Time to read : 7 Minutes

Most people insure their home and car but don’t take steps to protect one of their most valuable assets: their income.

Income protection may be one potential solution.

What is income protection insurance?

Income protection insurance provides you with regular monthly payments if sickness or injury means you are unable to work.

Does everyone need income protection insurance?

If you have dependants or large debts, such as a mortgage, income protection can ensure bills are covered and food is on the table – even if illness or injury means you are unable to work.

Depending on your income, ongoing living expenses, whether you run your own business, work as a freelancer or casual, or have access to extensive sick leave protection through your employer, the level of income protection you need may vary.

To decide if income protection is worth the investment, understanding how it works can help you make a decision that suits your individual circumstances.

1. Income protection insurance is different to total and permanent disability insurance

With total and permanent disability insurance, you typically get a lump sum payout if you’re permanently unable to work in your occupation (or in any occupation relevant to your education, experience or training), if you lose your ability to physically or cognitively function, or if you suffer permanent loss of sight or limbs. This lump sum can then be used for related costs, such as  modifying your home, or covering the cost of medical procedures and ongoing medical care.

Income protection insurance is different because it provides you with a regular (monthly) income stream. Also – depending on the specific policy – income protection cover is usually limited to up to 75 per cent of your income. Some insurers cover a smaller percentage of your income (up to 70 per cent), depending on the policy.

2. Income protection cover is not one-size-fits-all

To work out how much you need, knowing your numbers is a good starting point. By preparing a realistic budget – including all your regular and occasional outgoings, such as loan repayments, utility costs, transport (don’t forget car registration), food, clothing, insurance (for many people, this means home, car and health) medical expenses, home and garden maintenance and entertainment (include subscriptions to streaming services) – you can assess what you really need to cover and what you could possibly do without. The total in premiums you pay each month/year have a direct correlation to the size of your income protection payout if you do make a claim. So making sure you have the right coverage, without catering for things that aren’t important, could help reduce your  premiums over the long term.

3. Does your coverage enable you to maintain superannuation contributions?

If maintaining ongoing superannuation payments is a vital part of your retirement planning budget, being unable to work could put a serious dent in your super savings. Consider how much you need to top up your super to stay on track, even if you weren’t receiving your regular employment income. By factoring superannuation contributions into your hoped-for payout, you can determine how much the additional cover protections will bump up your income protection premiums, and whether the extra payments required are worth the potential return.

4. You might already be covered

If you have private health insurance, major medical expenses could be covered. Check your health insurer to see what bills may be paid if you are sick or injured – and what won’t be.

And, remember, with around 70 per cent of Australians with superannuation already paying life insurance embedded within their super fund, you may already be covered for a form of trauma insurance or total/permanent disability insurance. So don’t double up on premiums!

There can be advantages to having personal insurance covered within your super, including:

• lower costs, thanks to the better bargaining power super funds have with insurers

• a streamlined process of paying the insurance premium directly from your super account, instead of from your income earnings

• it can be easier for people with pre-existing conditions to get some insurance cover through their super fund, than dealing with insurers direct

• potential tax benefits.

Remember, though, that all benefits within superannuation, including insurance proceeds, come under the strictly enforced guidelines of the Superannuation Industry Supervision legislation that may mean you have to deal with restrictive definitions of medical conditions, such as ‘permanent disability’, that may affect your access to an insurance payout.

Talk to your superannuation fund provider to check the level of cover their policy will pay out if you need it – as well as the reality of accessing a payout you may need. If the cover provided by any insurance that is embedded in your superannuation doesn’t match your financial needs, tailoring income protection insurance that offers a greater level of payout and coverage may be worthwhile.

5. Your income dictates your amount of cover

Income protection insurance is designed to replace a portion of your income. But just how much it pays out is directly related to your annual earnings in the 12 months prior to your claim.

6. Definitions of disability can vary

If you already have income protection insurance, it’s worth reading the product disclosure statement (PDS) carefully to make sure you understand the exclusions. Depending on your insurance provider, your income protection policy may define partial or total disability differently. By understanding your potential protection (or lack of it), you may decide to shop around for a better policy.

7. Understand waiting periods and benefit time frames

Waiting period

This is the period you need to wait before any payments from the policy start. Most income protection policies offer waiting periods of between 14 days to two years. To be eligible, you must have an injury or illness that means you are unable to work for the duration of the waiting period, before you can access payments.

Generally speaking, the longer the waiting period, the cheaper the policy. During that waiting period, you will not be able to access any payments, so think carefully about your fallback position, including savings, emergency funds and any accrued annual or sick leave, to decide how long you can really afford to wait without payments.

If your claim is approved, the first monthly benefit is typically paid 15 days after the waiting period ends. So, if your policy has a 30-day waiting period, you’ll wait 45 days after you first become sick or injured before receiving any benefit. 

Benefit period

The benefit period is the amount of time your monthly payments will last if the impact of your illness or injury leaves you unable to work for a long time.

Most income protection policies offer a benefit period of either two or five years, or up to a specific age (typically 65, but you can pay extra to extend this). The longer the benefit period, the higher the policy premiums. If you can’t work for a long time, though, it may be worth every cent of the extra income protection.

8. Know the definitions around ‘occupation’

Insurance policies for income protection define occupation differently. ‘Own occupation’ means the occupation you have been trained/experienced to work in. So, if you are a pilot and your policy covers your ‘own occupation’, you would be eligible for a payout if your illness or injury prevented you from flying.

‘Any occupation’ refers to any work – not the work you were used to doing. If your policy only covers you for ‘any occupation’, you may find yourself being pushed to work in another industry where your injury or illness wouldn’t preclude you from working, and you won’t receive the benefit payout you were hoping for.

The Bottom Line

Lisa Varker, a life insurance adviser at Compare Club, says the people who can’t afford to ignore income protection insurance include anyone who has “a job that relies on them being in good health to earn an income”.

Income protection is different from life insurance and TPD insurance for a couple of key reasons, she says.

“Income protection is a monthly benefit and is treated as income,” she says.

“It’s taxed and it stops when you return to work. Life and TPD are lump sum payments that are generally not taxed.”

As with any insurance policy, the most important ‘need to know’ is to always read the product disclosure statement (PDS) carefully. Always!

Deciding to take out any insurance policy is about measuring potential risk with the cost of ongoing protection from that risk – and it’s personal.

Income protection can be useful for many people, and a waste of money for others – depending on your age, the nature of your work, the quality of your cover and the ongoing cost of your financial responsibilities.

But by understanding more, and getting advice from a trusted adviser, you can be better informed to make the decision that suits your individual circumstances.

Read more: Insurance providers take the knife to income protection

Financial disclaimer

The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.