What is income protection and do you need it? | Crowe Financial Planning UK Limited

How it works

Income protection will pay a percentage of your income until the shorter of a fixed age, your return to work, or death, or if you are unable to work due to illness or injury.

Typically, this benefit is in the region of 50%-70% of your income, and if it is a personally held policy, this benefit is paid tax-free. If the income protection is a group scheme through work, it is taxed as income but typically paid at a higher percentage of your income because of the tax treatment.

There is normally a deferred period with this type of protection, for example, 12 weeks. This means the policy will not pay a valid claim until after 12 weeks of being unable to work due to illness or injury. You can adapt this deferred period, making it longer or shorter, but this will directly impact the cost of the cover.

There are typically ‘bolted on’ services within income protection, such as mental health support, bereavement support, counselling, and GP appointments available throughout the term of the policy, enhancing the overall support this type of financial protection can provide. These bolt-on services are also often available from day one of the cover.

Mental health claims are also becoming increasingly recognised within these types of policies. This is, however, a new area and when looking at appropriate cover, it is worth understanding that not all protection policies provide equal cover. Understanding the scope of the policy is equally important as identifying your protection needs, as some cheaper policies may not have the scope you believe them to.

Example

John is a desk worker aged 45, who has a fall and starts to suffer from severe back pain and needs to take extended leave from his job. John holds a personal income protection policy as his work policy is to pay statutory sick pay only, with no enhanced offering. After his 12-week deferred period, his income protection policy pays out 55% of his income tax-free, which allows him to cover his bills comfortably.

After a period of 18 months, John is able to restart work but not on a full-time basis, as this will exacerbate the back issues he is experiencing. John can, however, return on a part-time basis, using a standing desk. The income protection will ‘top up’ his income to the figure he was receiving prior to the accident to help a staggered return.

The key point here is that John was able to maintain his quality of life and financial continuity despite injury. The policy is not built to deter him from returning to work but is structured to accommodate a phased return.

Should a further qualifying injury or illness occur, John will be able to claim again on this policy.

Common barriers

Workplace protection

It is commonplace to think you will have sufficient cover through work. Statutory sick pay is £116.75 per week, which is paid for a period of 28 weeks only. Whilst your cover through work may be more than the statutory minimum, unless this lasts until retirement, you are putting your plan at risk.

If you were in John’s position, looking to retire at 65 (20 years’ time), that amounts to 240 months in which he must meet his outgoings and save for his future. Statutory sick pay is unlikely to cover all his essential outgoings, and even if he had more generous cover through work, it is still an extensive timescale that he needs to cover his bills, or a short-term timescale in which he must recover from illness or injury.

Whilst there is a common theme of ‘this will never happen to me’ the chances of a 30 year old man being off work for two months or more is 26% (roughly one in four) and for a woman, 37% (circa one in three) making the probability of this much higher than people realise and there may be a chance what your work place protection falls considerably short. (UK homeowners walking financial high wire without a safety net - Royal London).

It is viewed as inappropriate for your circumstances

You may consider yourself too young or the policy too expensive for your circumstances.

The younger you are, the cheaper the cover is likely to be. Underwriting will be completed, which is the process of assessing your health position, and this turn determines the amount the protection will cost you each month. The older we get, the more likely we are to experience morbidities, which in turn would increase the cost or result in exclusions from the policy.

Being young can therefore be a positive for exploring income protection. If set up correctly, the protection could be structured to either ‘lock in’ the cost at inception for the term of the policy, or inflationary increases can be factored in to help keep pace with income growth.

A further misconception is that income protection is expensive. The cost is linked to the level of cover you need and your health position, but if cost is a deterring factor, premium-driven cover can be quoted for which could result in a proportional level of cover, which may result in lifestyle changes but not long-term financial detriment should a claim arise.

Alternatively, you may have savings which could sustain your lifestyle for a period of time. Depleting these savings could effectively result in a financial reset, and realistically, how long would these sustain your current standard of living?

Summary

The objective of this type of protection is to allow for financial continuity should your earnings stop due to injury or illness. This is a policy that will pay your bills, enable you to continue going on holiday and allow you to continue investing if you suddenly lose your earnings.

Although an additional cost during your wealth accrual phase, when it comes to securing your long-term financial security, can you afford not to have some level of income protection cover in place?