What is Income Protection Insurance?

in this guide

How does income protection insurance work?
What income protection insurance covers
Do you need to have income protection insurance?
How to buy income protection insurance

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Income protection insurance, sometimes called IP cover, pays part of your lost income if you can’t work because of a disability caused by an accident or illness. It can take the financial pressure off and pay the bills for a while so you can focus on getting back onto your feet.

How does income protection insurance work?

Many insurance products like life insurance offer a lump sum payout when you make a successful claim. Income protection, on the other hand, pays a monthly benefit.

When you take out income protection insurance, you can usually select the waiting period, benefit period and the amount of income you want to insure.

Waiting period is the time you have to wait before you’re eligible to claim. You can typically choose between two weeks to two years. Some insurers offer immediate or day-one accident cover, so you won’t have to serve a waiting period, but bear in mind the shorter the waiting period, the more expensive your premiums will be.
Benefit period is how long your insurer will continue to provide your monthly payments. This is often two or five years, but some policies allow payments to continue up to a specific age (for example, 65). Since a lengthier benefit period means more extended protection, it’ll add to the cost of your policy.
Insurable income is the amount of income that could be replaced. The Australian Prudential Regulation Authority (APRA) limits the amount of income you can replace to 90% of your gross income at the time of claim for the first six months, and then 70% of your earnings after that. This means working part-time, taking maternity leave or becoming unemployed in the year before your illness or injury would impact your monthly benefit.

What income protection insurance covers

As a policyholder, you could lodge a claim if:

You’re unable to work due to prolonged illness, severe partial disablement or total disablement; and
You have used up your sick leave; and
You have served the waiting period required on your policy; and
You can prove you’re still unable to work.

Policies are unlikely to cover voluntary resignations, pre-existing conditions, typical pregnancy and redundancy. Different policies might define partial or total disability differently, too: it’s increasingly common for the disability criteria to be linked to being unable to work in any suitable job given your qualifications and experience rather than your regular job.

Other income you receive, like government benefits, could lower the monthly payments you receive from your insurer. There are no restrictions on how you might use these payments.

Policy types

Before APRA’s overhaul of the insurance industry, you could get two policy types:

Indemnity value

Still available today, this type of policy allows you to insure a percentage of your salary up to the limits discussed earlier (90% of your gross income at the time of claim for the first six months, then 70% of your earnings after that). If your income varies, your insured amount will be based on your average annual earnings over an appropriate time period.

Agreed value

Up to March 31, 2020, you could buy a policy where your insured income was a percentage of an agreed amount at the time you signed up for the policy.

Costs

It’s often a good idea to shop around and compare insurance covers because prices vary significantly. In addition to the waiting period, benefit period and insurable amount, your premiums could be affected by your:

Age
Gender
Job
Health, medical history and pre-existing conditions
Lifestyle factors such as whether or not you smoke
Hobbies, including high-risk activities like bungee jumping, water sports, motorsports and skydiving.

Generally, you can pay for income protection insurance with stepped or level premiums.

Stepped premiums are cheaper initially, but they’re recalculated yearly and tend to go up as you get older.
Level premiums are usually more expensive to begin with, but they don’t increase in line with your age, so they may be a cheaper option if you stay with the same provider for the long term.

Do you need to have income protection insurance?

Income protection is about meeting your living costs rather than leaving behind a legacy for loved ones, so it could be relevant regardless of whether you’re providing for a family or living on your own. It’s about whether you can cover the essential expenses in your budget, like rent or mortgage payments, groceries and energy bills without your regular wage.

While some may be able to tap into savings or passive income when they’re unable to work for a prolonged period, many people who need their regular pay to meet their living costs consider income protection to be essential.

Reasons you may need income protection insurance

If you don’t have an emergency fund. You may wish to consider income protection if you can’t fall back on sick leave or annual leave, say, because you’re a small business owner or are self-employed. You may also have a greater need to replace your income if you’re the sole breadwinner in your household or if you have family members relying on the income you earn.
If you have debt. It’s crucial to think about your debts, too, since you’ll still have to make mortgage or car loan repayments even if you’re unable to work.
If you want to expand your cover. Even if workers’ compensation or WorkCover already covers you, remember that this only covers you for work-related incidents. Generally, you’ll not be able to claim for injuries or illnesses unrelated to your work under WorkCover.

How to buy income protection insurance

Generally, you can buy IP cover if you’re an Australian resident between 18 and 63, though the maximum age on some policies is 59.

You may already have income protection through your super fund. It’s a good idea to check because most funds offer default income protection insurance. But you can also buy income protection directly from an insurance company, through an insurance broker or a financial adviser.

Getting IP cover through your super often seems cheaper, but it reduces your super and uses dollars that are taxed at a lower rate. Plus, policies outside of super, or standalone policies, tend to allow a higher amount of cover, shorter waiting periods and more features and benefits. It’s essential to read the product disclosure statement (PDS), so you can evaluate how well cover through super will meet your needs.

Costs vary depending on factors like your age, income, how risky your job is, your medical history and your lifestyle. Policy choices like the waiting period, benefit period, insurable income amount and whether you prefer stepped or level premiums also have an impact.

Generally, premiums for a policy outside your super are tax deductible, but premiums for a cover within your super are not. You’ll need to include any benefit payments received under an income protection policy in your tax return.