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Income Protection Frequently Asked Questions
Richard Campo from Rose Capital joins us to talk to us about Income Protection.
How does income protection work?
It protects your income. This is the shortest podcast in history!
This is actually the most technical protection policy you can take out, to the extent where the Financial Conduct Authority (FCA) actually requires you to have advice. You can’t organise this yourself and I would certainly recommend you speak to an independent advisor.
I try desperately not to use technical terms but it’s almost impossible in this area. So I’ll break down the key things in how it works.
There’s a period of time where you’ll be signed off work, which is fundamental to how income protection works. Your doctor signs to say you can’t do your job for whatever reason. That starts the clock, but some people want a three, six or 12 month ‘deferred period’ where the policy doesn’t start to pay out. You might have savings or you might have cover from work, as a lot of employers pay sick pay for that length of time.
Then, the policy kicks in and will then pay until either you go back to work, or the policy ends. This is where it starts to get a little bit more complicated because not all policies last until retirement. We’ll get onto that in more detail later.
You’ll receive a set amount each month to replace your income. It’s typically about 50% of your gross salary, for two reasons. The first is that tax doesn’t need to be taken into account; it’s all tax-free. Secondly, a general rule of insurance is that you shouldn’t be in a better position by claiming than not, so there needs to be an incentive to get back to work.
Is income protection worth it? Do I need it? Who should have it?
I truly believe everybody should have some form of income protection. The only exception is if you’ve arranged cover already or if your company provides it for you. A lot of big companies do provide this now which is wonderful.
As mortgage brokers, we focus on mortgages but you need income just to live. No income, no life. Even if you’re at home or you’re renting, if you can’t work, who’s going to pay your rent? This isn’t just for mortgages, it’s for everyone.
The primary focus is around people getting mortgages because you tend to be out on your own at that point and you’re typically a higher earner which puts you outside any state benefit. This is actually the broadest type of cover – is the only type that covers mental health conditions and musculo-skeletal disorders.
I’m a classic example here. I love boxing. I love rugby. There is a very high probability I’m going to screw myself up pretty badly at some point. An analogy I always use, forgive me, is Michael Schumacher. Income protection would have covered him where no other cover would. If you’re very fit and active this cover is ironically good for you because it protects you against all those eventualities.
A side point which isn’t spoken about enough is that the insurer will actively help you recover. They have a vested interest in getting you back to work. If you’re cynical, you’ll think that’s to help them stop paying out. That’s true, but the benefit to you is they’ll give you rehabilitation services, access to GPs and medical treatment and of course money to get you back on your feet. I would certainly want someone like that in my corner rather than nothing at all.
What are the benefits of income protection?
So we’ve covered the main benefit for the policy – to pay a monthly income if you can’t work.
A lot of insurers also include additional benefits to stand out, so you don’t just get a replacement income. You get rehab treatment, access to GP appointments, discounts on certain products and companies. Insurers are always looking to differentiate themselves from another provider and because of that you could save some money.
It’s very helpful to imagine if you don’t have protection. This is an exercise I’ve always done with clients. We look at their bank statement, around the first of the month where your direct debits go out. Imagine you don’t have income protection and your work stops paying you. Your savings are gone. Which one of those direct debits are you going to stop first?
It’s quite a brutal assessment but the reality is you don’t want any of them to stop. They’re there for a reason, aren’t they? No one wants to be in that position. So by taking out the broadest and one of the best types of cover, you keep living your life the way you want to and surely that’s the best thing of all.
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Are there any disadvantages to income protection policies?
There aren’t really any disadvantages, but you do have to be careful because it is very technical. You can overinsure – especially if you have cover through work or sick pay. You might have other benefits as well.
The other possible downside is you don’t get the right advice and it doesn’t actually pay out to the degree you were expecting. But any good adviser will talk you through this and look at what existing cover you have through work or elsewhere.
Is income protection tax deductible?
I don’t give tax advice but I can state facts and there’s some very simple facts around this one. As an individual, no, it’s not tax deductible, but then the benefits are not taxed.
If for whatever reason you want to get £1,000 of cover a month, you will receive £1,000 a month. There’s no tax to take off, so that’s actually really beneficial.
If you run a company, there’s an argument to put it through the business as a tax deductible cost – because most insurances are through a limited company. In that case you need to speak to an accountant because rules change over time. But as we sit here today, generally yes, you can offset that if you go through a company.
What am I not covered for?
The only thing you’re not covered for, to be very blunt, is if you die. That’s why you need life cover and please do listen to our podcast on life cover about why that’s so important.
There’s a common misconception to mention too: this doesn’t cover redundancy. That’s a slightly different type of policy. Income protection covers you if you’re off due to some medical condition where a doctor says you can’t work. It doesn’t cover you if you lose your job or you’re made redundant.
How much income protection do I need and how long does income protection pay out for?
I mentioned bank statements before, and that’s so relevant for this. We typically look through your bank statement and your total outgoings – that’s the level of cover you need. That’s a logical place to start.
There’s no straight answer, it depends because people have very different outgoings. Some people are very modest. Some have very high spending. It just depends on where you are on that curve.
As a general finger in the air, a good place to start is about 50% of your annual salary. Because there’s no tax to pay, that gives you about 75% of your standard earnings which is normally sufficient to cover most people.
In terms of how long it pays, this is where it starts getting a bit complicated. Traditionally, most income protection policies pay up until either the end of the mortgage term or retirement. Normally you pick one of those two things depending on your budget. But to keep costs down, some insurers pay for a limited period of time. It could be short as a year but commonly around two years. If you’re off sick it’s rarely for longer than that.
In terms of how long the policy lasts, you’d usually set it up to the end of your mortgage term as a bare minimum. We would recommend you have it set up to your planned retirement age, because even once your mortgage stops you still have bills to pay, food to buy. Everything costs money, so we would always recommend you go up to retirement.
This is complex so if I’ve confused anyone please talk to one of our advisors. They’ll explain it a lot better than me.
What else do we need to know about income protection?
In terms of the cost, it’s very different for everyone’s personal situation. Your age, your health and the cover amount are all massive factors. But if you budget about 10% of your mortgage payment each month that will give you income protection, life cover and also some critical illness insurance as a package.
If you can’t quite do that then we work backwards and get to a sum that you’re comfortable with. There’s no point putting something in place that you can’t afford or not going to stick with because then you lose the benefits of doing this.
These policies can be complicated but the principle is very simple – if you can’t work, you’re replacing your income. So if you think that’s important, talk to us and we’ll take you through the specifics. It just takes a bit of time and explanation.
Not all policies are equal. We don’t always recommend the cheapest provider – we will choose a provider with a great claims record that offers rehab services and benefits that will make a difference to you. The insurer is fundamentally important. People tend to have quite negative conceptions around insurance, so we need to know that they pay out and look after you. We only deal with providers that are good, and we work to find the most suitable one for you. We’re here to get the best policy for the client at the right cost.