to make a claim. Therefore, those in the riskiest occupations tend to pay higher premiums.
How much does income protection pay out?
Income protection payouts are usually based on a percentage of your earnings: 50% to 70% is the norm. Sometimes, an insurer might pay out a higher percentage of one portion of your salary (perhaps the first £50,000), and a lower percentage on anything above that.
For example, say you earn £40,000 a year, and you take out an income protection policy designed to pay out 60% of your salary.
Over the course of a year, your policy will pay out £40,000 x 60% = £24,000.
The good news is that payments from income protection policies are made free of income tax.
When does income protection pay out?
Income protection policies pay out only once a pre-agreed period has passed, generally ranging from one to 12 months after you put in a claim.
The longer the 'deferral' period you choose, the lower your premiums. The default deferral period tends to be 13 or 26 weeks, but it can sometimes be as low as four weeks.
How an income protection insurer defines your inability to work will also influence if and when your income protection policy pays out.
There are three methods insurers use: activities of daily living, suited occupation, and own occupation. We've explained this below.
Activities of daily living
Some older income protection policies use a method called 'activities of daily living', which include your ability to do basic things like showering, getting dressed, using the toiler
This is not a simple one! Historically, one of the main issues with IP payouts was how the insurer defined your inability to work. One fairly common method was 'activities of daily living' which included very basic things like showering, getting dressed, using the toilet, brushing your teeth, or walking, climbing stairs and getting in and out of a car.
If you were unable to do, for example, three of these things, your income protection policy would pay out.
These types of policies tend to be cheaper but aren't very good. You might be so ill that you cannot work, but can still walk, lift and write, and an insurer may turn down your claim, arguing that you could do some type of job.
'Suited occupation' income protection
If an income protection policy is bought on a 'suited' basis, this means that your insurer accepts you can't do your job anymore, but may not pay out when you make a claim if it believes you can do something similar to which you are suited.
For example, you may have a senior role managing a team of people, which you can no longer do because of stress.
With a suited policy, the insurer might deem that you go down a level, where you're doing a similar role but no longer managing a team, and therefore refuse to pay out.
A suited policy is better than one that uses activities of daily living to assess your ability to work, but the type that offers the best protection is an 'own occupation' policy (see below).
'Own occupation' income protection
'Own occupation' income protection policies do what they say on the tin - they pay out if you can't do the job you currently hold at the point of making a claim.
An insurer will not make an assessment that you could take a different, similar job, and therefore refuse to pay, like a 'suited occupation' policy.
This type of income protection provides the highest level of protection should you get ill and be unable to do your job.
What is 'index-linked' income protection?
Inflation is an important thing to consider when taking out an income protection policy.
When you are working, you'd hope that you would be getting an increase in your salary to ensure that your pay keeps up with the rising cost of living.
But if you come to claim on an income protection policy that only pays out a proportion of your salary today and doesn't account for future rises, the amount you receive will be worth less and less over the years.
You have to option to add an 'index-link' to your income protection, meaning it rises with a measure of inflation, such as the consumer prices index (CPI) or the retail prices index (RPI), each year.
This will increase your premiums each year, too. They're usually increased by a little more than inflation.
What is 'stepped benefit' income protection?
When deciding what type of income protection you need, you should always check with your employer to see what sickness benefits they pay.
If, for example, your employer pays you in full for a period, then reduces how much it will pay you, 'stepped' income protection could be useful.
With this, you can choose two different levels of payment, designed to pay out after different time periods.
So, you could get a lower payment while your employer is still paying you a higher percentage of your salary, which then increases if your employer reduces how much it will pay you.
Will income protection affect my state benefits?
The UK's benefits system is designed to support people who cannot work through illness or disability, are looking for work, or have a low income.
And it is changing radically at the moment, as the UK looks to consolidate multiple different benefits into a single system called Universal Credit.
If you have an income protection policy and are looking to claim Universal Credit, this will affect the amount of level of state benefits you'll get. Income protection is treated as 'unearned income'.
This is taken into account when calculating how much Universal Credit payments you receive. For every £1 of income you receive in unearned income, your maximum Universal Credit payment will be reduced by £1.
If you think this might apply to you, read our guide to how Universal Credit is calculated.
What is accident, sickness and unemployment insurance?
Accident, sickness and unemployment policies (ASU) are a cheaper alternative, named because - depending on your choice - you can buy policies to cover you in the event of accident, sickness or unemployment.
Like short-term income protection policies, they'll typically provide cover for around one to two years.
The main difference with ASU policies is they're sold without full medical underwriting - which means you have less certainty that you'll be covered when you put in a claim.
What else does income protection cover?
Income protection policies will come with a whole range of benefits. Not all insurers will offer all of these features, but these are some you may encounter.
Payouts for hospitalisation
Some policies pay you a proportion of your income protection if you go into hospital, even if this is before your deferral period is over.
Waiver of premiums
This means you won't have to pay premiums while your claiming on your income protection policy.
Most income protection policies come with life insurance, usually equivalent to a year or two years' worth of monthly premiums.
Payments when you go back to work
Many income protection policies don't stop paying when you go back to work. If your earnings are reduced because of your illness (perhaps because you are working fewer days), your income protection will continue paying out, albeit at a reduced rate in line with your reduced earnings.
This will end once your earnings recover to the level when you took the policy out.
No deferral period if you get ill again
If you've made a claim once and you get ill or incapacitated again within 12 months, many insurers will waive the deferral period, meaning you don't have to wait to get a payout.
Get expert income protection advice
If you're looking to buy income protection, Which? Insurance Advisers can help you find the right policy for you and your family. Call them today on 0808 2911 960 or fill out the callback for below.